It all seemed so different a few weeks ago, with the latest Greek bailout package agreed only on July 21st and the US stepping back from the brink of worsening a self-inflicted injury over the debt ceiling.
The reverse, obviously, has been the case.
Recent US economic data has been weak (tonight's non farm payroll numbers will be critical), thereby either extending the life of the so-called economic "soft patch", or making a double dip recession in 2012 more likely, depending on your point of view. The Purchasing manager's Index (PMI) data last month, on a global basis, also looked pretty lacklustre, with a marked slowing in the Eurozone - even in previous powerhouses like Germany - and China.
Concerns about the spreading of the Eurozone debt crisis to envelop Spain and Italy have charged to the fore, thereby severely testing the political will and financial resources of those in the Eurozone tasked with holding a series of ever retreating front lines.
What is clear is that the ability of central banks and governments to step into the breach is much more limited than in 2008/9 at the time of the Lehmans melt-down.
The political focus on debt reduction and austerity spending cuts in the developed world now limits governments' ability to further offset any continuing weakness consumption spending and in the private sector. Similarly, with banks remaining politically toxic, the possibility of further bailouts looks remote in anything other than the most extreme cases.
As Gillian Tett points out in today's FT, the parallels with 2008 look uncanny: starting with pronouncements that the problems in Greece (for which read "Sub-Prime" in 2008) were not sufficiently large to put the system as a whole at risk etc.
The behaviour of markets yesterday suggest that many market participants are choosing to shoot first and ask questions later.
Since July 22nd, the day after the latest Greek bailout, the MSCI World equity index has fallen by 10.3%, putting it in official "correction" territory. The dollar has recovered some ground and gold has risen to new highs.
So - what's our view?
(1) We have long held that the second half will see a recovery from the "soft patch". This is starting to look optimistic, but won't be proven for another month or two. The problem, of course, is that by the time the data comes through, markets will already have discounted either the good or bad news: the current market rout has been concentrated in the last 6 trading days. Tactical market calls are therefore reduced to guesswork.
(2) Europe's problems are reaching an end game since Spain and Italy are simply too large to bail out (see the chart below from JP Morgan). Weaker members will have to be allowed to default since the levels of debt in Greece, Ireland and possibly Portugal are simply too large relative to the size of their economies. Some recapitalisation of Europe's banks seem likely in that scenario (hence the severe weakness in their share prices over the last month).
(3) Global interest rates will remain close to zero, despite inflationary pressures (which we do expect will ease in the second half).
(4) Corporate earnings growth, so far, has been very healthy. Although this maybe of only academic interest if the banks start teetering again, an interesting piece from JP Morgan last week reiterated that their forecast of a 9% jump in the US market by the end of the year was at the low end of market forecasts (as at the beginning of May). With the falls of the last three days taken into account, that would seemingly now translate to forecasting a 15% rise from their current - more depressed - levels.
So - sell, buy, or sit tight?
Aside from the back end of 2008, the best tactic in recent bouts of market volatility has been to ride it out. The question, therefore, is whether or not we are facing another "back end of 2008 scenario" over Europe. Debt and democratic dysfunction in the US will not help.
We hope not, but there is no doubt that we're in for a difficult month, since nothing short of an implosion will be enough to encourage European leaders to cut short their trip to the beaches, thereby prolonging the vacuum of leadership. As we saw in 2008, what seems limited in scope and short in duration can be driven by markets to a much more painful reality.
Even if leaders do come back from holiday, their recent attempts at structuring rescue packages have consistently fallen short of the "big deals" the markets now seem to feel is needed in an environment when global growth is sluggish.
Crafting long term investment views in this type of environment is either difficult, or somewhat pointless.
What is obvious, though, is that downside risks have grown over the last few weeks and that these now look larger the upside potential. In that environment, sitting on cash or very well diversified portfolios seems both prudent and appropriate. Not time to be brave yet.
Yippee. Deja vu all over again.
Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186
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