It's all about growth

The typical Euroland obfuscation drags on towards an inevitable Greek default, plus an enlarged bail-out fund, plus a further step towards a debt and fiscal union. Eventually a deal will be done, although whether this gets done in a rapid enough time frame to please the markets, remains to be seen. If so, we'll get a continuation of the relief rally that we saw in Europe and the US last night.

However, the bigger issue remains one of global growth.

Whilst a Euroland bailout will help to head off a deeper debt-driven depression, it also means that European governments will be focused on debt and deficit reduction for the foreseeable future. The grudging support of the Germans will require nothing less. Given the size of the public sector as a proportion of GDP in places like Italy, France & Spain, it is difficult to see a major contraction in such spending (often euphemistically referred to as "investment") not resulting in renewed and possibly prolonged recession.

The same is true in the US, where petty politicking has reached further into the reputational sub-basement. The White House has clearly given up trying to achieve an element of compromise in the face of Congressional leaders' opposition to even considering increases in taxes as part of any "grand bargain". Voters will be left to decide on the merits in 14 months, although it remains to be seen whether or not the new Congress that results will give either side the majority it wants to push through their favoured proposals.

As a consequence, we will be stuck in a short term cycle for some time, in which the focus is on monthly data which purport to show the onset of recession or otherwise. That means the US employment data on the first Friday of every month will assume totemic importance, as will the monthly global purchasing managers' index data which is released around the same time.

As if we needed more, it seems as though volatility will be with us for a while.

For example, it is notable that this month in USD terms, non-Japan Asia has been the worst regional performer, with the AAXJ index in USD's down by 16.9%, compared with a drop of 'only' 12.9% in the MSCI Europe index. One would be hard pressed to explain the logic for this given that it's Europe with the major debt and banking crisis, not Asia/EM.

Nevertheless, this highlights that the high beta Asian and EM markets remain very vulnerable to sentiment driven flights from risk, partly because of leverage being unwound (lots of investors had bet on further structural weakness in the USD and shorted it accordingly by buying Asian shares in local currency), partly because of fears that the Asia/EM exposure to a slowdown in trade would result in any Europe/US recession arriving almost as quickly in those economies (just look at the gyrations in Korea this month), and partly because in any crisis foreign investors simply take their money back home dumping anything foreign.

Obviously, the flipside is that these same markets have strong recovery potential as and when volatility eases. In 2008 AAXJ dropped by 52.2% in USD terms. In 2009, they jumped by 72.5%.

On present global market form, however, that jump could be some way off.

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186

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