Posted by: Matthias Paul Kuhlmey
Instead of “we told you so,” let us take the high road and begin this blog with “here we (I) go again” (for the music lover, this would be Whitesnake, 1987). Mr. Ben Bernanke, aka Dr. Twist (from now on), is “in it” deep. Ben, it is time to stop the “flip flopping” – either the economy is recovering, or not, and needs financial stimulus, or not. The same request needs to go out to our somewhat spoiled investment community: Market direction cannot indefinitely be determined by simple expansion of a Central Bank’s balance sheet (here, the FED), or the prospect thereof. At the end of the day, a buyer of an asset should be driven by the notion that he or she is paying less than the real or inherent value of that asset; this, most certainly, has not been the case since the onset of the big reflation trade in March 2009.
To be clear (apologies if somewhat repetitive): Most developed economies are exposed to the aftermath of a balance sheet recession, not a regular recession; with this in mind, all good effort put forth by the FED cannot heal the issue. Market participants are attempting to reduce debt and are not necessarily tempted by lower rates to “lever-up” further. With U.S. 10-y rates already at 1.60 levels, one may ask how low rates need to go (from the FED’s perspective), and what yesterday’s ill-guided Operation Twist is really all about. In case you missed it, Dr. Twist announced that the FED is extending a 2011 policy of selling shorter-dated Treasuries, with proceeds being used for the purchase of longer-dated paper in the amount of $276 million, thus potentially lowering rates on the long-end of the curve.
The main issue remaining is that there is too much debt in the global system; this is what is haunting Europe today. In Monday’s radio interview, we took the position that it is not about Greece any longer (already priced-in to equity and currency markets) – it is about Spain and Italy. According to David Rosenberg, the “average Eurozone country has a median 500% total Debt/GDP ratio across the household, business and corporate sectors,” and “Italy’s sovereign gross financing-needs this year come to 29% of GDP” – unsustainable! Therefore, our global financial system will require a reset, most likely politically motivated, with the “wave being initiated’ in Europe (don’t be fooled, this is also a U.S. issue, but potentially less so and later).
Expect volatility to remain high. The strategic, long-term investor needs to consider selective buying into this weakness; the biggest risk in the years to come is loss of real purchasing power. Cash and bond holdings will not “do the trick” to prevent it from happening.
P.S. one important addition: For Germany, it is all about Greece. Tune in to watch the EURO 2012 soccer match between Germany and Greece on Friday, June 22, 2012. Even German Chancellor, Angela Merkel, is preparing for a trip to be watching the game live and in color. Bravo!