The start of this year looks very different to 2011 and 2010 even though the themes and stress points remain the same: Risk is cheaper, non government net issuance is negative, investor allocation to financials and growth related assets is low, another upturn in the global liquidity cycle is starting and Euro break up fears recently hit new highs, according to Graham Neilson, chief investment strategist, Cairn Capital…
Cairn has been taking a more positive tactical slant against a structurally bearish economic and deleveraging backdrop. A number of key catalysts for being more tactically positive fell into place during Q4 2011. I still believe that an investment approach centred on trading broad ranges and buying favoured assets during stress points and big allocations swings makes sense.
Deleveraging pressure across major developed economies, particularly in Europe still implies that developed economic growth paths will stay on a slower and lower plane, with macro cycles and volatility pockets more frequent and quantitative easing the preferred, and indeed only, developed economy policy option. This structural backdrop has been the same for nearly three years.
I have been less negative on US and emerging market growth and expect US growth to beat Eurozone growth this year and next. That a gradual US economic improvement and Eurozone recession has become the consensus 2012 view is a mild positive, even though Eurozone growth is still likely to disappoint that sharply revised consensus view. The US economy will face severe fiscal headwinds in 2012 and 2013; however, prospects for corporate spending and net exports look encouraging with consumer sector growth staying low and slow but becoming less vulnerable over time. Emerging markets with established and functioning banking systems, low levels of public debt and limited domestic leverage overhang should be looking forward to looser monetary policy and improved growth prospects into 2012. Emerging markets were a growth and liquidity drag for much of 2011 but are likely to be a more positive factor in 2012.
I am still a strong believer in systemic hedges and shorts around the Euro sovereign and growth themes, given the persistence of the well documented “fat tail” of the current Eurozone crisis. The quest for EU fiscal union is missing a key structural point and is only addressing the effects of the Eurozone crisis and not its causes. The Eurozone will remain a source of economic and market angst with the necessary release valve of the Euro weakening, although it is likely to squeeze higher in the near term. Quantitative easing is an overestimated growth tool, particularly in Europe and exit conversations by certain member states will re-emerge.
The persistent structural debt overhang and related economic squeeze in Europe continues to drive my dislike for peripheral corporate and financial risk, with negative implications for core government bond spreads. These hedges/shorts associated with peripheral and core sovereign spreads should become attractive again as the early year liquidity driven “sugar rush” squeezes out existing shorts. As the credit markets approach the tight end of spread ranges, safe haven government bonds correct more dramatically and/or risk markets more generally discount a Eurozone liquidity driven relief scenario too far, I will become more cautious once again.