Email of the day (1)
Comment of the Day

April 19 2012

Commentary by David Fuller

Email of the day (1)

On the market outlook:
"Hope you are well.

"As I understand it, your view is that notwithstanding short term overbought conditions and a corrective phase having already started, the main risk for the cyclical bull market in risk assets is the oil price (and commodity price inflation in general)?

"Listening to your audio yesterday, where do you forecast this European saga will end? Draghi has arranged for the ECB to lend 1 trillion dollars at very low rates to Spanish and Italian banks on the basis that the banks would buy the respective government bonds at 3-4% - doesn't the recent spike in yields demonstrate that this wasn't necessarily a good idea?

"Furthermore, what is the endgame from all the stimulus from the FED and the ECB - does it need to continue in your view until fiscal union in the Eurozone is achieved, and the US economy finds other ways to improve growth (e.g shale gas which you often allude to?) I believe that liquidity is an essential factor to take into consideration along with valuations/dividend yield and sentiment in making an assessment of investing in equities - and there are some good dividend yields on offer and agree that this remains an attractive area to invest in the medium term particularly where autonomies are concerned. I am concerned however, that one day the stimulus will simply stop having an impact on broad equity markets. In reality, is all the stimulus really impacting the broad economy or has it been simply been impacting asset prices?"

David Fuller's view I am fine and thanks for some very important questions which concern most of us.

Yes, I do maintain that high energy prices and commodity inflation in general are the main known threats to the global economy and therefore most so-called risk assets. This is why I refer to oil prices so often, including yesterday. The Eurozone's problems are hugely important, not least for Europeans, but to put this in perspective and as Jim O'Neill likes to say, China produces the economic equivalent of a new Greece every week and a new Spain approximately every five weeks.

How the European sovereign debt saga ends will be determined by Europeans. Assuming they wish to maintain the Eurozone, which I have always described as a political construct, Mario Draghi had no choice but to make the ECB the lender of last resort, in my opinion. It is way too soon to judge the outcome but problems which were a decade in the making are certainly not going to be resolved quickly. Meanwhile, yields will fluctuate.

My guess is that stimulus from the FED and the ECB will be reduced on signs of self-sustaining GDP growth, which the US is likely to achieve well before the Eurozone, Germany excepted. The objective, which the BoE and now the BoJ have also taken up is to prevent or breakout of a deflationary slough. In other words, they are erring on the side of inflation, as I have said all along. If Europeans maintain their determination to preserve the euro with its current members, the sooner the Eurozone achieves fiscal union the less daunting this task becomes. Nevertheless, this will most likely take years, if democracy is to retain a say, because individual countries will wish to hold referendums on fiscal union. And some countries may vote to leave the euro, with Greece most likely heading that list of candidates.

Arguably, the stimulus has helped some of the favoured markets more than the underlying economies, although this is hard to quantify because we cannot be certain as to what would have happened without the stimulus. Meanwhile, the crucial challenge going forward is to restore GDP growth because that is by far the best way to cope with debt. Without GDP growth the risk of a destructive deflation intensifies, followed by hyperinflation as monetary authorities print ever faster. We have seen this throughout history, and most recently in Zimbabwe.

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