Why aren’t risk markets rejoicing at another $1 trillion in liquidity?
Posted on 12 May 2010
While we are waiting for the dust to settle…the stalling of the rally in equities markets, the continued pressure on the euro, and the new highs in gold, all suggest that this bailout package is different from it’s US forebears. Why is my $1 trillion different from yours?
United States of America is a single balance sheet
When the US government stumped up for the debts of AIG, Fannie Mae and anyone else in the TBTF category – the clear message was that the US government would stand behind (important) debts incurred within its borders. The markets accepted the step change in the risk profile of the US markets and bid up risk commensurately (with a little help from cheap money). The limit of this strategy is the credibility of the US government and its capability to repay the aggregated debts.
Europe is a collection of non-recourse loans with a under-capitalised centre
The one big difference is that the Euro is not a single country, federation or commonwealth. It’s the fatal flaw in the Euro (see here for the argument). The limit is not the balance sheet of the theoretical Euro area in aggregate. It’s the balance sheet of the member states individually plus a vaguely defined buffer – the degree to which member states are willing to subsidise one another. In this latest episode, we have seen the outline of the limit. Germany, the creditor-in-waiting, wouldn’t agree to an unlimited liability – a Euro Bond or the ECB buying sovereign debt. Rather the solution is to use an SPV funded for a specific purpose. We can’t blame them – it’s a sensible policy. Just that it illustrates the unassailable problem with the Euro.
Conclusion
The evidence to date suggests that the ‘bailout’ package will not put a rocket under risk markets in the way that earlier quantitative easing did. Rather, with gold higher and the EUR lower, the indications are that market has seen what the euro has under its kilt and is not impressed.
5 responses to Why aren’t risk markets rejoicing at another $1 trillion in liquidity?
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Yep, the bazooka fired and it looked more like a pop-gun.
One wonders where all this will end. What the world will look like in 10 years time. I know you don’t really focus on individual stocks, but I am interested to know your views on equities for the next 5 to 10 years.
It’s not looking pretty is it? I subscribe to the view that we haven’t seen the washout in valuations that is needed to reset the system. So guess that means that in the big picture, I think we are still in a bear market. Having said that sectors run at different paces, so I’m open to opportunities.
Notwithstanding the RSPT, I’m an owner of gold stocks (think we discussed these a very long time ago – still don’t really understand the valuation metrics, but the run on paper money has some ways to go). Not ready to buy industrial metals yet – the conditions suggest they could break either way – if they drop, they’ll drop hard, which will make them more interesting. With risk spreads heading out, I’m punting that cap rates have further to expand, so haven’t dived into property notwithstanding that the sector has recapitalised. In general, it’s about stock selection for me. Still hopeful of eking out double digit gains over the next 5 years – but realistically it’ll be a challenge with the market likely to be flat in real terms.
How about you Justin? Still got my eye on MXUPA, Brookfield is going from strength to strength globally.
I’m teetering with making some wholesale changes to my portfolio.
I’ll be keeping MXUPA though, which I managed to snaffle at $35, but just didn’t have the courage to back my convictions with a significant amount of money.
I’m beginning to think that equites might not be the place to be over the next 5 or so years, so I’m considering further investments in some of the floating rate hybrids. Although the big problem is of course debt, selective corporate credit might do ok. I’m sort of thinking that capital preservation with some return might be the order of the day.
I’ve sent you an email with a couple of attachments – it comes from a young hedge fund manager in Texas who keeps a blog which I have been following for a few years. he makes a couple of interesting points about the rise and rise of systemic risk, which now dominates all other sources of risk (and one which we clearly aren’t demanding the correct premium for).
I think a difference is this Euro Bazooka is not entirely quantitative easing and it does not solve the problem of too much debt/GDP in the PIIGS. The bailout merely helps the french bankers get their money back.
What I’m looking at more is the Fed swap lines and the EuroCB’s quantitative easing. That will be printed money and ‘stimulative’
The other side of this coin is the austerity measures required for IMF participation will be draconian. How Angela Merkel will survive this is beyond me.
I’m long US bonds but beginning to wonder if BOTH Gold and UST’s may actually work out for the near future. ??? Whoever would have predicted that?
Read my most recent blog entry about china housing prices falling like a rock. The Chinese are tightening and they get what they want but they might not like the results. . . .
These austerity measures…the IMF plumps down cash to bail out the bankers (in Latvia it was Swedish banks, in Greece it’s the French etc), then says to the debtor ‘now crush your economy and drive unemployment to depression era levels’…is the intention to nurture regional conflict? And all the while, the Fed goes on buying any smelly piece of paper, and the administration issues some more Treasuries to bail out another industry, as if the US is immune to the very same forces.
Caught your blog (via my RSS feed) on China Greg. I’m wondering whether the fall of the House of Europe will bring China back to earth, that is, in the absence of another $500bn in new construction – which, based on the form guide, is the most likely outcome.