Clouds gather again as the sunny start to 2012 fades

Fri Apr 20, 2012

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It is difficult to see how economics and markets can be detached again from politics in a year when there are so many political events, elections and transitions

By Nick Evans

Well that didn’t last long. After an unexpectedly sunny and bright start to the year, markets have turned cloudy and stormy again in the last few weeks. Far from looking like a possible repeat of 2009, 2012 now looks a good deal more likely to be like 2011 all over again.

Normal service has been resumed in the eurozone, with Spain’s mounting financial and financing difficulties putting a dampener on the earlier euphoria that had been triggered by the the ECB’s LTRO operation at the end of last year.

Just as the Fed, the Bank of England, the Bank of Japan and other major central banks have been doing, the ECB scheme – a wily way to introduce QE in Europe without enraging the inflation-phobic German public or provoking the outright opposition of the Bundesbank – was aimed at flooding the markets with liquidity.

It seemed to work, for a while – at least in terms of propping up the continent’s insolvent banks and giving investors and market participants some degree of comfort that the financial system in Europe was not about to collapse.

But, like most of the developed world with the possible exception of the US, it does not appear to be working in terms of fuelling any kind of durable economic recovery or genuine return of business confidence.

And it is certainly not working – and is unlikely to do so for a long while yet – in terms of tackling the devastating levels of sovereign and financial sector debt that remain the prime danger in the eurozone, just as they are in the US, Japan and the UK.

So the quandary remains. Do policy-makers in the major developed economies continue to operate for the foreseeable future a life support mechanism of what some have termed ‘perma-QE’ – rewarding debtors, punishing savers and creating an artificial economic environment in the hope that the day of reckoning can be postponed indefinitely?

Or do they switch off the machine, allow the economic and business cycle to run its natural course and – in all probability – trigger a tidal wave of deleveraging about which they are happy to talk and theorise, but at whose likely severity and scale they can only guess?

Not an easy call – and certainly not one that anyone looking to get re-elected is likely to want to make. And it is thus difficult to see how economics and markets can be detached again from politics anytime soon, especially in a year when there are so many major political events, elections and transitions looming (in France, in the US and even in China).

So where does that leave hedge fund managers and investors? In a quandary too – anxious not to miss out on any rallies (even if they may be bear ones) and outbreaks of optimism, but equally anxious to protect against (or profit from) any major downward moves and tail risk events.

Throw in rising oil and energy prices, geo-political instability in the Middle East, uncertainty over soft or hard landings in China and the likelihood of a very different economic and fiscal picture in the US once the interminable election is over – and it is hard to see why markets in 2012 should be any less macro-obsessed or politics-driven than they were in 2011.

About the only two certainties in the current climate are 1) there will be more regulation – most of it ill-conceived, wrongly motivated, unnecessary, onerous, overly complex (even to its own creators), self-contradictory and counter-productive; and 2) there will be more taxes – most of them ill-conceived, wrongly motivated, unnecessary, onerous, overly complex etc.

And the over-riding worry is, of course, inflation – which the policy-makers seem to believe they can control, but which (if history is any guide) is more likely to be out of control long before they are prepared to admit it and long after they are able to do anything about it.

All in all, it is an interesting backdrop for our annual EuroHedge Summit on 24-26 April – where the industry’s leaders will gather once again to discuss the key issues, risks and opportunities facing hedge funds under the title of ‘Strategies for a Challenging World’.

The challenges are certainly there – and it will be revealing to hear what strategies the assembled managers, investors and counterparties have for dealing with them. So let us hope that, despite all the gathering clouds, the sun shines on Paris in the spring. And let us also hope, given this column’s usually unerring gift for getting things wrong, that this rather gloomy offering is a sure harbinger of bright times ahead.

ISSN: 2151-1845 / CDC10004H

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