Financial markets and natural selection?

More Neil Staines, 9 hours ago16 December 2011

“Ignorance more frequently begets confidence than does knowledge”
– Charles Darwin 

Equity markets are looking a touch more resilient this morning as Asian indices followed New York higher and as a result broader risk correlated assets (such as Gold, AUD, Italian bonds,…) have had a brief bounce. In part this is driven by a certain amount of year-end apathy as momentum fades and short-term positions are kept, by definition, short term and squared out. 

US, EU growth differential
The current ‘risk’ dynamic is worthy of a mention at this point, particularly in light of the US macroeconomic backdrop. Yesterday saw further evidence of the improvement in the US data as weekly (new) jobless claims fell to their lowest level in three and a half years at 366k. In addition to this a survey of New York manufacturing activity rose sharply to its highest level since May (a performance mirrored by a comparable Philadelphia index). This improvement in economic activity ‘should’ be positive for equities, particularly in light of the Federal Reserve's commitment to keep rates at effectively zero for another 18 months at least, however, just as expectations for the growth trajectory of the US (at least in the near term) are rising, forecasts for the Eurozone and conditions in bank liquidity conditions are deteriorating.  Whilst this is the case, corporates in the US (and similarly in the UK) will not be motivated to spend their very significant cash piles on investments for the future. Likewise investors may well be forego equities when the risk of a negative event emanating from the Eurozone remains high.

Dissent from the East
The Eurozone’s planned treaty change came under further pressure from the peripheral Eastern European states yesterday as the Czech Republic and Hungary suggested that they would not be party to a tighter European Agreement if it compromises their fiscal independence. Meanwhile the eerie silence surrounding the detail of the proposed treaty change continues, the European Central Bank continue to purchase Italian and (to a lesser degree of late Spanish) debt in the secondary market and the ECB’s vast liquidity measures have singularly failed to prevent the region's banks from simply placing any spare cash on deposit at the ECB instead of putting the money to work in the real economy. This morning I have heard the ECB’s liquidity measures in the Eurozone described as equivalent to turning the taps on full blast to fill up a bath with a hole in it – rather than fixing the hole! 

The broad news developments have also been broadly more supportive of the USD over the EUR overnight with news from the US that congressional leaders have reached an agreement to avoid government shutdown as leaders from both parties signed up to a USD1 trillion spending bill to fund governments for the first nine months of 2012.  Meanwhile in Europe, the FT reports that the European Financial Stability Facility draft prospectus will contain warnings regarding a Eurozone break-up (not likely to instil confidence!)

Wise men?
Confidence will continue to be the dominant factor in financial markets as we move towards the final (full) week of the year, in particular the confidence vote of Mario Monti’s EUR30 billion emergency budget in the Italian parliament today will likely raise a few eyebrows but is unlikely to come up against any significant opposition given the severity of the task at hand and the de-politicisation of the budgetary responsibilities. Whilst I must admit I have not been following the frankincense and myrrh prices too closely of late, I would suggest that the gold price will be a very strong barometer of position unwinding and broad risk sentiment in the last few days of 2011 – confounding the historic correlations however I feel that any periods of fear and concern will see gold lower (on position unwinding) and not as long term correlation would suggest higher (on a safe haven bid).

“Power without a nations confidence is nothing” – Catherine II

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