Events this spring have increasingly revealed that the global recovery is extremely fragile and deflationary forces are still gathering strength. We continue to be locked in the downward phase of the long-term inflationary roller coaster that began decades ago.
The four year pattern of repeated eurozone crises, punctuated with half-baked attempts at resolution and fudges when compromise is not attainable, is moving to decision time again.
Dramatic key developments over the past few weeks highlight just how critical the current environment is for investors. To be sure, this is a fast moving game and opinions and assumptions have to be challenged on a daily basis, hardly a great environment for investors when risks are large, but not measurable, and policymakers appear frozen.
There are signs of growing stress and tension in global economies, the financial system and societies, which are creating many confusing cross currents in financial markets. This is reinforcing the enormous uncertainty over the trend of asset prices and evaluation of risk.
Ongoing recapitalization of the eurozone financial system and the likelihood of a soft landing in China have reduced two of the key risks facing investors. These positive developments, combined with the continuing U.S. recovery, have paved the way for a 20%-30% rally in global markets since last fall.
Markets had been increasingly factoring in a “successful” new Greek bailout package, but only after it was accomplished could definitive conclusions be drawn. The threat of another 1929-32 and 2008-09 financial meltdown and an out-of-control crash has been removed.
This week’s Barrons headline may be saying it all, demonstrating how bullish sentiment has become following the rise of almost 23% in U.S. stocks since October. Once again the bearish consensus of last summer and early fall has been caught offside by the stock market.
In the current environment, it is difficult to assess fair value for financial assets, due to several extraordinary factors. The macro environment is unsettled and the risk of a severe financial shock due to a disorderly eurozone breakup is quite real, as discussed below. Massive government intervention in bond markets has distorted yields.
The old saying “Watch what they do, not what they say”, has never been more true than with recent ECB (European Central Bank) actions. As we have said for some time, the main central banks of the world are the only game in town now that the sovereign debt crises—actual or potential—have taken governments out of the play.