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Boeckh Investment Letter

Investment and economic commentary by J.Anthony Boeckh and Robert Boeckh

Quarterly Asset Allocation: December 2012

Macro Themes

1.   Tail risks are receding:  the eurozone is holding together, Greece recently got an S&P upgrade, China has executed a soft landing and the U.S., despite its dysfunctional politics, has a number of things working in its favor. 

2.   Global growth will remain weak: leading indicators are not providing any evidence of an imminent return to trend growth rates in emerging or developed nations. 

3.   Central banks will likely step up the flood of liquidity and low interest rates will remain in place, as key central banks are set to drop inflation targets in favor of nominal GDP and labor market outcomes. 

4.   While excess capacity and labor market slack imply that the short-term inflation outlook is benign, shifting central bank policy and stepped-up government intervention may result in a pickup in inflationary expectations in the coming year.

Eurozone

Eight months ago, we thought that there was a good chance that Greece would leave the eurozone. We, among many others, underestimated the willingness of core eurozone members to enter a transfer union—albeit reluctantly and with baby steps.Germany has been the key player and now seems to have recognized it is in so deep that it is cheaper to keep the eurozone intact than let it fall apart. A carefully balanced game of brinkmanship was necessary to secure domestic political support, while simultaneously pushing painful fiscal reforms through the fractured political systems of the laggard peripheral nations. It has not been pretty, but success has been achieved on both fronts. Christian Democratic Union leader, Angela Merkel, has secured the ongoing support of her party and the PIIGS have swallowed bitter medicine. More importantly, we have seen evidence of a willingness to make the sorts of compromises that will be needed to patch the eurozone together. Eurozone finance ministers recently approved a €43.7bn bailout for Greece (€16bn of which is earmarked for the four largest Greek banks) as well as a €39.5bn bailout for Spain’s four nationalized banks. The bottom line is that bailout funds are flowing and both Greece and Spain have secured enough funding to stave off bankruptcy through 2013.

Economic conditions remain tough. The banking system is fragile and the full extent of bad loans, particularly in Spain, have not yet been realized. Private sector debt levels remain too high, and given anemic growth, deleveraging of the aggregate economy is nearly impossible: debt is merely being shoveled from the private to the public sector. Manufacturing production expectations are abysmal (Chart 1), unemployment continues to creep upward in Spain, Italy and France (among others) (Chart 2), and consumer confidence is nearly approaching the lows of the 2009 crisis (Chart 3).

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