Weekend Update

A huge “newsy” week last week helped throw global markets into a serious tailspin. The two biggest are questions re what the ECB can do re Italy and the debt ceiling and downgrade kerfuffle for the US. The latter in fact exacerbates the problems of the former since it throws a risk premia spotlight on France and UK (the two weakest remaining AAA sovereign).

Links:
Impact of the Downgrade — Dead on analysis. The downgrade will exacerbate political schisms in the US as both sides will choose to blame the other (or shoot the S&P messenger) instead of dealing with the problem. The downgrade has more impact on European/global financials than it does on US financials because of the dollar’s reserve status. Trade ideas (assuming no major coordinated PR/actual move by ECB/G7): Long safe havens (Gold, CHF, global big-caps with rock-solid balance sheets and dividends) — this current decline is the last decline for awhile where the dollar will be a safe haven compared to most – you do not want to be in dollars when it ends; long Treasuries (shorter-term) and Euro-periphery debt (on yield spikes). Short euro, short “infrastructure”/commodities (coal, steel, shipping, copper, A$), short bunds, short financials.

Case for Going Global – Stronger than Ever Another dead on (longer term) analysis with a couple aha’s! for me. G7 govt bonds are pricing in slow/no growth; “emerging” govt bonds are pricing in 6-9% growth. ie – G7 is expensive, EM is cheap — on pure yield/price. EM’s have 2x more foreign exchange reserves than the entire G7 combined – and far lower govt debt. EM’s are undercapitalized (aha! – inflation there is more a consequence of “hot money” inflows relative to a small existing capital stock – iow – their inflationary pressures will drop as their GDP grows). G7 countries are all in for decades of deflationary pressure and capital exodus. EM equity markets still have lower PE’s – so they are pricing in slow growth. Trade flows are increasingly among EM’s themselves – and that will accelerate. Big disconnect/opportunity. Volatility is here to stay – because capital productivity increases (which precede GDP increases) in EM’s won’t be smooth and because G7 relative decline will also be herky-jerky. Trades: Long EM bonds, short G7 bonds. Long capital surplus countries (mostly Asia). Long commodities. Long EM equities – esp mass consumer and infrastructure – not traditional exporters. Long/watch solid financials focused on allocating capital to EM’s — ie with no legacy balance sheet in G7.

That latter link is intermediate-term. Shorter-term, the trade is still risk-off – and for EM’s that can mean “hot money inflows” turn on a dime into “hot money outflows”. But these are the opportunities to buy the dip.

My own thoughts. Any conflict between “hyperinflationists” and “deflationists” is over for awhile. The hyperinflation scenario is dead. Deflationists have won. Non-G7 will be dealing with inflationary surges – but those pressures will diminish over time. G-7 is solidly in deflation — until such time as existing debt is repudiated. Which is emphatically NOT happening any time soon. Yes – prices of non-asset “stuff” will increase in G7 and squeeze the snot out of consumers (esp the poor and the middle class and the young). But that is NOT hyperinflation or money printing.

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