A New Hope

Moreover, significant uncertainty still surrounds the outlook for US fiscal policy, where recent payroll tax cut and employment benefit initiatives still have to be extended for the rest of the year. On top of that, a very substantial amount of fiscal tightening is in the offing for early next year unless additional changes are made to fiscal policy before the end of 2012. Meanwhile, weakness in the Chinese real estate market and rising geopolitical tension over the Iranian nuclear program are keeping the risks alive on new shocks to a still imbalanced global economy.

At the same time it should be acknowledged that some rays of light have been breaking through the clouds over the last two months. Market sentiment has improved and tension in European peripheral treasury markets has eased substantially. Two key factors seem to be driving these dynamics: a significant reduction in the risk of a near-term self-fulfilling liquidity crisis in Europe and tentative signs that the global business cycle has moved from a soft patch to a recovery phase.

Investor concern over a possible funding squeeze for European governments and banks in the first quarter of 2012 has eased on the back of the 3-year liquidity provision by the ECB that was initiated late last year and will enter into a second round by the end of this month. Not only has this enabled banks to fund themselves, it has also created the opportunity to employ some of the supplied liquidity for playing the “carry game” in peripheral treasury markets. Arguably most surprising of the whole operation has been the extent to which this has created downward pressure on bond yields in Italy, Spain and Ireland in recent weeks. In the background it might also have helped that also other central banks have shown renewed willingness to open the liquidity tap as the Fed and the Bank of England have clearly hinted at more QE to come recently and the Chinese central bank announced to look for ways to increase credit provision to first-time home buyers.

Next to this it has been crucially important that the growth perspectives have improved. One could even argue that tentative signs have become visible that the “excess saving” players in the global economy have finally begun to contribute a global rebalancing act as Germany and many emerging market economies have shown remarkable consumer demand resilience in recent months. Also important in this respect is the increased willingness by the corporate sector, especially in the US, to hire and invest more. The latter has been most notably reflected in the recent strengthening of the US labour market recovery.

Combined these macroeconomic dynamics have resulted surprisingly broad-based improvement in global purchasing manager indices over the last two months. The improvement was visible across sectors (manufacturing and services) and regions (even in the Eurozone), thereby increasing confidence for a more sustainable upturn. A less negative growth outlook not only improves the income prospects for companies, households and governments, but also makes debt burdens more manageable.

So even with investor eyes firmly focussed on a still clouded horizon, it is understandable that a new hope has cautiously started to build in investor’s minds. A new hope that our fragile economic system is not necessarily only surrounded with downside risks and the rays of light that have occasionally started to warm our faces should remind us that uncertain times also create market opportunities. Exploiting these opportunities should always be done in a balanced fashion, but for us the balance of risks has now clearly shifted in favour of equities (compared to other asset classes) for the first time since early April last year. Let’s hope the sunny side of market expectations can stay with us longer than many thought was possible at the start of the year!