Granite Hills Investments - Weekly Market Overview 07 February 2012

[GraniteHillsInvestments]

The world remains a confusing place!
Over the past week there has been a mix of both positive and negative news. The US economy is showing signs stabilization as unemployment data has turned more positive. On the negative side geo-political tensions are growing and the threats from global disunity are growing. This can clearly be seen by the veto in UN by Russia and China over the situation in Syria.

While, the US economy does appear to be performing somewhat better, there are still many questions regarding the sustainability of the current growth indicators and levels. Currently all the hopes regarding the economic success of the US are being pinned on the unemployment rate. While it has fallen somewhat over the past number of months it does remain at high levels. A number of analysts also point to the fact that many Americans have given up their search for finding a job and have decided to leave the unemployment count. This certainly does help the statistics but it is not positive for the country as a whole. Also it should be mentioned that the winter so far has been relatively mild which has kept construction lay-offs due to seasonal factors at a lower rate.

Given that the US economy is very reliant on the consumer it is not great news that consumer confidence remains at relatively low levels. The low level of consumer confidence is evidence that the American public are not buying into the moderately falling unemployment rates. The US consumer is still battling with high debt levels, job insecurity and general insecurity as to where the US economy is going in the longer term. Hence consumer confidence remains weak.

The two shorter term economic indicators mentioned above point to a rather mixed picture for the US economy. The swings in the data releases are the reason as to why markets are having difficulty finding longer term trends. The more positive releases particularly with unemployment are the reason for the rather positive equity markets so far in 2012. However, what does remain very interesting is the fact that government yields have not increased with the improving equity markets. This is most likely the case because investors do not trust the short term data and market action and still very much believe that the US FED will be forced into further programs of QE.

The long term outlook for the US economy is negative the short term remains more mixed. The start to 2012 has been quite positive. This though has more to do with the fact that the US has so far successfully managed to keep attention away from its problems and focused more on global issues. This tactic will not work forever and at some stage the US will be forced (most likely by financial markets) to address its domestic problems. The question as always is timing which is all but impossible to predict!

The rise of geo-politics is not a surprise. As the world and particularly the Western World remains deeply affected by a financial crisis it is typical for the blame game to start. As is evidenced throughout history geo-politics typically plays itself initially on a stage away from the major players. This is becoming evident yet again. The Middle East is playing the central role currently for the geo-political theatre. As witnessed at last weekend’s UN Security Council meeting over the Syrian situation there are three main protagonists in the ring The West (generally represented by the US), Russia and China. Each player is playing to their own domestic political agenda.

1. Russia – traditionally a major ally of Syria and big trading partner especially in the arms industry. Russia wants to pull its weight again in global affairs. It has felt left out since the fall of the Soviet Union. Putin under increasing domestic pressure needs to show he can be a strong man on the global stage especially in the lead up to the Presidential elections coming shortly.
2. China – over the past decade China has being quietly increasing its interests all around the world especially in the Middle East and Africa. China is more worried about a US which might reduce its growing influence in the region as a whole. China already sees itself under threat from the West in terms procuring energy supplies in the Middle East particularly from Iraq and Libya. China like both Russia and the US wants to be seen as a strong force on the world stage. Furthermore, with the weakening Chinese economy and a change of leadership scheduled for later in 2012 it is helpful to distract attention from domestic issues.
3. The US – has built up a big role for itself in the Middle East with two main objectives securing a steady oil supply for itself and defending Israel. This means that as long as the US remains a global power it will always be involved in the Middle East. The US while it is looking to bring about peace in Syria through a change of power from what has turned out to be a very barbaric Syrian regime it is likely the US has other motives in mind. First and foremost if there was a change in the Syrian regime to one which might be more sympathetic to the West (even just for a short period) this could potentially weaken Iran greatly. Currently Syria is one of Iran’s strongest allies in the region. Ultimately, the US like both Russia and China are using the Middle East to further their perceived strength on the global stage while their domestic situations remain very strained. Also worth noting each of the three Nations faces a change of leadership during 2012.

While currently being played out in the Middle East (Syria and Iran) geo-political tensions can rapidly change location and quickly include more players. The Middle East is the prime location for a time bomb as it is the oil well of the world and world politicians have never really addressed the political issues of the region with a permanent solution in mind.

Given that the world remains in an economically fragile state moves towards more protectionist policies can be expected and these invariably lead to increased geo-political tensions.

Bonds:

Bond markets continue to trade in tight ranges. The interesting fact is that bond markets have not really reacted to the rally in equity markets since the start of 2012. The likely reason is that investors believe that the equity market rally is only temporary in nature. The global economy remains weak and therefore bonds remain an attractive investment albeit at very low yields.

Bond yields in the Eurozone remain stable. However, there is a real danger that contagion could spread if a deal is not made quickly regarding Greece’s second bailout and the deal for private bond holders of Greek government bonds to take losses under a voluntary program.

Bond markets are likely to remain focused on events especially the Eurozone debt crisis. Any negative news will see buying of the major government bond markets (US, Germany and UK) as investors remain very much attached to capital preservation rather than capital gains in the current climate.


The Euro continues to trade in a range versus the USD. As pointed out on a number of other occasions it would from an economic point of view be much better for the Euro if it weakened significantly versus the USD to help spur on an economic recovery within the Eurozone. The Eurozone is made up of a number of strong exporting countries which would further benefit from a weaker currency. Furthermore, a weaker Euro would help debt burdened members have a competitive devaluation to help them trade out of their current problems. However, markets remain concerned about the long term viability of the USD which provides an unwelcome support for the Euro. A further danger which could trigger a rally in the Euro is Greece leaving the Eurozone. After an initial amount of turmoil with the currency it is highly likely that markets would view Greece’s exit as positive for the bloc as a whole.



The Australian Dollar the world’s fifth most heavily traded currency is continuing its very impressive performance increasing in value by over 5% so far in 2012. Although there are signs that the Australian economy is overheating markets have chosen not to factor them as of yet.

In the past 24 hours the Reserve Bank of Australia (RBA) has kept interest rates unchanged following two decreases towards the end of 2011. The RBA believes that although the Eurozone debt crisis will affect the global economy as a whole the Australian domestic economy will remain resilient. The biggest danger facing the Australian economy comes from China. A slowdown in the Chinese economy leading to reduced demand for Australian commodities will be the catalyst which will eventually bring ill winds to the Australian economy and markets.

Equities:

Over the past week equity markets have continued to perform well. However, as concern is now growing both regarding the situation in Greece as well as geo-political tensions in the Middle East the shine is coming off equity markets somewhat today.

Given the extent of the rally into 2012 based on very little hard evidence of seeing light at the end of tunnel in terms of the weak global economy it can only be expected for equity markets to pull back.

My expectation for equities in 2012 is for them to remain volatile and react quickly and sharply to news flow. As long as there are no major economic shocks (either positive or negative) 2012 will remain a transitional year for equities following a particularly weak 2011 especially for European and Asian equities.

With concern beginning to focus more on the effects of the Eurozone debt crisis on Emerging economies there is the risk that these equity markets will continue to come under more pressure as they did in 2011. I remain bearish on Chinese equities for this reason and also due to the weakening of its domestic economy.

Commodities:

The great struggle for commodity markets continues. On the one hand given the weak global economic outlook this does not make commodities attractive as an investment given the lack of inflation potential.

On the other hand with the rise of geo-political issues commodities particularly gold and oil do become attractive investments given that they are a scarce resource and hold their value in times of turmoil.

There is also the third aspect which is the one which is very likely to prevail in my view, which is stagflation. Given the current state of the global economy the various tensions and ultra loose monetary policy by Western central banks the potential for inflation to become a real problem along with low to no economic growth is highly plausible. This economic scenario will be positive for all commodities.