Granite Hills Investments - Global Macro Outlook 2012
Throughout 2011 Granite Hills Investments produced trade strategies focused on various global macro themes. The performance of the strategies was extremely good in very tough market conditions. Each of the strategies can be implemented by either exchange traded options, futures. The implementation of the strategies using options is a lower risk approach using a method called Limited Risk Option Strategies. The risk limit used throughout 2011 was putting a maximum of 5% capital at risk on any one strategy. The performance for 2011 was +6.77%. The use of futures was a high risk approach as no capital at risk approach was used. In the case of using futures the performance was a very impressive +44.40%. Full details of all the trade strategies and individual performance can be viewed by clicking on the following link:
Below is Granite Hills Investments global macro outlook for 2012. This will be form the basis of many of the trade strategies to be published in 2012 along with others as new developments become apparent in markets. To gain access to these interesting global macro trading strategies you can buy a subscription for €400 annually. This will entitle you to a minimum of 40 trade strategies during your subscription period as well a weekly update on all open strategies and closing note when the strategy has run its course. Please follow the link to buy your subscription:
2011 will probably go down as one of the most difficult years for a long time for investment markets. The year was dominated in particular by the growing Eurozone sovereign debt crisis and the frustration at how governments just were unwilling to face the realities of the crisis. The Eurozone crisis while primarily affecting the Eurozone also as the year went on started denting the outlook for overall global economic growth. As 2011 progressed it was becoming clearer that other areas were facing weakness. In particular China seems to have started to falter. Faced with increasing inflation and property bubble the Chinese monetary authorities progressively tightened monetary policy leading to a slowdown in the domestic economy. The one major bright spot came from the US which as the year came to a close economic data pointed to a rosier picture regarding the state of the economy.
2012 is going to be yet another interesting year. There are a number of themes which are building up and will dominate as the year moves on. Many of the investment themes for 2012 will be carried over from 2011 but there are new ones emerging especially related to geo politics which will be a major influence on how markets behave throughout 2012. Below are listed the themes which will be major market drivers in 2012.
Over the past decades China has developed from a very under-developed economy into a major global force. Not only has China become a significant factory ground for global production making it a major exporter or goods it has also become a major importer especially of raw materials including both agricultural and industrial commodities to fuel its domestic development. While China has now grown to be recognised as the world’s second largest economy it’s new found wealth is very concentrated and GDP per capita keeps it very much as developing country. According to IMF GDP per capita in China was $7,544 in 2010 ranking it in 94th place globally.
China is now being negatively affected on two fronts. Firstly its export sector is under pressure. China’s biggest export destination is the EU. With the EU basically in recession now imports from China have started to decline. Moreover, as labour shortages become a problem putting upward pressure on wages some producers are now looking for other countries to produce goods in at a lower cost. Given the fact that the Chinese domestic market remains under-developed there is little scope for the domestic economy to make up for the loss export income. Although inflation has cooled off in recent months it remains high in China. Inflation has been driven by two major factors the property market and wage growth. While it can be expected that monetary policy may well be relaxed somewhat in the short term the authorities do not have much room to go on a path of significant easing.
Both the export and domestic economic situation in China make the outlook for Chinese growth to be quite bearish.
With China now being a much more open economy a slowdown in China will have significant impacts on other nations. China over the past number of years has built up trading relationships stretching across Asia, South America and Australia. All these regions can expect to see a slowdown if Chinese growth starts to falter. Many countries have put too much a reliance on sustained high growth in China.
A further issue which has the potential to add to uncertainty in China in 2012 will be appointment of a new Chinese President in October. Given the secretive nature of the selection process it is hard to tell who is going to take over and what their policies will be especially regarding the economy and foreign policy.
Currently Granite Hills Investments has a short position on Chinese equities. It is a longer term position and even with the recent rally in Chinese equities the short position remains in profit. As the year progresses and the slowdown in China, becomes more prominent, the equity market in China will continue to suffer as will the markets of its major trading partners.
2. The US
The US in both political and economic terms is going to have an interesting 2012. With the US Presidential election already very much on the agenda it is going to make an interesting year. The question is whether President Obama is going to take a more aggressive stance against the Republican majority in the House of Representatives or will this year continue to be like 2011 where continued bickering among the Democrats and Republicans led to very little being achieved at all. It is a hard call to make yet as to whether Obama will get re-elected but certainly the continued disunity within the Republican Party is helping Obama’s chances.
After tittering on the verge of recession in the middle of 2011 towards the end of the year the economic picture started to brighten in the US. There has been resurgence in job growth and a number of other indicators pointing to a pickup of confidence and growth within the domestic economy. However, what is clear the current growth figures will not be strong enough to lead the US out of the appalling fiscal mess it finds itself in. The level of debt in the US - both public and private – is at grotesque levels and there appears to be very little sign among any politician or central banker willing to want to start taking corrective actions.
However, given events taking place outside of the US it is unlikely that attention will focus in the short term on the US’s problems. The USD is still seen as the major reserve currency and with many investors still in a state of fear they will continue to pour money into the US and therefore prop up the US economy certainly in the short term. Longer term the issues facing the US economy are very likely to cause some very serious issues in terms of both credit worthiness and inflation.
3. The Eurozone
Since late 2009 the Eurozone has taken on the role of a Shakespearian Tragedy/ Comedy. This is likely to continue throughout 2012. Probably the best thing that can happen to the Eurozone is for global investors to ignore the bloc as much as possible while the leading political comedians of Merkozy continue to make a complete and utter mess of things. While the probability of some major resolution for the sovereign debt crisis remains small in 2012 it is unlikely that unless there is a major blowout that the Eurozone is going to remain centre stage for investors. Investors have become weary and despondent with the carryon of the Eurozone authorities. Furthermore with the very poor performance of Eurozone financial markets in 2011 it is likely that a very large amount of all the negative news is already priced into Eurozone assets. Therefore, it can be expected that Eurozone markets will have a bumpy ride along the bottom in the short to medium term.
One positive area worth mentioning is the recent action taken by the ECB. The ECB through its extra liquidity program of unlimited three year loans to banks has certainly significantly reduced the probability of a Eurozone banking crisis.
Meanwhile, at the real economy level the Eurozone is in a very weak position. The probability is high that the Eurozone will enter into recession in 2012 if it is not already there. The level of unemployment remains high and confidence across the zone is low. For the bulk of 2011 Eurozone economic growth was hanging on to positive growth in Germany. However, indicative signs are that Germany is now also beginning to slow down somewhat. The slowing economic scenario will add pressure on the ECB to further reduce interest rates and potentially start its own program of Quantitative Easing. A further fall in the value of the Euro currency would be a good scenario for the Eurozone as it would help the Eurozone become more competitive in terms of exporting. Also with many countries facing a deflationary cycle due to severe austerity measures being forced upon them an inflationary boost from a weaker currency would be of little danger at the moment.
4. Geo-Political Risks
While the above points mainly focus on the state of various economies and the impact they are likely to have in 2012 the area which is growing in importance and is likely to bring large amounts of uncertainty and volatility to markets are the growing geo political risks. Below is a list of some of the areas which are likely to provide concern in 2012:
Iran continues to develop its nuclear capability while all the same time saying it is purely for peaceful means. The West does not believe the Iranian government and are constantly increasing pressure on the Islamic Republic by increasing economic sanctions. With Iran now threatening to cut off the Strait of Hormuz the danger is that if they do carry it off even just minimally the effect it will have on the global economy will be very serious given the level to which the price of oil is likely to jump.
The main threat though to regional stability is the threat of Israel acting unilaterally to take out Iran’s nuclear capability. While this scenario is not given high probability by many analysts it is a mistake to underestimate it. If Israel feels that they are under threat they will react irrelevant of what the White House or anyone says. This is by far the most dangerous threat to the region a conflict between Israel and Iran.
B. North Korea
There is not a huge amount to be said about the new North Korean leader Kim Jong Un which is really the major issue. All we know is that he is very young and lacks any political experience. Therefore, it probably can be assumed that many of the old military elite will have a big say into the running of this highly secretive Republic. Given North Korea’s military strength and the fact it has nuclear capability makes it a real source of worry in the region. Increased tensions with South Korea or mere military exercises by the North will increase nerves and unsettle financial markets globally.
C. Arab Spring
Instability is on the rise again in the Middle East. With many political systems under change in Arab world following the Arab Spring of 2011 the amount of uncertainty is growing particularly in Egypt and Syria. Egypt up until recently has provided a strong force of stability in the region mainly due to its peaceful relationship with Israel. However, with the overthrow of Hosni Mubarak and the current void in the political system has the potential to unsettle the region. Assuming the military (which could be considered a big assumption) does hand over to a newly elected government, it is very likely that the new government will be made up of predominately Islamist parties. Depending on what their policies especially towards Israel this has the potential of increasing tensions in the region. A strong and stable Egypt is a very important factor for the Middle East not just from a political point of view but also for the economic well being of the region given its size.
Syria remains a very volatile situation and looks like falling into deeper trouble. President Assad appears to be willing to do anything to cling onto power. The evidence so far from the Arab League delegation in Syria seems to point to them having very little ability to influence a move away from the violence currently taking place. If the situation does not come under control at some stage soon there is a real danger that the UN could well be forced into action would have the potential to further destabilize the region.
D. Other Geo Political Risks
There are other areas which are posing potential for increasing risks which include:
• Turkey – the clamp down by the government on opposition politicians and journalists.
• Hungary – Is Hungary moving away from multi part democracy to a more one party system?
• Threats from some countries in Latin America especially Venezuela.
• Russia – will Putin move further from Europe and build his dream of a Eurasia after his inevitable rise to President in March 2012?
As already mentioned geo-politics is likely to play a big roll in 2012. Above are just some of the potential risks but as the year goes by more will certainly appear on the radar.
Markets – 2012
Above are the themes which will most likely be dominating investment markets throughout 2012. The focus is now what effect will they have on financial markets. Overall markets are likely to remain volatile. Markets are going to remain quite short term focused as investors levels of fear remain high and capital preservation as opposed to capital accumulation especially among institutional investors will be a major concern. The major surprise which has the biggest potential of causing the greatest upset would be return to strong global economic growth throwing out many of the current concerns. This would likely lead to a massive rally in risk assets. While this would naturally be the preferred scenario it also the one currently with the lowest probability but as we all know surprises do happen so don’t rule it out completely!
Yields on the major government bonds are likely to remain low (US, Germany, UK and Japan). This is based on two major factors. Firstly, the low to negative economic growth in these regions will help keep yields low. It is unlikely in 2012 that Central Banks will go into a tightening mode as far as interest rates are concerned. Secondly as shocks hit the markets especially some of the geo-political risks mentioned above there will be likely at times sharp shifts into the safe haven assets of the major government bond markets.
However, as governments continue to pour money into economies to try and stave off recession especially in countries such as the US and UK this is just adding to what is already growing into a mega sized bond bubble which is going to pop at some stage. Over the past two years on many occasions the end of the bond bubble has been forecast with many investors building large short positions. The only result though has been big loses if shorts have been held for any length of time. There are two major catalysts which are likely to cause a major reverse in the bond markets and these are credit worthiness and inflation.
Markets are likely to keep a strong focus on the fortunes of the Euro. The Euro given the weakness of the Eurozone economy should continue to weaken. However, currently the danger of the currency falling apart remains small. The political will in the Eurozone is very strong to keep the Euro alive. There is no mechanism for a member to leave the bloc therefore either a member forced out or voluntarily leaving would cause chaos which no Eurozone government wants to be either blamed for or responsible for.
With the outlook for ECB to reduce interest rates the Euro will become a carry trade contender with many investors especially hedge funds looking to borrow in Euros at very low interest rates and then sell them to purchase higher yielding currencies such as the Australian Dollar (AUD). This could add to downward pressure on the Euro.
As geo-political tensions increase the USD, JPY and CHF will benefit from their safe haven status. While on a fundamental basis the USD should without a doubt be considerably weaker the fact that it is the global reserve currency is going to keep it in demand.
Following very poor performance of equities in 2011 especially in Europe and Asia it is hard to see these equity markets falling much further without a major shock. However, that does not mean equities are a strong buy. Equity markets will remain trading around current levels within relatively tight trading ranges. The markets likely to remain under the greatest pressure are the Chinese equity markets and the major trading partners of China such as Australia, Brazil and its Asian partners.
Any glimmer of hope regarding the global economy is likely though to cause a significant rally but this certainly must only be a very small probability especially in the short term.
Commodity markets are likely to remain very tricky. On the one hand with global economic growth forecast to remain weak this does not help commodities. Commodities need inflation to do well. On the other hand though commodities especially the likes of gold and oil tend to perform extremely well in the types of geo-political crisis mentioned above. Therefore, it can be expected that commodities are in for a particularly volatile year ahead.
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