Kicking the can down the road: is there an end in sight?
August 24, 2011

Kicking the can down the road: is there an end in sight? - Zélia Cardoso de Mello The downgrade of the US treasuries, riots in London, markets in vicious and unpredictable swings, Italy and Spain adding to European troubles; in short, pandemonium. The Brazilian President changed his 4th Minister in 7 months since the inauguration, and China is showing more signs of slowing down. This was a particularly troubled August in which a downgrade didn’t result in increased borrowing costs, showing that investors don’t have any other place to go, except for Switzerland: there is no other market as liquid and deep as the US treasuries market, so even with real return next to zero (or even negative), investors are still coming in. The market volatility shows the high level of uncertainty and how the players are split between those who believe in a double dip and those who don’t. The investors have been reacting to news, be it good or bad -mostly bad – such as the Philly Fed’s index that came in at minus 30.7 in August. A reading that low in the past has signaled that a recession was coming in the near future. Financial crisis and stalled economic growth are still the main themes and fiscal austerity is still the main answer from the leaders. They insist in ignoring the obvious fact that the root of European problems is not fiscal, and require structural reforms to gain competitiveness and make the labor market more flexible. Ignoring that and refusing to address the real problem jeopardizes the existence of the common currency itself.

In the US, the impending announcement of measures to stimulate jobs by President Obama on Labor Day and the possibility of a QE3 is giving some life and optimism to the market. We know little about the possible content of Obama’s speech, but we can almost be certain that it is not going to be approved by this Congress, so it may be merely wishful thinking.

The fiscal austerity that has been proposed and implemented in both in Europe and the US impacts mostly those who have already lost a lot in the last few years. In the US, the increase on income disparity observed in the last 15 years, along with the income transfer from labor to capital, has put a strain on the well-oiled American machine of job creation. If there is no income, there is no consumption, except by borrowing, and we know where that ultimately leads. Given the present circumstances, the weak private demand is not being complemented by the Government. The increase in the demand of Chanel, Gucci, Louis Vuitton, Mercedes and BMW’s are not enough to lead to economic recovery.

That is why the London riots are significant: they reveal that some parts of the population are ready to put their fists down and emphatically proclaim, “enough is enough.” The Middle Easterners got tired of their oppressive governments, and we have seen them falling like dominos. The London protesters were young and poor people. When the riots began, the English authorities were abroad on vacations. I wonder when the last time was that the protesters took a vacation, and if they even left their town, let alone their country. A few months ago Bloomberg reported that more senior citizens in Japan are stealing. According to the report, (and I quote), “criminal offences by people 65 or older doubled to 48,605 in the five years to 2008, the most since police began compiling national statistics in 1978, a Ministry of Justice report said.” This might be the result of cuts in pensions and increases in health care costs. Last weekend there were riots in Germany and the target was luxury cars. In Philadelphia a curfew was set up for underage kids. Other flash mobs are being seen all over the US. As I stated in the beginning, sheer pandemonium.

Meanwhile proud Brazilians celebrate the fact that the economy is in much better shape than the developed countries. However, the stock market didn’t reflect that situation having fallen almost 20% in 2011.Whoever believed in the Brazilian companies is probably regretting. Nevertheless at least the Brazilian President is governing and taking tough decisions. She has showed she has the necessary resolve to tackle problems and showing leadership, apparently absent in the developed world.

How should the investor navigate the storm? The safe haven now means negative returns. One could advocate that now is the time to buy and there are good opportunities in the stock market. However, if we are going in another recession, the stock market will go down even further. Barron’s this weekend was recommending investing in emerging markets stocks that have lost almost 20% since the beginning of the year. If you don’t believe in recession go for it and build a long term portfolio. If you believe we are in fact getting into another recession, wait and the bargains will look even more appealing. Another reason to be patient is the so awaited meeting of the FED at Jackson Hole this coming weekend. Last year the FED announced QE at that same meeting: we know that although didn’t do much good for the economy at least helped inflated all class of assets in the first semester giving us the illusion of recovery.


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