To evaluate the likely top market movers for 2012, the top considerations were:
1. Likelihood of occurring in 2012
2. Impact on global economy if it occurs
Our overall conclusion is that the global economy this time next year will be anywhere from stagnant to deep recession, depending mostly on whether the EU avoids a breakup, orderly or otherwise, in 2012. The global economy remains mired in a process of shedding the debt that has fueled much of the growth for the past 30 years. The process is necessary, unavoidable, and bearish for the coming years. Here are the chief concerns for 2012.
EU: Sovereign Debt And Banking Crisis
A slowdown appears likely, but can the EU avoid a crisis?
Likelihood of occurring in 2012: High for slowdown, medium for crisis
Yes, plenty of other black swan events are conceivable, but the EU remains the most likely source of trouble and market moving events. Specifically:
1. If the EU can continue to prevent a major sovereign default, markets stand a good chance of ending 2012 flat to higher.
2. If not, the most likely result is a banking and global economic crisis at least as serious as that seen in 2008 after the Lehman Brothers bankruptcy.
While some like Nomura Bank believe markets have partially discounted an EU credit event, we do not. As of the end of 2011 the bellwether S&P 500 is around 1260, less than 8% off its 2011 high of ~1360, and less than 13% from its all time high at around 1560. That hardly seems to discount the global depression risked by a wave of sovereign defaults. Remember, compared to 2008m the world’s economies are weaker and the developed world carried far less debt, particularly the public sector following assorted stimulus measures over the past years.
While we believe #2 will occur eventually, it’s impossible to say how long it can be deferred. That will depend greatly on unpredictable political decisions. The EU appears to be aiming for an “orderly default.” While the details of that are unclear, the term does suggest they’re aiming for defaults without market panic, asset price collapse, and bank runs. Theoretically that may be achieved via a clever combination of capital controls, bank holidays, money printing, and state guarantees of too big to fail (TBTG) institutions. We wish them luck. Too much more austerity risks an exit by the debtor nations, and any significant devaluation of the EUR risks an exit by Germany and possibly a few other nations committed to preserving the value of their citizens’ savings.
There are so many uncertainties and ways that this could play out.
While the modern world as we know as seen numerous defaults in peripheral economies, it has never experienced the potential wave of sovereign defaults that could occur. Unlike in the past, the 17 Euro-zone nations cannot print their way out of default, and are unlikely to ever be able to agree to do so. Germany and a few other relatively healthy hard money economies have shown no sign of willingness to accept being stuck with a drastically weakened currency. Even if they would, they’d demand a level of austerity and surrender of budgetary control that the debtor nations do not appear ready to accept.
A few weeks ago ratings agency Fitch publicly concluded what some senior EU and IMF officials have asserted anonymously for months: that the EU and EUR as we know it is beyond repair, given the low chance of member nations agreeing to a workable solution. We agree, but can’t say when the breakup comes or what form it takes.
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DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING DECISIONS LIES SOLELY WITH THE READER. IF WE REALLY KNEW WHAT WOULD HAPPEN, WE WOULDN’T BE TELLING YOU FOR FREE, NOW WOULD WE?