Rocking with Status Quo

21^st November 2012

The US election result maintained the political status quo, with Obama in the White House and the majority in the Senate, but the House of Representatives remaining in the hands of the Republicans.  It was the expected outcome but markets rocked to the pessimism of deadlock fears over the so-called Fiscal Cliff.  This highlights the main issue for us, in that market and political timing are rarely aligned.

Western economies need much reform over the coming years and whilst much of this is already taking place, change, which often requires new legislation and constitutional amendment, inevitably takes time to implement.  As investment managers with a broad client discretionary agreement, we are free to make changes whenever necessary.  This is not the case for our global, democratic leaders and policy makers. That is not to say that they cannot act swiftly in response to a major crisis - the G20 proved that in early 2009.

Indeed, at a recent presentation at the London School of Economics, Dr Gerard Lyons, Chief Economist at Standard Chartered Bank, praised the efforts of our former Prime Minister, Gordon Brown, and other global leaders in co-ordinating the initial response to an economy sliding deeper and deeper into recession. This period he referred to as 'SSS,' - Sizeable, Synchronised and Successful - in propelling the global economy into a recovery. This global, synchronised policy lasted until the first Greek bailout in 2010. Thereafter, policy changed tack, 'TTT' Dr Lyons cited – Tiny, in scale compared to the previous stimulus, Targeted, rather than synchronised and Temporary, which has created the so called "risk on, risk off" rallies.

We have now entered the latest stage of policy, Dr Lyons argued.  After SSS and TTT, now comes 'UUU.'  In this case the first U is Unlimited, commencing with ECB's President, Mario Draghi stating his readiness this summer to do whatever it takes to defend the Euro and then the US Federal Reserve announcing unlimited money printing until unemployment falls to an acceptable level. Unclear is the next U, a reference to the law of diminishing returns which has seen the impact of recent monetary policies last for shorter and shorter periods. And finally, the Unknown consequences of the many hundreds of central bank initiatives that have been introduced around the globe since the credit crisis of late 2008. The obvious consequence is inflation if central banks are unsuccessful in removing policy and extracting liquidity without disruption to the economic environment.

Inflation though is clearly not the main concern for markets today.  A global recession next year is more immediate. Sentiment and confidence have deteriorated post the re-election of Obama, despite the all-in approach of global central banks.  We believe a repeat of the dysfunctional US debt ceiling debate will be avoided and a compromise will be reached on the Fiscal Cliff.  In addition, the Eurozone debt crisis and economic growth in China will continue to rock n' roll but gradual improvements will allow investors to commit more to equities.