By Stewart Cowley, a fund manager at Newton There appears to be a battle being waged in the fina...
By Stewart Cowley, a fund manager at Newton
There appears to be a battle being waged in the financial markets between the cyclical economists and secular gurus.
On the cyclical side, economists point to the health of the consumer and their willingness to borrow to sustain growth (backed up by notions of increased government spending) while the secular gurus highlight the readjustment of the markets to a period of over-investment that is only now being worked out.
The argument hinges around a US economy that has become flabby due to corporate America's over-consumption of foreign-supplied money.
The natural conclusion is that there should be a period of readjustment, which will be a function of capital privation to slim down an engorged economy. The readjustment should be painful requiring a declining stock market, a falling US dollar and a new bout of falling bond yields.
The recent decline of the equity markets, depreciation of the US dollar and reversion of bond prices to levels seen at the beginning of the year lend some credibility to the secular argument. But to make this a money making opportunity, the recent trends need to be sustained.
In effect, the near-term economics must be swept aside in favour of huge, irresistible, gravitational forces.
Since the beginning of the year, we have been warning there would be a messy phase for the bond markets where the 'growth=inflation' rule would confuse the bond and currency markets and caution was the best policy.
To a large extent, this is what happened ' in a brief period back in early March, the bond markets sold off, the US dollar rallied and economics triumphed over the secular gurus.
At the same time, we noted that current and forward looking P/E ratios in the equity markets didn't seem sustainable even given the most generous assumptions.
If there is one piece of evidence that favours the secular argument, it is the behaviour of the US current account deficit ' it is increasing at an alarming rate.
You can view the current account as being the difference between consumption and production ' spend too much without earning enough and your bank account pretty quickly goes overdrawn. You could say that what the US requires, and by some measures has not occurred, is a true and deep recession that we seem to have avoided last year.
Of course, the low inflation credentials that would be leant to the US during a period of capital privation would keep bond yields low but the winner, in currency terms, would be the euro as there are few places in the world to put your money with any real confidence.
In this strange interconnected world that we now live in, the deflationary squeeze that an appreciating euro would put on the fragile European economy would manifest itself not only through currency gains but also a bond market that outperforms the US equivalent. If the secular argument is about to hold sway over economics then long-dated European bonds is the place to be.
Long-dated European bonds look attractive.
Low inflation environment.
Rising euro could lead to bond market boom.
US's over consumption of foreign money.
Period of economic readjustment likely.
Bond yields could have further to fall.
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