2008 redux?
Whether we're heading on a path to repeating the 2008 crisis is a question we often receive. There are many indications that the global banking system is in far better shape today than it was back then and that the crisis is likely to be relatively contained to the eurozone. But we don't take pictures like the one below lightly either.
Foreign Banks Shovel Money to Fed
Source: FactSet and Federal Reserve Bank of St. Louis, as of September 9, 2011.
Foreign official and international accounts have deposited nearly $103 billion at the US Federal Reserve, up from less than $58 billion at the beginning of 2011 and well above the prior crisis high of less than $89 billion in January 2009. This indicates a loss of trust in the European banking system.
Lars Tranberg from Danske Bank said European banks have been reduced to borrowing dollar funds for "a week at a time," as opposed to the typical six-to-12 months. "This closely resembles what happened in late 2008, though the difference this time is that the major central banks have dollar swap lines in place. If the dollar funding market completely freezes up, the ECB can act as a backstop."
Growth under attack in the eurozone, pressuring the global economy
The eurozone is an important part of the global economy, as it accounts for nearly 20% of global GDP. While the eurozone has not recently been a big driver of growth, a breakdown in economic growth or the banking system would be felt globally. With growth already slowing globally, a recession in Europe would hurt. While we think a recession in several European countries is very likely, we believe a broader global recession akin to that experienced in 2008 can be avoided.
As a result of falling confidence in the longer-term viability of the euro and the potential that the ECB may need to pursue its version of quantitative easing by making unsterilized purchases of either sovereign or bank debt, the value of the euro has fallen. There's also pressure (rightly so) on the ECB to lower short-term interest rates.
This has resulted in a corresponding increase in the US dollar, as you can see in the chart below. History is mixed as to whether a stronger dollar (which we expect) would necessarily be negative for the stock market. Recently, the two have moved inversely, but over long-term history, a stronger dollar has more often been met with a stronger stock market. Regardless, a stronger dollar would mean weaker profits for multi-national companies, but less inflation.
US Dollar Breaks Out on Upside
Source: FactSet, as of September 9, 2011.
What's next?
The situation in the eurozone remains fluid, with key events still ahead, including final approval of the new Italian austerity package, French banks bracing for a potential downgrade by Moody's and the European Commission pushing for a global agreement on a potential financial transaction tax later this month.
Importantly, the second Greek bailout and expanded European Financial Stability Facility has yet to be ratified by the parliaments of all 17 nations that comprise the euro, which is expected to occur in September and October. Additionally, Finland's demand for a collateral guarantee in exchange for its bailout contribution is expected to be resolved in mid-September.
What's an investor to do?
This all begs the question about how an investor should be thinking about portfolio positioning. From a stock perspective, we continue to think that the US market will remain a decent relative performer (though not necessarily a decent absolute performer). In fact, on a year-to-date basis, the US stock market is ranked seventh among the 33 largest stock markets globally. And we know readers will be shocked, just shocked, that Greece's stock-market performance is dead last.
While we've been negative on Europe, we don't believe in completely avoiding the continent, but instead supplementing diversified European exposure with an allocation to Switzerland's defensive market. Elsewhere, we're favorably disposed to Japan, where we believe there's an improving environment in which companies can operate more competitively globally. In combination with low expectations and declines in valuations, it could bring about the long-awaited revival of Japanese stocks.
Lastly, we believe the global economic slowdown and strength in the dollar may provide emerging markets with inflation relief. That would enable a pause in monetary tightening to the potential benefit of stock-market performance, once the uncertainty and high correlations (degree to which asset classes move in tandem) eases.
Important Disclosures
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
