Monday, June 15, 2009

End of recovery in risk appetite?

A week ago in Breakdown in EURUSD and Gold signs of things to come? I wrote that "...the break of the upward trendlines (in EURUSD and Gold) might well signal the start of a much broader correction across risky assets and be followed by a breakdown in the positive momentum in equity markets as well. Risk appetite might well take a setback again in the days and potentially weeks ahead." By now also equities and commodities such as oil have started to correct while government bond yields are falling again. I do think that this correction has further to run in the weeks ahead.
Yes, things are less bad in the economy than they have been in Q408 and Q109. But it should become evident soon that less bad does not mean good. My personal base case is that growth in the quarters ahead will oscillate around 0%, i.e. we will have some quarters with positive growth interrupted by the odd quarter with negative growth. This would clearly not constitute a self-sustaining recovery. Households everywhere remain under severe stress from falling asset values (household net worth in the US decreased by another 2.5% in Q109 or USD1.3trn) and rising unemployment. Furthermore, the default cycle in the corporate sector is nowhere near its end as excess capacity across a host of industries will continue to rise. Rising excess capacity amid slowing demand means that supply needs to be cut as well which in turn implies further rises in unemployment.
With growth far from becoming self-sustainable and a scenario for oscillating growth below trend, financial markets should as well not show a sustained ongoing recovery across risky assets. I rather think that valuations in risky assets following the recent strong recovery seems to have gotten ahead of itself. Therefore, I think that we are only at the start of a more significant correction in risky asset markets including commodities. On the other side, government bonds and the USD should perform further in the weeks ahead.

1 comment:

  1. I agree with that view, sentiment was going too bullish lately