More Downside Risk

• The selloff in the S&P 500 on Friday on the back of steep drops in Southern European equities and new lows in the Euro underscored the view that there is further downside risk in global equities. Global investors continue to reduce risk asset positions and seek gold, the USD and long-term US treasuries for safe haven.
  
• We see nothing on the foreseeable horizon to significantly backstop the Euro sovereign debt contagion. A US-style package of bank stress tests, visibility on potential balance sheet risk and programs to ring fence financial contagion would help, but would be politically time-consuming and in the end may not save the Euro, which is at least going to parity with USD and could still cease to exist in its current form and membership.
  
• While Japan’s economy is showing encouraging signs of recovery as are corporate profits, the Japanese government appears powerless to turn the tide on the strong yen, firstly because prime ministers and their cabinets in Japan are beginning to look like endangered species with average life spans of less than 12 months.
• The DPJ has quickly fielded its number two man, Naoto Kan after the sudden resignation of Yuko Hatoyama and the party’s puppet master, Ichiro Ozawa. Because of earlier comments as finance minister about wanting a weaker yen, the emergence of Mr. Kan did create some transitory weakness in JPY/USD, but this is unlikely to last. At the same time, Mr. Kan as a fiscal hawk is expected to press forward with two fiscal consolidation programs that were to be released in June.
  
• However, his socialist-leaning “third way” plan of taxing households to create a big government that re-allocates these tax revenues to welfare expenditures, while admirable from a societal perspective, will do nothing but reduce Japan’s economic growth potential, and may even exacerbate Japan’s waning ability to growth itself out its debt problem over time with a much-needed secular uptick in economic growth potential. As a result, the business and financial community are already abandoning the DPJ to support former reformist financial services minister Yoshimi Watanabe’s of the Everyone’s Party.
  

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