TJI Market Newsletter // This Week's Summary //

The ECB Buys Time, But Watch China

• The supply of USD FX liquidity swap lines plus QE1 and QE2 kept Euroland banks afloat during and since the 2007/2008 financial crisis while the ECB Trichet was in na-na land raising, not lowering interest rates and talking about containing inflation while insisting no U.S.-style bailout plan was needed for Euroland. His successor, Italian Mario Draghi, has immediately moved to lower rates twice and has overseen the Long Term Refinancing Operation (LTRO), the largest-ever single refinancing operation in the ECB's history. Aided by additional coordinated USD liquidity swap lines, these actions have noticeably alleviated the immediate pressure on Euroland bank balance sheets, and represent the most significant progress in the crisis to date. The real litmus test of a lasting solution, however, will be seen in the Euroland bank stocks such as BNP Paribas, whose stock price indicates the immediate crisis has passed, but is still a long way from sustainable recovery.
  
• After piling into Japanese equities in late 2010 and especially immediately after the Tohoku disaster, foreign investors (particularly U.S. index funds) were dumping Japanese equities in the latest risk-off wave. While deep value investors are still interested, the contagion in Europe has again reminded investors that Japan's massive government debt is like a bug in search of a windshield. While there are no indications of rising rates yet, a rise in the government's JGB funding to just 2% plus would mean debt service costs equal to the total national budget, as social welfare programs and debt servicing are already near 70% of government spending. Further, the heavy selloff in China stocks on evidence that a property bust is becoming a full-blown rout has particularly negative implications for the widely expected recovery in Japan's economy in 2012, when GDP growth is expected to snap back from minus growth in 2011 to over 2%--assuming no major slowdown in exports, the majority of which are bound for China and the Asia region. Thus we see limited upside for the market benchmarks, and remain very selective and defensive regarding individual stocks, while continuing to avoid the BRICs markets in general.
  
• Finally, we don't buy the "gold bull market is over" scenario. Rather we see negative real rates and continued developed economy government money printing as strong support for an eventual move about $2,000/ounce.
  

See previous summaries >