Nov 20, 2012, 09.00 AM | Source: CNBC-TV18
In an interview to CNBC-TV18, Jan Lambregts of Rabobank International spoke about the global performance of the market post the US elections and the issue revolving around fiscal cliff.
Jan Lambregts (more)
Head of Research - Asia, Rabobank Group | Capital Expertise: Equity - Fundamental
Below is an edited transcript of Jan Lambregts’s interview on CNBC-TV18.
Q: Over the weekend news from the US sounds marginally positive. Do you think there is any chance for an amicable resolution to the fiscal deficit reduction in the US?
A: The basic problem in the US is that the deficit structurally is far too high. Now, notice the word “structurally” that I used, I would emphasize on that. A lot of people would probably tell you that because of the bad economy the deficit is high. If just the economy picks up the deficit will get better and that’s not true.
If you adjust for an economic cycle you would still end up with a structural deficit in the US of around about 7 percent, simply too much has been promised to too many. There is too much entitlement spending and very difficult decisions are to be made. On top of that, there are a lot of stimulus measures from the recent past, which seem to expire on the 1st January 2013 that is the cliff about which we will hear a lot.
If, Republicans and Democrats come together under the leadership of the newly re-elected president in the US and figure out a way to reverse the cliff it will be difficult. Extreme outcomes have gone over the cliff and driving it to the wall or even a gram bargain are possible here. This will probably go in January and will damage the US economy somewhat in the beginning of the year, diminishing growth prospects for next year by 1 percent.
Q: Clearly, this is an orderly decline. People are factoring that the dividend yields will go down because the tax rates will rise. So, this is something to be factored in and not a risk-off. Do you see this mood persisting or once it has been factored in the markets it could stabilize and move higher again?
A: It can indeed stretch for a while and of course Fed also might have problems in the euro zone. We will get back to that later, but the fiscal cliff does enter a limbo and until that point you do see a negative reaction. She also points out the negative reaction that was due to the re-election of Mr. Obama, as people start to understand that American voters have voted into office the status quo and there were things perhaps not to like about Mr. Romney.
Obama hasn’t proven himself to be the most business-friendly president. The question is whether it will change in the second term. So, there too we have a negative impact on the stock markets.
Q: You are not in the mood to use this current dip in equity markets to add-on your risk or equity positions?
A: Still, be some distance away we have to reverse the fiscal cliff. We have to see the promise of the euro zone crisis more decisively addressed, starting to emerge more prominently, the question is ofcourse on Europe, we still have two hurdles to take. We have still not factored Greece.
We need to see more debt forgiveness; official creditors are now taking a hit. We need to see the situation surrounding Spain, probably also Italy, resolved where these countries basically sign up Memorandum of Understanding(MoU)to accept ECB support funds which is a bailout in all but name.
Q: What is the sense you are getting in Europe now? Is the bottom given to the market by Draghi now getting challenged again? There are some concerns around Greece, Spain not asking for bailout yet, what are your thoughts?
A: The ECB is not the Fed. Fed has more or less promised investors to bet on the equity markets because it will just keep printing money to pump these equity markets. That’s not what the ECB wants; they will do whatever it takes. When we look at the euro zone we see two key problems from the past. The first one is that in the euro zone a monetary union has been built without a matching political and fiscal union.
Secondly, the ECB for the longest time decided to set itself apart and not act as a true level of last resort, not buy its own bonds like other major central banks were doing. Independent of whether you think that’s a good policy or not, we aren’t doing it was ofcourse hurting them. Now these two issues have been addressed.
We have seen at the halfway point of this year Mr Van Rompuy, President in the euro zone say that there is a road to fiscal and banking union underway and all the core countries and the peripheral countries agreed with him. And ofcourse, in July the ECB said, they will do whatever it takes and in September they followed that with the outright monetary transactions plan being put into place. So, we see that the confidence has tipped favourably, but we still have Spain and Italy to signup and with that comes conditionality which is the current battle. Nothing ever goes easy in the euro zone. Always two steps forward, one step back.
Q: So, do you think as we enter 2013 there is any greater assurance that a Greek exit won’t happen?
A: We do not enter 2013 with that reassurance. The reason is that in Europe things get done only when the pressure is on the cooker. The solution to the crisis is very much a ship that they are building while sailing it.
So here you need the pressure to be on politicians, to be able to sell unpopular measures at home. So, they have to sell it to the whole public and for that they need pressure. From the past couple of years the line seems to be heading down and down in confidence and every once in a while you have a little bit of revival, but the end point seems to be a breakup.
Now we have turned the corner, the breakup scenario is being priced out of the market that gives the bond markets some time to relax and the comfort there to come in. This gives time to build a better monetary union. Whether Greece will leave or not, we regard the Greek issue pretty much if we look at the whole euro zone as a bath tub. You look at Greece, it is the plug, the euro zone is the water.
You pull the Greeks out and let them leave the speculation, it will start and the whole bath tub starts to empty itself, so it’s a drain. Its not that Greece is so important by itself, it is the fact that if you show the euro zone that the euro is a reversible project, the speculation will start other and countries will follow suite when the speculation starts to become a self fulfilling prophecy.
Q: How would you deploy assets now? We had a rally in risk-on assets, the bond markets had stabilized as you said, gold has not been firming much. So how would you allocate your portfolio at this point?
A: Equity markets are to be avoided in the little time that is left here. A lot of money has been put to work this year, to an extent it was successful. People are now cashing on it. People have too many uncertainties here to really bet big on equity. So this is both from the euro zone, but the pressure is currently building towards more lasting solutions to be further put in place.
The implementation of Spain to be strong-armed into a bailout and there is the fiscal cliff, which will drag into the next year and therefore damage growth and will also draw heavily on sentiment. So that means you have some safe-havens there and this is always a little bit perverse when things are tough in the US. US treasuries typically tend to benefit so that is something to look forward there as well.
We think as the pressure in the euro zone goes up, you would again be looking at core bonds to do well in the short-term at least. Again on the shorter term, for currencies it is more of a mix picture whether to favour a Euro or a Dollar, remains very much to be seen. Both sides have quite significant weaknesses. Long-term, we are pessimistic though on the dollar as the Fed is printing money like there is no tomorrow in the currency we see Euro-Dollar around 1.35 by year end 2013.
Q: More immediately up until 2012 has run out, what will be the key data and events that you will watch out for on both sides of the Atlantic?
A: First day to really look for is November 20. It’s when the key players in the euro zone meet again to talk about the Greek bailout. Greece cannot fund itself at the moment and therefore relies on rescue money. That rescue money is given in small portions and for a couple of months now, no rescue money has come forth. So, you have to talk about it, they have been postponing it a lot.
Greece has been finding itself in all sorts of devious ways but now it’s really going to come to halt. Ultimately, it’s like a bath tub. Greece is the plug so they will continue to carry the Greeks around. It can be afforded by the rest, the wealthier countries in the euro zone, but they do so begrudgingly and not really volunteering for it. That’s the key event to watch here. I am also quite closely watching remainder of the US data this year.
In the US we have seen the first signs before hurricane Sandy started to wreck havoc there with the data. We did see the housing market pick up and are quite excited about that. It is a story to closely track. It’s still quite nascent, but if the housing market recovery in US were to continue we may be upwards revising our growth forecast for the US.