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Bold Policy Decisions Needed to Instill Confidence



     Recent economic data has confirmed our concerns for an economic slowdown and has validated our defensive portfolio approach. Fiscal policy uncertainty in both Washington and Europe has clearly impacted business and consumer confidence across the globe, and financial markets remain guarded as investors recalibrate their economic and earnings expectations. Yet, although systemic and cyclical concerns continue to lurk in investors’ minds, we believe that with credible policy actions the necessary visibility and confidence can be restored.

     As we have argued in our weekly writings, policy makers need to put economies across the Atlantic on a sustainable path. The reality is that bold decisions need to be undertaken which should include sovereign and mortgage debt restructuring, budgetary reforms and job creation via tax incentives and retraining programs. Economic growth may suffer substantially in the near-term as developed economies reset themselves to live within their means, but the key point is that policy makers should opt for a short recession instead of a protracted economic slump which further deters private investment and meaningful employment and income growth. Countries such as Sweden, Canada and New Zealand have proven in the past that sovereign deleveraging can be undertaken in an orderly fashion with an eventual economic recovery on a viable footing. 

     In the U.S, August manufacturing data (black line) has confirmed the economic slowdown and our expectation is that GDP growth will continue to remain subdued in the coming quarters. Nonetheless, the ECRI leading economic indicator does not appear to indicate an incoming recession at this stage. Although the indicator has turned marginally negative, it is not yet at the -10% recessionary level.




     Nevertheless, if policy uncertainty continues risks remain on the downside. As the below graphs attest, consumer confidence across the Atlantic has been deteriorating and also the export outlook for China (black line) and Germany has also been impacted. Moreover, it is noteworthy today that the Brazilian Central Bank has cut their benchmark interest rate despite rising inflation. The Central Bank’s statement cited policy and growth concerns in the U.S. and Europe whilst also expressing a disinflation bias as their reasoning behind the rate cut. Historically, when a central bank starts cutting interest rates that indicates a peak in the economic cycle and thus Central Bank rate cuts attempt to cushion the economic slowdown ahead.



     Employment growth is one of the cornerstones for income and economic growth, with a critical impact on demand for big ticket item purchases, services and credit. As seen below, unemployment rates in the U.S. remain elevated and the employment-to-population ratio remains subdued, with the latter impacting federal budgetary health via reduced tax payments. Our expectation for tomorrow’s non-farm payroll number is for an uptick in the unemployment rate as job seekers have indicated that jobs are getting harder to obtain. Therefore, it remains critical that job creating policies are instigated in order to improve the consumption component of GDP, ease the budgetary demand for unemployment benefits and prevent long-term skills erosion in the workforce.






     Lastly, it is imperative that politicians in Europe have a consistent and collective approach in the tackling of sovereign debt and banking challenges.  The constant disputing between the ECB, the IMF and various national governments continues to perpetuate uncertainty in the credit markets. As we can see below, healthy European banks have been increasing the level of money they deposit overnight at the ECB, which implies that they are incrementally more hesitant to lend to other financial institutions. In the U.S. credit market it is also noteworthy that the cost for insuring against default for High Yield and Investment Grade corporate paper is making new recent highs.





     In conclusion, economic data suggests that systemic and cyclical risks are still present.  As we have repeated in our previous writings, our overall portfolio stance remains defensive until we gain visibility into credible policy decisions and confidence for an accelerating U.S. and global economy. Therefore, we remain focused on capital preservation, income generation and taking advantage of pockets of value that episodes of risk aversion create.





Christos Charalambous CFA  

Senior Strategist




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