With the last week of the year approaching and talks towards preventing the Fiscal Cliff back to the start. It is a wonder that Friday’s drop wasn’t seen more often this month. In fact the S&P was up almost a percent in the past week. With the $600 billion in spending cuts and tax increases days away how can so many in the markets be this relaxed? I think it is a condition where the outcome of not striking a deal so severe that investors prepare to be pleasantly surprised. The conditions that would face the US economy and the markets, if a deal is not reached, are so inconceivable and short term a strategy would be impossible to put together or out of date at a moments notice.
I believe that markets have room to grow but in the short term it is hard to determine if we will have another 20% drop in a matter of weeks or if the really is sustained. Bond yields are getting so low that they seem a death trap other than in the worst of conditions (conditions that warrant losing money in real terms at a steady, but predictable, clip). Fixed income will have to start seeing yields rise on order to stay competitive to equities; the absence of Fiscal cliff and Euro zone breakups threats, will see investors run to other risk assets as central banks around the world stoke inflation like never before.
I have liquidated the strategy for the year and will be posting the final write up after Christmas. I will also be looking to build the next strategy for the New Year and will try to start taking a more detailed, stock specific approach as well.
Futures are down 1.5% on the news of the abandonment of ‘Plan B’. This means that the fiscal cliff talks that have added around 2% to the equity markets in the last 5 trading days has been reset to zero. As the deadline approaches I think the downside of these setbacks will outweigh any positive talks, until a real resolution is reached. Coming down to the wire on the talks will no doubt spike volatility and create a flight to safe haven assets. This will play nicely into building a short position on certain fixed income assets that I do not believe will perform as well in the next year. High yield bonds being the main FI asset that I think have seen the best of its returns behind it.
The talk about the shadow banking system in China has me thinking about the possibility of a disorderly unwinding when the Wealth Management Products (WMP) start to have liquidity issues. Because a lot of these are funded by traditional banks there could be the potential for spillover into the mainstream banking sectors. This is not a sure short however, but more a study in the methods of Chinese intervention to bailout these banks, should issues occur, and the legal system. Many of the depositors into these WMP assume that they are low risk, almost like a money market fund, though the money is sometimes invested in some longer term, real estate assets which could cause issues with liquidity once outflows in these funds exceed inflows. Then the question of who is liable for the losses will come into play. While the funds do not guarantee capital preservation, it is implied that you will be made whole (much like money market funds).