Tags: Syria | long-term | Europe | US

Prepare for Correction in US, European Markets

Tuesday, 28 May 2013 09:01 AM

By Hans Parisis

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Since Federal Reserve Chairman Ben Bernanke's testimony last week before the Joint Economic Committee of Congress on how he sees the economic outlook, it's now all about when to taper or to taper less, which would mean the economy and employment are really improving, or not tapering at all and even tapering more, which would mean the economy or employment are not getting better. Confusing, isn't it?

By the way, Credit Suisse research expects the Fed likely to taper in September, which would be without any doubt an issue for the equity and bond markets in the United States and in many other important places.

From my side, I don't expect the Fed to start tapering until they have softened the beaches, which could easily be until the end of the year. But I also expect the Fed coming a day late and a trillion dollars long.

In the meantime, equity markets seem not to worry too much and appear to continue building on the shifting sands of grossly mispriced markets for equities and bonds, especially in the United States, but also in Europe.

Anyway, for having a somewhat better idea on how the U.S. economy is performing we'll have to wait until May 30 when the first estimate of second-quarter gross domestic product (GDP) growth will be released. A decent number of experts now expect GDP to come in below 2 percent.

That said and because of what's going on in Europe, remember that as a long-term investor, one should always try not to disregard geopolitics, even if practically all of the time this is an extremely complex subject to sufficiently, let alone fully, understand in the context of its economical and therefore consequential financial impacts over the median- to long-term time horizons.

On May 27, the 27 EU foreign ministers surprisingly "agreed not to agree on a former decision" and cancelled, in response to the demands of France and the United Kingdom, their embargo on arms to the Syrian rebels. The EU arms embargo will now "automatically" come to an end June 1. In my opinion, this should not be underestimated in any context.

To me, this action confirms once more my view of the European Union, as well as the eurozone, as rowing boat where everybody should row at the same pace, but instead, many choose their own pace and therefore the boat barely moves forward or even starts spinning in circles from time to time.

It must also be remembered that all other foreign ministers besides those of the United Kingdom and France haven't demonstrated any desire whatsoever to send arms to the Syrian rebels, hence nothing legally binding could prohibit them to change their mind at any time in the future.

This EU foreign ministers' disaccord on their previous accord will certainly not help to reach a "trustworthy" compromise at the coming international conference on Syria next month in Geneva, Switzerland.

I mention this fact because it adds serious risks for the Syrian situation spinning out of control into a full-blown regional conflict between on the one side the Shia Muslims, including the Alawites, which count Syrian President Bashar al-Assad in their ranks, and on the other side the Sunni Muslims.

Long-term investors would do well to watch out for the spillovers if such a situation would develop (hopefully not!) over the near to median term. Now, saying such a situation could be the catalyst for a perfect storm is certainly far-fetched.

Nevertheless, in case such a situation would occur at a moment when, for example, the United States faces another fiscal cliff that causes another recession in the United States, or a soft landing in China is turning into a hard landing (which cannot be excluded at all), or the eurozone crisis resurfaces with a vengeance (no, that threat has not gone away, that's for sure) or Israel starts its war against Iran, which causes oil to spike to the $200 per barrel zone, then, no doubt, the globe could suffer another perfect storm. Of course, the probabilities of one or more of these situations occurring are still extremely small. But that doesn't mean it should be considered as completely impossible.

I still expect a correction in equity markets, not only in the United States, but also in Europe. If I personally had funds to invest today I'd prefer to remain in cash in U.S. dollars. I'd like to keep my exposure to risk as low as possible.

On Europe, I want to mention the fact that Peter Praet, chief economist of the European Central Bank (ECB), stated the ECB is operationally ready for negative rates. He also mentioned the ECB is well aware that when deposit rates are reduced to negative numbers there may be unintended consequences.

Long-term investors should keep in mind the ECB still has room to lower its key interest rates, which could bring the euro at lower levels.

On Japan, we can say that "Abenomics" is performing "so far, so good" with a weaker yen, which I still expect to weaken further to 105 yen per dollar or even weaker (110) within the next 12 months. If that is a good thing for the rest of the world, including the United States, is a completely other subject. Personally, I'm convinced it isn't.

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