Tags: US | China | dollar | long term

Nothing Is Forever

Tuesday, 07 Jan 2014 10:31 AM

By Hans Parisis

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At the start of this new year, I thought it would be a good idea to remind long-term investors to temper their expectations and to not become complacent.

As those of you who follow me here know, I have been relatively positive about the U.S. economical fundamentals as well as the dollar for quite some time. This doesn't mean I'm under the illusion the United States is fully shielded or protected from another potentially turbulent period this year, particularly because of Congress' kick-the-can habit. Rising yields could also disturb the markets after an initial pullback.

By the way, that same kick-the-can habit, even to a much larger extent, is also true for the euro area, but here I still don't have that same positive attitude/expectations as for the United States because, at least in my opinion, the eurozone crisis is not over yet. No, not by a long shot now that after the German elections any form of debt "mutualization" is definitively off the table and the absolutely urgent and necessary adjustments, especially in the periphery member states, will be implemented through austerity and price deflation. No, bringing down debt through inflation, debt forgiveness or even default will not be allowed as long as Germany will be calling the shots in the euro area.

Besides all that, long-term investors should ask themselves about the euro itself. How much longer will we have a situation where negative euro area data releases fail to undermine the single currency while positive releases only serve to underpin it? Nothing is forever, and that applies also to the relative strength of the euro we have been witnessing so far. Be prepared so that you don't get surprised when the tide turns! Also, never forget the eurozone is not Germany and Germany is not the eurozone.

Coming back to the United States for a moment, it's a fact the U.S. economic recovery continues gaining strength/momentum, and if UBS is right, we should expect a solid growth rate of about 3 percent in 2014.

That said, long-term investors would do well not taking the recovery for granted. As outgoing Fed Chairman Ben Bernanke said last Friday, the overall recovery "remains incomplete." However, at the same time he gave an upbeat commentary on the economic outlook in the United States.

Besides many other reasons, the shale energy revolution is providing substantial economical benefits to the United States, which is on its way to practically full energy independence in the foreseeable future.

Now that the Senate has confirmed Janet Yellen to lead the Fed for four years beginning on Feb. 1, and as she is considered by many on Wall Street as a "dove" (doves are more concerned about employment than with inflation, which are the Fed's two mandates), I'd like to refer to what former governor of the Bank of England Mervyn King said during a prepared speech in October 2012: "[P]olicy measures that are desirable in the short term appear diametrically opposite to those needed in the long term."

Let's hope Yellen has knowledge of the content of Mervyn King's 2012 speech. Yellen's appointment will become most relevant when in 2015 it comes to monetary policy tightening.

Of course, the Fed can't do everything and has to remain within the limits of its dual mandate and therefore the risks are still out there if Congressional wrangling over debt management re-emerges in a similar disruptive way as it did the last time. If that would be the case, it's not an overstatement to say there could be a serious probability that confidence of the United States' creditors could be tested and there could be the possibility some of the creditors could become tempted to consider an alternative course away from the dollar dependency. Of course, we aren't there yet, but it certainly can't be disregarded as well.

Looking to China, I remain suspicious of the profound structural issues, such as their colossal "shadow banking" time bomb, which refers to the lending/financing universe outside the classical banking system, that lurk beneath the headline growth figures and the very serious challenges they will inevitably bring.

I still don't expect a serious disturbing event this year, but you never know. Anyway, the Chinese authorities have pledged they won't allow any bank to go bankrupt in order to avoid panic. While 2015 is still far away, I think if until then they aren't able to put order in the shadow banking sector we could be in for nasty surprises.

In Japan, they'll have to face the challenges of the looming fiscal reform and the hike in the dreaded sales tax that will rise from 5 to 8 percent in particular. So far, nobody really knows if Prime Minister Shinzo Abe's historic gamble on Abenomics, which stands for combination of aggressive quantitative easing from the Bank of Japan, a surge in public infrastructure spending and the devaluation of the yen, will one day pay off. If not successful it will be "fasten your seatbelts," but I wouldn't start worrying now as I think we are still some time away from the final outcome. Remember that Japanese public debt represents more of 200 percent of its GDP and exceeded 1 quadrillion yen ($10.46 trillion) in 2013.

Finally, as far as geopolitics is concerned I still think Iran with its nuclear capability remains a serious risk. If there is an agreement with the United States this year, that outcome will definitively change the political power balance/imbalance in the Middle East. If that would be good or bad, only time will be able to tell.

Taking all this into account my preference remains concentrated on "safe" investment possibilities, while trying not to be part of bubbles, in the United States, as well as the dollar, at least for now.

Remember, nothing is forever and that is also true for my preferences. I always try to be able to adjust in case I think it's necessary. Believe me, that's easier said than done.

In this context, I want to add I still believe in physical gold, no, not paper gold, but I wouldn't be a buyer now as I still think gold remains in a longer-term downtrend, which doesn't mean we couldn't see a nice short-time pop.

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