Mike Dolan: Playing the US fiscal cliff just like euro survival
Published 09/11/2012 | 17:08
BATTLE-weary investors heading into another intense and market-sensitive period of political brinkmanship in Washington may do well to consult their European campaign maps.
While the two years of attrition in European markets may not be a blueprint for victory per se, they may provide some clue as to how investor minds better equipped to deal with hard data and mathematical models should navigate political minefields.
Global money managers in the United States and around the world have for years expressed frustration and dismay at the inability of Europe's fractious political and national elites to find a silver bullet to end the euro sovereign debt crisis.
The economic and financial solutions are there, many argued. Only political infighting, partisan positions and ideological posturing stood in the way of key compromises to stabilise the bloc and neutralise the systemic threat to the world economy.
That sounds mightily familiar to anyone trying map the next six weeks of U.S. political negotiations to sidestep the looming "fiscal cliff" - which, in the absence of a deal, could see about $600bn of expiring tax cuts and automatic government spending cuts shock the world's biggest economy back into recession.
Figure out exactly how freshly re-elected Democratic President Barack Obama and his opponents in the still Republican House of Representatives thrash this one out and you you'll be fine.
But no one's 100 percent sure how this will go, or at least the precise timing of it. The risks of failure -- however large or small -- are obvious. And what of temporary failure or delay? What about kicking the can down the road again?
A Reuters poll on Friday showed most economists believe an agreement will be reached before the deadline but that partisan bickering beforehand could damage the economy.
"It remains our view that a compromise will emerge as neither side wants to be blamed for plunging the economy back into recession," Keith Wade, chief strategist at Schroders said this week. "The difficulty is that time is limited. Given what we have seen in the past and in Europe today, politicians will want to take any agreement to the wire."
For long-term investors trying to see through the fog, how do you retain your nerve or conviction about the eventual outcome during weeks of stomach-churning market moves as negotiating positions are relayed via alarming news headlines?
This has been the playbook in Europe throughout the euro crisis to date -- a "war" that's far from over given this week's latest anxiety about Greece, the unresolved issue of a sovereign Spanish bailout and signs of sharp German economic slowdown.
Long-term investors typically had four main options:
1) Avoid the eurozone altogether -- nigh-on impossible for massive euro-based pension and mutual funds if not the biggest global funds
2) Seek safety internally within the bloc's perceived safest havens, such as German debt.
3) Take a medium-term view of the outcome that allows you to you pick up short-term pricing anomalies and wait for overwhelming policy response.
4) Tactically play the ups and downs.
This year at least, those who even could have avoided the euro zone completely may have had lower blood pressure and a decent year on Wall Street or in emerging markets so far but they would also have missed some very big euro moves indeed.
Total returns on are up more than 60 percent in Portugal's 10-year government debt, more than 30 percent in Irish equivalents, 23pc in Italian benchmark bonds, and even up 2pc for the asset in eye of the current euro storm -- Spanish 10-year paper.
Given the euro is basically little changed against the dollar since January, these would not have needed currency hedges for most overseas funds either.
Investors who stuck to a medium conviction the euro would survive intact, and that policymakers would eventually do all necessary to support it, would have had a relatively good year to date despite all the apocalyptic commentary.
As for the internal safety trade, once again, the anxiety conscious may have been happier with less than 7pc returns on 10-year German bunds, but that has been less than a third of the 20pc -plus returns on German equities.
For trend-playing tactical traders? Well, if hedge funds specialising in macro trading strategies like this are any sort of proxy for that, then that was possibly the big one to avoid.
Hedge funds, who typically charge the largest fees, have had another miserable year with average returns of just 4.3pc -- according to Hedge Fund Research -- but average macro strategies are actually down 1.3pc year-to-date.
So what are the lessons for those looking at weeks of fiscal cliff angst stateside? Playing the panics and second-guessing daily trends doesn't appear very fruitful in this environment.
Avoiding U.S. assets altogether is much less of an option, not least because global markets tend to correlate more highly Wall Street gyrations anyway.
The temporary safety trade of U.S. Treasuries looks the easiest call for the risk averse but only for those who are increasingly yield averse too. Mainly for those in search of temporary bunkers during thinning year-end markets anyway, this week's moves show that strategy is the default move.
But if, just like opinions on eurozone survival, you believe the U.S. cliff will ultimately be avoided by some form of compromise, then many may simply close their eyes to the headlines and day trades and look at equity market lurches like this week's as potentially big buying opportunities.
And that appears to be where most asset managers appear to sit -- whether that's a complacent consensus or not.
"The fiscal cliff may turn out to be just a distraction. If just a short-term solution is found to the problem, markets should recover fairly quickly," said Dan Morris, global strategist at JPMorgan Asset Management.
"If tough negotiations lead to a drop in equity markets that should be viewed as a buying opportunity."