Jack-in-the-Box or risk Pandora’s Box

Even as economies and earnings recover, focus on rolling restructuring is likely to broaden. Overdue as a check and balance, until 2010, it appeared overlooked by authorities and by markets. In replicating pre-crisis behavior, the resulting Jack-in-the-Box responses of easy money from authorities and of momentum-itis in the markets have risked a Pandora’s Box further along. Restructuring demand has been selective but its Its vehemence is partly an indirect consequence of quantitative ease with low interest rates and potentially a direct result of a lower threshold of acceptability for leverage than as recently as in 2009.

Back in 2007, U.S. housing was at the epicenter alongside credit default risk. However, the real tussle is over momentum that comes to the fore during relative stability and fundamentals that come to the fore during enhanced volatility. In the nitty-gritty, we start with gold, oil and the U.S. dollar exchange rates. While we have gold as hedge against uncertainty, now at 17.1x crude oil (at $71.9/bbl wti and gold at $1231/oz), it is no longer underappreciated. The risk epicenter now is over European sovereign deb t but the Euro at $1.23 is now near our $1.20 target and Japan is not immune. Global stability next needs yen decline from 92 to 110-120/$. China would now be advantaged by Renminbi appreciation as would emerging economies. In the markets, focus on sovereign risk has as corollary, country and corporate balance sheets. Increased global focus on financial regulation and transparency has as corollary, market leadership and earnings growth assumptions. However, since the 2009 trough to recent highs, markets moved on low quality and finance expectations of the 2006 variety. We believe continued monetary tightening in emerging economies, the growth implications of sovereign risk tightening in advanced economies and increased global regulation of allowable risk in financials are contributing to greater realism in deliverable growth. It appears to be in early stage and volatile change, incomplete until financial strength performs demonstrably better.

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