Tuesday, May 26, 2009

FX and Interest Rate Risks

Tyler Durden at Zerohedge came across a new piece by Bob Janjuah, Chief Stategist of RBS. It reads like all the stuff I have been obsessed with.

http://zerohedge.blogspot.com/2009/05/deep-thoughts-from-bob-janjuah_26.html

Here are some excerpts -

“Investing in risk only on the basis of 'liquidity' led to the crash of 2001/2002/2003 (where we blew up corporate balance sheets with debt), as well as the current crash of 2007/2008/2009 (where we blew up consumer balance sheets with debt), to which the Pavlovian response has been to blow up government balance sheets with debt.”

“Investing just because retail are buying has never been a strategy I would want to follow. And as for trading, YET AGAIN I am hearing a lot of the 'I'm just playing momentum, and will be smart enough to get out in time ahead of the turn' trading strategy. Have the events of the last few years taught us NOTHING?!?!”

Heyidiot.com...

Like I have been saying, all the Government has done is move the responsibility for all the bad debt from the Banks to the Taxpayers. My biggest fear all along is that there is nobody large enough to bail out the Fed…

“we are either at or close to the limits of fiscal 'support' so it is uncertain how much more debt even the public sectors can credibly get away with. At the same time, it is clear that at the moment the only 'solution' policymakers in Anglo-Saxon can come up with is more of the same that got us into the debacle we are faced with, namely the reflationist policy of PRINT/BORROW/SPEND/BUY MORE RUBBISH WE DON'T NEED/PUSH THE PROBLEMS INTO 'TOMORROW' & PRAY IT GETS BETTER - its all about avoiding taking the adjustment/the hit.”

Avoid the pain at all costs. Why lay somebody off when you can print a few billion and keep him employed another year in an inefficient job that produces nothing of value?

Why go through the efforts of renegotiating Trade Agreements to bring real Middle Class Jobs back home, when you can print a pile of money and pretend that consumption fueled by lending is better than investment fueled by saving?

Why cut spending when you can issue 30-year Bonds that the kids will have to pay off some day?

“As such, all this really means to me is that if the WEAK H2 09 scenario does play out as we having been saying all year, then we should expect a quantum increase in the scale/levels of QE (Quantitative Easing) the FED and BoE (Bank of England) may be forced to undertake, as this will be the only way, absent a real and sustained pick up in the private sector (which we CAN'T see at all) to create nominal growth.”

Inflate away the Debt is the game plan. The best way to do this is to crash the Currency. Short of an actual economic recovery, the only way to get rid of the Real value of all of the Debt is to inflate it away.

“Since early 2007 the Credit market has been the driver/lead indicator for markets. As the policy response has been to load up all the risks & debt onto public sector, going forward THE LEAD DRIVERS WILL BE FX (Foreign Exchange Rates) & RATES (Interest Rate) MARKETS, in terms of levels, direction and volatility, and NOT the Credit or indeed Equity markets. IN OTHER WORDS, just focusing on what S&P and/or the Crossover index is doing is NOT going to be enough.”

What this means in English is that the risks going forward will be how your assets’ Real Prices hold up versus a falling Dollar and rising Interest Rates. You will need to be aware of how a falling Dollar and rising Interest Rates impact your holdings – hint both will be bad, especially to Bonds.

“all I can see ahead are higher VOLS (volatility) in both markets and the real economies of the world, a higher risk free rate, higher hurdle rates to investment, and more selectivity around capital allocation and investment.....this means Risk
Premia MUST be higher....

Higher risk premia means LOWER PEs.....combined with profit outlook which is basically flat on 08 for 09 and 2010 at least, this means STOCKS ARE TOO HIGH.”

Historically, when you have been in periods of rising Inflation and Rising Interest Rates, investors become risk averse – therefore, stock valuations fall. This is also a result of the fact that as Bond Yield increase, they become more attractive to own than Stocks, so their Prices fall relative to the Earnings they generate.
The bottom line of this piece is to warn investors that the real risks going forward are a falling Dollar, rising Interest Rate, falling Bond Prices and cheaper Stocks relative to current valuations.

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