Monday, May 24, 2010

How Governments Brought Uncertainty and Risk Back Into Capital Markets

Several pieces of information or opinion I received over the weekend leave me with the clear sense that the recent, sudden slide in US equity market prices is very clearly attributable to actions of governments around the world. As such, what governments, including Germany, the Euro community, and the US Congress and Fed have done is effectively inject fear and uncertainty into investors in global capital markets.

For example, PIMCO executive Mohamed El-Erian penned an opinion piece in the weekend Wall Street Journal discussing the return of the "nervous weekend."

Referring, originally, to US government weekend triage actions in the fall of 2008, now it's European governmental entities providing the stream of market-roiling actions.

Among El-Erian's observations were,

"I fear that markets may not get sufficiently reassuring answers any time soon to these questions.

There is still a deep hesitancy among European policy makers to acknowledge that the approach to rescuing Greece is incomplete. But few outside observers are fooled by a strategy that results in a further increase of the country's already excessive debt-to-GDP ratio, relies too heavily on a blunt and draconian fiscal policy instrument, and sustains a debt overhang that will deter new investments and amplify an already painful drop in GDP.

The bottom line is simple yet consequential: The disruption in financial markets is not a garden-variety market fluctuation. Instead, it's an over-due recognition that the global economy faces an uncertain future that involves slower growth and greater government regulation."

In another Journal editorial, columnist Jason Zweig focused on professional investor Seth Klarman's recent comments in an interview he gave to Zweig at the CFA Institute's annual meeting. Among the remarks attributed to Karman were,

"The government is now in the business of giving bad advice. By holding interest rates at zero, the government is basically tricking the population into going long on just about every kind of security except cash, at the price of almost certainly not getting an adequate return for the risks they are running. People can't stand earning 0% on their money, so the government is forcing everyone to speculate.

All we got out of this crisis was a Really Bad Couple of Weeks mentality.

I am more worried about the world, more broadly, than I ever have been in my career.

Will money be worth anything if governments keep intervening anytime there's a crisis to prop things up?"

And, finally,

"Sometimes, when you can't figure out a good defense, the best thing to do is to go on offense."

Finally, the US Senate passed a dysfunctional, horrible financial regulatory so-called 'reform' bill authored chiefly by a retiring Chris Dodd, who is beating a hasty path home to Connecticut ahead of corruption charges over his sweetheart mortgage deals from now-defunct Countrywide.

New Hampshire GOP Senator Judd Gregg, also retiring, but for different reasons, contended this morning on CNBC that this bill is a knee-jerk reaction to show voters that Senators will punish "Wall Street."

He ticked off a number of serious flaws in the bill, and noted that, surprisingly, House financial committee chairman Barney Frank actually has a Senate bill further to his left than to his right.

Take all of the actions these three people have noted, together, and you have a heretofore rising, low-volatility US equity market turned upside down in just a little over three weeks.

When governments lie about their finances, e.g., Greece, and then attempt to duck responsibility and consequences, followed by uncoordinated fiscal policies among the Euro's members, and the US Congress adds to fears with bad legislation, global investors are rightly concerned.

In fact, my volatility measure, which is calculated differently from, but tends to track the VIX, has hit recent highs in the past week.

Count me among those who believe this equity market swoon is by no means over, nor is fear out of the equity markets by a long shot.

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