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RCS Investments Market Outlook Mid 2012

RCS Investments Market Outlook Mid 2012

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Published by Rodrigo C. Serrano

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Published by: Rodrigo C. Serrano on Jul 06, 2012
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07/10/2013

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Market Outlook (Mid- 2012)
Rodrigo C. SerranoNew York, NYDirect 305-510-0181Email Uformula.rcs@gmail.comWebsites:http://rcsinvestments.wordpress.comhttp://rationalcapitalistspeculator.tumblr.comhttp://www.linkedin.com/pub/rodrigogserrano
 July 5, 2012
 Executive Macro SummaryGlobalization’s dark side has arrived. The global economy is currently held hostage by a political crisis in the Eurozone, critically harming the already weak foundations of the globalrecovery.Fiscal prescriptions demanded by Germany and other core-countries have led to recessions throughout the periphery, along with increasing nationalism. While last week’s announcementfor a euro-wide banking regulator, to be instituted by the end of the year, drew worldwideacclaim and caused a powerful rally in risk markets, the accord is unlikely to eliminate thefestering wound threatening our global economy. There’s a dangerously high probability thatEurope’s announcement has come too late and that European officials will find themselvesobligated to take very uncomfortable and hurried steps towards fiscal union in the months tocome.Meanwhile ongoing austerity in Europe has led to a “larger than expected” slowing in China,as the export-dependent country’s largest client is falling into a deep recession. Chineseofficials have instituted policies aimed at both subduing the country’s buoyant real estatemarket and moderating inflation. With no significant stimulus on tap, I am skeptical that thecommunist country can withstand an exogenous economic and financial shock emanatingfrom the Eurozone.Finally the Eurozone crisis has begun to affect U.S. consumers and businesses. Confidenceand clarity in future growth have diminished. Job creation and business investment haveslowed. The national savings rate just hit a 4-month high and is a testament to the growing worry over events transpiring across the Atlantic. We are currently in the midst of a crisis of confidence, which may lead to the self-fulfilling prophecy of global recession.The coming year may mark the next disorderly phase (2008 was the first) of what I’ve called the “Global Economic Restructuring” process; which has been the fundamental macro trend to recognize and track over the past few years. Continued intervention and manipulation on the part of political and monetary officials have delayed this adjustment and in fact have
 
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 worsened today’s large imbalances. Indeed, they have created an uncertain environment,damaging confidence for long-term investment.To be sure, government officials will likely continue to intervene in our capital markets shouldeconomic conditions continue to deteriorate. These actions may cause bullish shifts insentiment as well as powerful relief rallies, especially given that investors have grown toembrace central bank intervention as a panacea. However, in the absence of significant fiscalstimulus (both in the U.S. and Europe), monetary authorities may find themselves unable tostop the eventual process of restructuring that needs to take place.The coming years are likely to remain turbulent as China continues on its course to become the “world’s consumer,” as the U.S. was for many decades, while the U.S. and most of Europeretool their economies to feed China’s eventual insatiable consumer demand. There are wildcards in regard to the long-term direction of the global economy however, the mostsignificant being in the presidential election this coming November.Regardless, if world leaders can successfully navigate the treacherous waters of globalrestructuring over the coming years, eventually today’s seemingly endless period of weakeconomic performance will lay the foundation for a powerful secular bull market that may lastfor decades.Until then, investing today will require flexibility, risk management, and a willingness toembrace the fact that buy-and-hold investing has taken a back seat for the time being.-------------------------------------------Current Investment EnvironmentBoth bulls and bears are wrestling for control of U.S. equity markets. Recently Europeannounced a solid step forward towards fiscal union, agreeing to institute a region-wide banking regulator by the end of the year, while core-countries allowed the use of bailout fundsfor direct capital injections to ailing banks. Officials also renounced the preferred status of  the bailout funds vs. peripheral sovereign debt, putting to rest the lingering concern of seniority over sovereign bondholders. In the U.S., the housing market has provided forincreased optimism that the worse is finally over for the real estate market. The job market, while slowing, is showing signs of resiliency. Alternatively confidence in any Eurozone solution has waned markedly after 19, 20 (lostcount) summits without a sustainable resolution. Moreover, economic data has beendepression-like in the Greek and Spanish economies, while Germany is showing signs of infection. Finally, Eurozone austerity is having a profound effect on the Chinese economyand may be hitting U.S. shores given last week’s ISM manufacturing data.
 
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 What will be pivotal in the coming weeks and months is if Eurozone officials successfullyconvince investors that plans announced at the latest summit are plausible and will beimplemented. Investors are on edge and confidence remains fragile. News of stabilization inChina or a reacceleration of the U.S. recovery would entertain optimism and could pushEurozone concerns to the backburner until the end of the year.OutlookI don’t have sanguine expectations for a market-friendly solution in Europe and remaincautiously bearish on the outlook. While the results of the summit were encouraging, theycontained no immediate actionable items, only promises. Funds from the EFSF/ESM will likely be unavailable until a region-wide banking regulator is set up…by the end of the year.Officials may not have until then. Confidence is falling and economic activity seems to befollowing suit; deteriorating data is reducing confidence even more. A negative feedback loopis developing. Ironically, buying time is becoming counterproductive, as continued austerity promotes weakness and misery, sapping political will and promoting disunity. Astrengthening negative feedback loop may ignite a crisis of confidence and spark a rush to thenearest exit. With an elevated likelihood of an exogenous shock from Europe, I remaincautiously bearish on China as well.Meanwhile at home, earnings growth has decreased markedly and earnings estimates have been trending lower for most of the year. Furthermore, margins are at historically high levelsand likely signal that gains due to productivity have ended. Given further slowing in theglobal economy, there’s a high probability that earnings have peaked for the cycle.Sentiment wise, there is increasing bearishness; however, there are signs that investors remain too optimistic for what may come around the bend. The underlying hope that Europe will take care of business still remains, as does the seemingly unflappable belief that furtherquantitative easing will juice risk markets. I am increasingly skeptical. There is a growingrealization that quantitative easing has not produced a sustainable recovery and that its costsoutweigh the benefits, both in the economy and the markets. Further, how effective willmonetary stimulus be in the face of a contraction in fiscal policy?Should the Eurozone splinter, I fully expect another quantitative easing operation, which is likely to produce a strong short covering rally. However, in the absence of expansionaryfiscal policy and strong growth in the global economy, will it really make a difference in thefundamental picture? More importantly, will investors see it as a difference-maker after twofalse dawns?-------------------------------------------

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