From the beach in Goa

As expected, markets closed lower on Friday, but by not as much as expected and, indeed, off their lows.

My very clued up friends advise me that there is a wall of money from investors who have missed the recent rally and who are ready to buy on any dip. I have no doubt that they are right and, indeed, even if markets don’t correct shortly, I suspect that these guys will be forced in, especially as we near the end of the 1st Q. However, the market has rallied to a point where, in my humble opinion, risks are beginning to outweigh prospective returns. After all, how much more will markets rally. By 5%, possibly 10%, seems to be the consensus – I’m afraid that’s not enough to interest me, in particular, given the macro/geo political risks. In addition, personally, I hate consensus views, though, I suspect, I’m also beginning to get a bit less confident as to the sustainability of the current rally.

We all know that Greece will default and, quite frankly, I’m going to reduce my coverage of that country significantly – its far too boring and has played out for far too long. In addition, a Greek default, apart from the initial knee jerk sell off (good opportunity to buy the market, I suspect) is, I believe, almost fully priced in and, most likely, good news for the rest of the Euro Zone.

Portugal, well the Euro zone will need to provide additional funding. Furthermore, a conversation between the German Finance Minister and his Portuguese counterpart, caught on an open mike, confirmed that Germany ie the Euro Zone, will provide additional support – it will certainly be necessary and, in my opinion, deserved. The Euro Zone has to be prepared to offer a “carrot”, in addition to the stick (austerity measures). In any event Portugal has to be saved, or the rest of the Euro Zone is kaput.

The Germans, whilst playing hard ball with the Greeks, are sympathetic towards the Portuguese, who are introducing radical structural changes to improve their (previously non existent) competitiveness/lack of growth – unlike the Greeks. In my humble view, contagion threats remain limited following a Greek exit, especially as a result of the ECB’s 3 year LTRO. Indeed, Portuguese bonds continue to rise – the 10 year yield declined further to around 12.85% on Friday (yields were even lower during the day and nearly 600bps off recent highs) – even after the nonsense with the Greeks. I really should have followed my own advice and bought the bonds – Oh well, that’s the problem of being a 1 man shop.

Whilst yields on Portuguese debt are declining, yields on Italian and, in particular, Spanish bonds, rose. Indeed, Spanish bond yields are converging towards Italian yields. No surprise – I remain firmly of the view that Spain is in far worse shape than Italy and, I suspect that the market is (finally) beginning to get it.

Over the next month or so, the market will begin to focus on the upcoming French Presidential elections. The opposition (Socialist) candidate, Monsieur Hollande is in the lead in recent polls. However, don’t write of Sarkozy, my French friends tell me. France is struggling – there is no doubt of that, but a President Hollande is something we don’t need at present, irrespective of your views of Monsieur (“bling bling”) Sarkozy – actually he’s being less “bling bling” these days. However, whilst Hollande’s continues with his rhetoric ie that he will renegotiate the austerity pact etc, etc, we all know that, if elected, he wont be able to. Mrs Merkel is rooting for Sarkozy, which is amusing as the two of them do not get along – its “better the devil you know….. ” principle, as far as Mrs M is concerned.

One of my best friends lambastes me on my views on China. Well, if I’m wrong on my China derivative plays (short the miners, luxury sector, A$ and quite, likely EM’s) I will lose money – my own money, may I add.

As far as I’m concerned, all recent available data (OK, a bit too early to establish an totally informed view), suggests that the Chinese economy will slow by more than expected. Friday’s loan data came in below expectations. Sure the Chinese authorities have the firepower to introduce stimulus measures (likely) and ease, though with oil at around US$118 and food prices not declining by much, indeed if at all, combined with the policy of raising wages, inflation could well rear its ugly head again.

January’s inflation data was impacted by the Chinese New Year and should decline in coming months, but, I for one, am not quite as certain as other analysts that inflation will continue to drop sharply in the 2nd half of the year, especially if oil remains at current levels and food prices remain elevated. Remember that China imposed, in effect, price controls to curb “reported” inflation last year. These measures have resulted in suppliers reducing production – something that cannot be sustained. Indeed, China recently allowed prices of petrol and diesel to rise to deal with shortages created by their price control policy – the 1st time in 10 months. If they allow others to increase prices…….

Basically, my problem with China remains the same. I believe, quite firmly, that any action taken by the Central authorities to correct (much needed) previous imbalances (of which there are many), will have a significant negative impact on the economy, with resultant social consequences. In addition, in my experience, I do not believe that a command economy can grow by the rates that China has, uninterrupted, for an extended period of time.

I remain (ever increasingly) bearish on Japan. A friend of mine reminds me of the dreadful demographics of the country, in addition to the other issues I have raised – he’s totally right – its going to be a massive problem for the Japanese.

My well established/positioned Indian friends, whilst generally sanguine are, however, certainly becoming far more cautious than they have been. I always listen to these guys – they are way, way better than any analyst, I assure you.

The US economy is improving – recent data confirms that. I trust it will continue. I was surprised by the weaker University of Michigan confidence data though, given better employment data and job openings (JOLTS survey).

I’ve found in the past that I (generally) make money on my high conviction calls, though then proceed to fritter some/all of it away due to over trading. That’s something I’ve changed significantly for some time now. I suppose the real issue is that I have no real high conviction play at present – the negative China derivative play comes close, but I accept is not quite there as yet. Having said that, I believe that there will be numerous opportunities in coming months and, as a result, patience is called for.

Having said that, there’s the Roubini/Rosenthal contrarian index !!!!

I’ve had a great YTD, particularly on my over long European financials play – a truly fabulous start for the year. As a result, I suspect, I can afford to be a bit cautious and wait to see how things pan out. In the current economic climate, there will be lots of opportunities and I just do not feel like chasing a rally, which seems pretty long in the tooth to me.

Probably loving being a beach bum here in Goa as well.

Have a great weekend.