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Six Tail Scenarios That Deutsche Bank Are Watching For Next Year

Tyler Durden's picture




 

Jim Reid and his team from Deutsche have produced another magnificent compendium of information and prognostication in their 2012 Credit Outlook and while their up-in-quality preference (non-financial) may not be earth-shattering strategically, their timing view is of note. Instead of viewing the looming refi-ganza among European sovereigns and financials in H1 2012 as a reason for doom and gloom, they see it as the necessary evil to drive the ECB into the markets in size only for the latter half of the year to disappoint significantly as the reality of the underlying problems rear their ugly head once more. The down-then-up-then-worse-down perspective on markets for next year hardly sounds optimistic but it is the following six scenarios away from European woes that keep them up at night. From the positivity of a US housing rebound or Election year cycle to much more extreme downside risks such as geo-political concerns and non-European sovereign risks, their views on China, QE-evolution and Inflation concerns are noteworthy.

Before the six scenarios though, one of the most interesting longer-term charts we have seen recently for some context of where European Sovereign Yields have been:

 

 

Obviously there is plenty of room for decompression still and that is Deutsche's view of H2 2012 market reactions to another risk flare - but that's tale well told recently.

Six Curve Balls for 2012

1->Disappointing China/EM Growth And Ongoing Geo-political Risks

There does seem to be a complacency that EM growth will continue to be the global engine and help provide the developed world some kind of safety net. What if China does see a hard landing? The imbalances are becoming more intense and with it the risks. Our GEM strategist John-Paul Smith has concerns over China for three main reasons. 1) Inflation is likely to remain stubbornly high; 2) The banking sector is unlikely to be able to help policy easing given the increasing worries over previous over lending, asset quality and subsequent NPLs; and 3) The recent data on deposits and capital flows may be an indication of incipient flight out of fiat money in China as depositors begin to realise the asset quality problems the banks have. JP’s base case is in line with the house view that China will be able to fine tune the economy but it is arguably going to be much more difficult than it has been in the past and as a minimum the country is unlikely to be the driving force for global growth it once was. For more on the challenges for GEMs please see ‚GEM to underperform again in 2012 (6 December 2012) – John-Paul Smith and Mehmet Beceren.

 

A similar view is held by our Asian equity Strategist Ajay Kapur. He suggests the following.

 

"We are increasingly concerned by the combination of high and increasing leverage in China, coupled with an impending peak in China’s working-age population ratio and its level, combined with a rapid ascent in property prices there. Our preliminary work shows this has been a potentially dangerous combination in the past 40 years when and where it has occurred, highly likely followed by a credit and property bust, either brief or prolonged.

 

Timing this is tough, and we are familiar with the "this time is different" list of arguments in China – low mortgage penetration, urbanization, it is a localized problem, etc. It always is different – that is what we heard in Japan, Korea, Thailand, the United States, Spain, Ireland, etc., when confronted with similar combinations of elevated leverage, property price escalation and peaking working-age population ratios. However, it wasn’t that different in the eventual outcome of suffering large capital losses."

 

2->Japan/US/UK Sovereign Risk?

Many believe that Japan could well see a funding crisis. Given its huge debt level it seems unrealistic to think that longer dated bond holders will ever be paid back in full in inflation adjusted terms. As the population ages and savings decrease, the domestic appetite for JGBs will diminish. There is no sign that this will happen in 2012 but with all eyes on Europe it’s important to keep tabs on this situation.

 

With regards to the US, their comparative "safe haven" status has allowed them to be one of the few developed markets without the need for immediate sizeable austerity. The budget problems of August 2011 will start to put some breaks on the debt accumulation but more through politics than being forced to do it by the market. At what point does the market conclude that US longer dated bond holders are unlikely to be paid back in full in inflation adjusted terms. Again this is unlikely to be 2012’s problem but we mustn’t ignore the considerable fiscal issues the US faces.

 

For the UK, austerity and an aggressive BoE seem to have helped turn the Gilt market into a safe haven in 2011. However, these are unusual times and the BoE will likely own somewhere between a quarter and a third of the Gilt market as 2012 progresses (around 24% when the latest round of QE ends at the start of 2012 with more QE likely). Will the market take fright at this level of monetization at some point and will the very weak growth seen since austerity was implemented start to impact the UK’s sovereign worthiness in markets?

 

Maybe the answer to all of the above is that Japan, the US and the UK will benefit while Europe struggles. However, longer-term they all face enormous funding issues.

3->Inflation To Come Roaring Back?

We don’t think this is imminent but we do think that if we continue to print money (which we probably will across the globe in 2012) the collapse of the Fiat currency system that has prevailed since the Gold Standard was abandoned in 1971 could eventually occur. So the path to future fiat currency destruction could be further cemented in 2012.

 

 

Figure 24 from our "Roadmap to the Grey Age" document reminds us that inflation across the globe behaved differently from the Twentieth century onwards. Prior to the twentieth century creating money was difficult to do consistently when most currencies were backed by precious metals. The ease of creating money in the Twentieth century dramatically changed during periods when the Gold Standard was halted (during wars and after the Depression) or post its collapse in 1971. Indeed today we live in a world of total fiat currencies where printing money can occur at the press of a button. Such temptation is going to be difficult to resist given the problems we face. Fiat currencies have lasted as long as they have probably due to Globalisation subduing prices thus offsetting substantial money creation over the last 40 years. We’re not sure such a system can last forever and although 2012 will not be the denuement, this is a key story to think about going forward.

4->Does QE Change?

So far money printing has all been about buying bonds. However there has been doubt about whether this actually helps out the underlying economy. Could the debate change as the year progresses? Will central banks consider buying other assets (equities, real estate) or even policies more in-line with Bernanke’s famous ‘helicopter drop’ analogy? For those that don’t think QE has any impact on long-term inflation because it doesn’t impact wages, maybe a radical solution would be to print money and directly hand the money over to consumers?

This might sound farfetched today but we’ve learnt in this crisis that things that sounded outlandish, say 6 months before they happened, often became mainstream discussion points or actual official policy.

5->US Housing

US housing has now been in decline for nearly 6 years and although it still looks like we have some way to go before we work through the inventory problem it does seem that value has returned to certain areas. While we think it’s too early to sound the all clear, it’s possible we are wrong and any evidence of this is likely to excite the market that the US is finally pulling out of its housing led crisis. So watch US housing stats all year.

6->US Election Years

The often touted perception is that US election years are good for risk assets. Given that 2012 is such a year then we will likely see some talk about the positive ramifications for risk. However, there is an argument for saying that this relationship has changed over the last few decades and also may be deeply impacted in the current environment by an administration that has little ability to provide last minute fiscal giveaways.

 

Indeed Figure 25 looks at nominal returns by year of the S&P 500 since the data starts in 1824, since 1900 and finally from the first full post WWII cycle starting in 1948. In the early decades of this relationship it seemed like election year and the year prior to this saw notably higher returns than the two middle years of the administration. However it does seem that since WWII the year before the election has consistently been the year to see outsized gains.

 

Indeed between 1951 and 2003 (inclusive), 13 of the 14 pre-election years saw double digit S&P 500 gains. 1984 (+5.2%) was the only exception but was still positive. 2007's +5.5% and 2011's +0.85% (to date) returns seem to be telling us that things are again changing post the credit crisis. For the record the last election year in 2008 saw a 37% decline in the S&P 500.

 

We think that this changing trend is because we hit the end of a debt super-cycle in 2007 - that arguably started post WWII. In this new era, the ability of Governments to manipulate spending in accordance with the election cycle has been seriously impacted. So while we always think such analysis is fascinating and relevant we think we are in a period where politicians have their hands tied behind their backs, more than at any point in several generations, thus nullifying the election cycle impact on returns.

 

The other thing to watch is how the fiscal debate progresses as the election nears. This could have a substantial growth and sovereign credit quality impact as 2013 nears.

Much as they say it, these may not all be 2012 'events', but they are certain to all be discussed ad nauseum over the coming year for better or for worse.

 

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Tue, 12/13/2011 - 00:22 | 1972741 slewie the pi-rat
slewie the pi-rat's picture

tales of the tails, BiCheZ!

will the brakes on debt accumulation break?

Tue, 12/13/2011 - 02:22 | 1972942 GiantVampireSqu...
GiantVampireSquid vs OWS UFC 2012's picture

Reserve Banks Buying equities, and dropping money from helicopters, can't wait to get my face burnt by those headlines.

Tue, 12/13/2011 - 02:39 | 1972971 RafterManFMJ
RafterManFMJ's picture

 

 

Q: What's up?

A: A chicken's ass, when it eats.

Tue, 12/13/2011 - 00:21 | 1972746 navy62802
navy62802's picture

Where's the tail up the ass scenario?? Because the lord knows taxpayers are going to get that seventh scenario not mentioned in the article.

Tue, 12/13/2011 - 00:30 | 1972758 slewie the pi-rat
slewie the pi-rat's picture

that particular scenario has been  keestered

Tue, 12/13/2011 - 07:36 | 1973154 jeff montanye
jeff montanye's picture

it was, after all, the dodd-frank bill.  he is an utter (udder?) whore.

Tue, 12/13/2011 - 00:32 | 1972761 I am a Man I am...
I am a Man I am Forty's picture

OT:  MF GLobal's COO, Bradley Abelow (former squid), was formerly on the board of directors of the DTCC, along with Peter Madoff, can't make this stuff up.

Tue, 12/13/2011 - 00:33 | 1972769 moskov
moskov's picture

Haha...

 

UK/US/JAPAN are safe havens?

 

Safe my ass, they are just the ultimate time bombs going to explode into dust very soon.

Tue, 12/13/2011 - 07:39 | 1973158 jeff montanye
jeff montanye's picture

how soon is very?  the post notes they face epic funding problems.  

Tue, 12/13/2011 - 00:49 | 1972803 wandstrasse
wandstrasse's picture

joint statement by the bankers of the world: To prevent the planet from cruel self-destruction and return to barbaric relics, we urgently recommend to install a world dictatorship, driven by bankers. The world will then go on to grow to infinity, the elite will get just rewards for its super-human endeavours and nobody is required to face the truth. Deal?

Tue, 12/13/2011 - 01:23 | 1972857 willien1derland
willien1derland's picture

I am particularly fond of the ideal that all of the toxic debt that exists can only be supported by government driven contrieved currency creation of equal (NO) value!

The only way to save the financial system of the WORLD is to continue to offset the bad & fraudulent actions of the private financial sector past lawlessness with continued bad & fraudulent actions supported by the Central Banks of the world - because OBVIOUSLY the only way to pay for a worthless bond is with WORTHLESS CURRENCY!

Tragic Irony? Poetic Justice? It's your call Folks - Somehow I am reminded of the past cliche' that two wrongs don't make it right...

 

Tue, 12/13/2011 - 01:24 | 1972862 Teamtc321
Teamtc321's picture

No, so fuck off. Let the shit rain as you have planned bitchezzzzz. Call the ball wizard fuck. 

Tue, 12/13/2011 - 00:52 | 1972809 zorba THE GREEK
zorba THE GREEK's picture

The article seems to suggest things will hold together in 2012, but I get the distinct

feeling of a crisis coming before the year end. Just the fact that the Fed, the BOE, and the

BIS found it necessary to sell gold thursday when it started to rise rapidly from 1740 to

1765, smacks of desperation. The markets are only supported by confidence at the present,

and a confidence crises can spiral out of control faster than most investors can react to it.

The MFG failure has exposed weaknesses in the financial institutes which were unknown

to exist to the vast majority of investors. Uncertainty about the safety of assets and investments

is rapidly on the rise. The next negative incident could be the one which pushes confidence off

the cliff and triggers a run on banks and investment houses.

Tue, 12/13/2011 - 07:46 | 1973164 jeff montanye
jeff montanye's picture

the deutsche boys did note that the last u.s. election year produced an s&p 500 return of -37%.  when the money really does switch from bonds and stocks to gold and silver ....

Tue, 12/13/2011 - 00:56 | 1972815 chump666
chump666's picture

Right, right...

Look the big one is China and only China, forget Europe they are gone.  US is a fiscal writeoff...But China smokes them all.   Major slowdown in China via commodities crashing, yet oil is still bid over 90.  Remember China is a net importer. Nice.  Lock in major geo-political event or skirmish and it's highly likely between China and India outside Vietnamese waters.  It's all about energy baby. 

http://www.reuters.com/article/2011/10/16/china-vietnam-india-idUSL3E7LE...

Tue, 12/13/2011 - 01:03 | 1972825 JohnG
JohnG's picture

 

 

Oh just fuck it. 

I'll plant my gardens, feed my chickens and hogs....

Take my physical (BitcheZ).

Bug out to my house in the boonies and just live for the joy of what life I have left.

 

Make the best of what you can, and relax.  Don't allow this assorted crap to consume you; it just is not worth it.

 

Regards to all,

 

JG

 

 

 

Tue, 12/13/2011 - 02:07 | 1972930 Danielius
Danielius's picture

I'm already there.  Well, not at your place. A remote house in a remote corner of Europe with plenty o' farmland.  Heat the house with wood, electric bills about 20 bucks a month. Health insurance about 28 dollars a month.  A half liter can of Carlsberg is just over a buck. Got physical.

Tue, 12/13/2011 - 01:25 | 1972866 monclershop
monclershop's picture

This is my first time i visit here.Moncler ???????? ?????? I found so many interesting stuff in your blog especially its discussion.Moncler ???? ?????? ?????? From the tons of comments on your articles,Moncler ???? ?????? ??????? I assume I am not the only one having all the enjoyment here! Moncler ???????? ???????Sustain the good work.

Tue, 12/13/2011 - 01:30 | 1972877 slewie the pi-rat
slewie the pi-rat's picture

buh-bye!

Tue, 12/13/2011 - 07:51 | 1973169 jeff montanye
jeff montanye's picture

interesting choice of alphabet for a french/italian company's products hawked on an english language website.

Tue, 12/13/2011 - 01:31 | 1972878 CrashisOptimistic
CrashisOptimistic's picture

And once again, ZERO emphasis on oil, which is all that matters.

They are all living in a dream world.

Tue, 12/13/2011 - 01:35 | 1972887 chump666
chump666's picture

Deutsche bank are idoits.  Citi been on the money for awhile, very doomy reports.  Good stuff.  A recaped bank sounding the doomsday bell. As for  European banks, they are living in a DREAM world.  They need to be purged.  See the DAX last session hahahahaha.

The way risk FX (right now) is selling into the Euro open.  Gonna be the same.

Tue, 12/13/2011 - 07:53 | 1973172 jeff montanye
jeff montanye's picture

recaped idoits.  do they regain some super hero mystique? 

Tue, 12/13/2011 - 01:34 | 1972884 Caviar Emptor
Caviar Emptor's picture

The mood is souring. 08 was a wake up call. 09-10 was a reminder. 11 is now confirmation that things are not in a healthy state and we can't go home again. Not without a lot of either thoughtful or thoughtless change and re-structuring. Status quo is a no go

Tue, 12/13/2011 - 02:47 | 1972980 zhandax
zhandax's picture

That's the reason this shit takes so long; to give us the opportunity to make it thoughtful.  Thoughtless runs on auto-pilot and the fuse is lit.

Tue, 12/13/2011 - 01:37 | 1972888 BeatTheMarket
BeatTheMarket's picture

what about USA-Iran war?

Tue, 12/13/2011 - 02:39 | 1972970 CrashisOptimistic
CrashisOptimistic's picture

Iran is way post peak.  They pumped 6 million bpd about 40 years ago.  They are down to pumping 4 million bpd now, but the REAL kicker is they consumed only 400K bpd 40 years ago and now it's almost 2 mbpd.

Meaning, they can only export 2 mbpd of that 4 they pump.  400K goes to Greece (no one else will front them short term credit to buy oil) and 1.6 mbpd goes to China.

You hit Iran, you are attacking China's supply.  There is no other source of 1.6 mbpd for them to access.  They won't ignore that.

Iran is not going to be attacked.

Tue, 12/13/2011 - 03:20 | 1973003 Peter K
Peter K's picture

The biggest tail that DB should be watching is the DEM leaving the Eurozone. :)

Tue, 12/13/2011 - 03:26 | 1973005 Peter K
Peter K's picture

One interesting observation about the graph of the Euroland speads to Germany.

I remember the convergence trade of the Eurozone debt in 1998 very well. Italian rates rallied by 400bp within the span of 3 weeks. The joke at the time was that within 2 or 3 weeks, the Italians became Germans. And then all the Eurolanders became Germans.

This graph shows exactly why Euroland is the mess that it is. Because the Eurolanders ARE NOT Germans.

So what we actually have is the convergence unwind. Mr. Market will take the respective country interest rates back to where they should be plus 12 years of profligacy.

But the money question is, who will pick up the tab for the Franco/German experiment? 

Tue, 12/13/2011 - 07:17 | 1973130 falak pema
falak pema's picture

if italy and spain default all bets are off world wide; so Merkel is in the hot seat and will stay there all through 2012. Market Mayhem should kill the GER/FR front. Unless the shadow bank unwind unsettles City beyond red line. 2012 is now as hot as the St Andreas fault was in 1906 and el Nino in 1999. 

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