The market may have found itself in the purgatory of the summer doldrums, where unlike last year this time, not only are volumes over 50% lower, but volatility is non-existent, but that doesn't mean that investors are sleeping easy. In fact, quite the opposite because as the following chart from MS confirms, the lack of market volatility merely mimics the complete chaos and lack of decisiveness in Congress, where each passing day brings America not only closer to the most contentious presidential election in ages, but to another debt ceiling hike debate, and, of course, the fiscal cliff. All of these combined have brought US policy uncertainty to the third all time highest level, on par with September 11 and the collapse of Lehman/TARP, and just short of last year's imminent European collapse, which was only staved off courtesy of the coordinated global central bank intervention on November 30.
As for Europe, fughedaboutit
In the US, the main uncertainty is about the upcoming elections in November and the related resolution (or non-resolution) of the fiscal cliff, the 5% of GDP automatic fiscal tightening that would result from current legislation. This has led our US team, which does not expect the issues to be resolved before the election and sees increasing evidence that the uncertainty is affecting corporate and consumer spending decisions, to downgrade its 2H12 growth forecast twice over the past two months. The renewed recent rise in uncertainty is illustrated in a new measure of policy uncertainty constructed by academics from Stanford University and Chicago University, which combines the intensity of press coverage of policy-related uncertainty, the extent of disagreement among professional forecasters on inflation and government spending, and the frequency of scheduled tax code expirations. The authors show a strong link between their uncertainty measure and economic outcomes.
In the euro area, the main uncertainty is over if and how the current debt crisis can be resolved and whether a break-up of the euro can be avoided. This form of uncertainty rose strongly during 2Q, following the LTRO-induced sugar-rush early in the year, and induced our European economists to slash their outlook for 2H12 and 2013 in late July, with the euro area entering a renewed recession as we write. Exhibit 4 shows the European Economic Policy Uncertainty Index from the same source as the US one, with a sharp rise in the middle of last year after the Greek PSI decisions and a renewed rise in recent months.
And as we said before, anyone hoping that the Fiscal cliff issue will be resolved cleanly, clinically and efficiently, is advised to invest in Las Vegas real estate alongside John Paulson because "housing has bottomed."