Tuesday, 24 January 2012

The long and winding road


Stock markets have been extremely resilient this year, in contrast to some of the doom laden messages that appeared at the beginning of the year.  Moreover, the tone of the press seems unremittingly gloomy, particularly in the retail space where a number of companies have shut their doors for the last time. How can we explain this paradox?

Well, partly it is the nature of equity markets to look forward rather than at the present.  This, in part, explains some of the turbulence we experienced during the third quarter of 2011.  The fog bank that lay across the end of the year, made denser by procrastination among the eurozone leaders as they grappled with sharply rising government bond yields, showed no sign of lifting and what shapes could be seen through the mist looked extremely unpleasant and threatening.  Cue a market pull back.  In essence, markets were reacting to the prospect of the economic situation that we are now experiencing.

So what has changed?  In my opinion, two things.  Firstly, the announcement by the European Central Bank in December that it would provide liquidity of around €500 billion to European banks over a three year period shows that Mario Draghi, the new president, has a determination to deal with the problem that seemed altogether absent from his predecessor.  Secondly was an announcement from the heads of all of the major central banks that they would provide whatever liquidity was required to ensure the efficient operation of the global financial system. These measures should, therefore, mean that the likelihood of an imminent collapse in the banking system has been headed off at the pass for the foreseeable future (accepting, of course, that visibility is still an issue!).  The net effect has been that equity markets, rather than focusing on the grim realities of the here and now are beginning to look to the future.  

There will undoubtedly be further slips along the way as the current impasse between the Greek government and its creditors have shown.  The progress towards a sustainable fiscal future for the developed world will inevitably involve some “issues”.  Nevertheless, perhaps that glow on the horizon might just be the dawn of a brighter future rather than the smouldering embers of what remains of the financial system.

ROB BURGEMAN

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