Oops -- This Thing Still Isn't Over!

Last week I noted that I was ready to dip back into the market (one day prior to BoC Governor Mark Carney's pessimistic take on the market) but I have since had some cold feet. I stayed with bonds (high grade corporate and government) and don't see changing this in the near term.

And an article in the online Economist dated yesterday vindicates this. I'll let them tell it:

The bad news is that today’s stability, however welcome, is worryingly fragile, both because global demand is still dependent on government support and because public largesse has papered over old problems while creating new sources of volatility. Property prices are still falling in more places than they are rising, and, as this week’s nationalisation of Austria’s Hypo Group shows, banking stresses still persist. Apparent signs of success, such as American megabanks repaying public capital early (see article), make it easy to forget that the recovery still depends on government support. Strip out the temporary effects of firms’ restocking, and much of the rebound in global demand is thanks to the public purse, from the officially induced investment surge in China to stimulus-prompted spending in America. That is revving recovery in big emerging economies, while only staving off a relapse into recession in much of the rich world.

This divergence will persist. Demand in the rich world will remain weak, especially in countries with over-indebted households and broken banking systems. For all the talk of deleveraging, American households’ debt, relative to their income, is only slightly below its peak and some 30% above its level a decade ago. British and Spanish households have adjusted even less, so the odds of prolonged weakness in private spending are even greater. And as their public-debt burden rises, rich-world governments will find it increasingly difficult to borrow still more to compensate. The contrast with better-run emerging economies will sharpen. Investors are already worried about Greece defaulting (see article), but other members of the euro zone are also at risk. Even Britain and America could face sharply higher borrowing costs.

Big emerging economies face the opposite problem: the spectre of asset bubbles and other distortions as governments choose, or are forced, to keep financial conditions too loose for too long. China is a worry, thanks to the scale and composition of its stimulus. Liquidity is alarmingly abundant and the government’s refusal to allow the yuan to appreciate is hampering the economy’s shift towards consumption (see article). But loose monetary policy in the rich world makes it hard for emerging economies to tighten even if they want to, since that would suck in even more speculative foreign capital.

These worries are compounded, I think, by the U.S. Fed's (and to a lesser extent the BoC's) focus on the phantom menace of inflation that appears to be giving recovery short shrift. Hence my comfort with bonds. So the fat lady may be warming up, but she's not on stage yet.