Remember the phrase “kicking the can down the road”? Of course you do. You can’t forget it, because everyone uses it to describe the European debt crisis with sickening frequency. (Marketplace made a lexicographic inquiry into the origins of the phrase, and the Wall Street Journal‘s Total Return blog riffed on it.)
Rebecca Patterson, the chief market strategist for J.P. Morgan Asset Management, and her colleague Michael Hood understand this lexicographic dilemma and share our frustration. Today, they put out a Christmas wish list, of sorts, that tracks the number of press mentions of overused words, mocks them, and also explains the bank’s outlook for the global economy. Easy Street enjoyed the note, so we reprinted it below, with J.P. Morgan’s permission.
The Global View: Terms I wish would disappear in 2012
Rebecca Patterson & Michael Hood
As 2011 winds to a close, and we think about New Year’s resolutions and wishes, there are a few terms that I wish would fade into memory along with the year:
- kick the can,
- muddle through,
- bazooka,
- EU summit,
- hard landing,
- downgrade.
What are the chances we can start 2012 with different, and hopefully more upbeat vocabulary? Let’s consider each term in turn, so to speak.
Kick the can. Surprisingly, a Factiva search only showed this phrase in about 3,000 news articles during 2011. The term felt even more overused, however, when thinking about other media (especially TV). “Kick the can” was most often used to describe what felt like politicians’ bias to postpone making tough decisions and instead implement short-term, temporary strategies. In Europe, “kick the can” included providing incremental financing for Greece and other peripheral countries in return for increasingly strict fiscal policies. In the U.S., “kick the can” was used mainly in context of politicians not addressing longer-term U.S. fiscal challenges, both in August but also in November with the so-called super committee.
Will we see more can-kicking in 2012? Certainly, it feels that way, at least from a European and U.S. perspective. The mid-December battle in Congress over extending certain stimulus measures, with one proposal giving a two-month extension (rather than the previously discussed one year), feels like can kicking. And implications for the U.S. economy in 2012 are not trivial. Indeed, we estimate that an extension of stimulus measures, supporting growth, would help pull down the U.S. unemployment rate towards 8% by end-2012. Absence of such action would leave, all else equal, the jobless rate closer to 9% over the same period. The sentiment towards U.S. growth will influence not only U.S. asset trends in the year ahead, but also global risk appetite.
Europe also seemed destined to keep can kicking into the new year on a number of fronts. One problem facing Euro area leaders is that dealing with any one of their major challenges – Greece’s apparent insolvency, other peripheral countries’ tenuous access to primary markets, and the possible undercapitalization of the region’s banks – seems to exacerbate the other problems. The decision to seek “private sector involvement” in writing down Greek debts, for example, touched off large-scale selling of peripheral bonds in general, widening spreads for other countries; similarly, the move to ask banks to boost capital ratios accelerated de-leveraging in general, tightening financial conditions. These unintended consequences have then produced a softening of original positions. Meanwhile, leaders, now heading towards a new Treaty to tie EMU states closer together, seem likely to “kick” the self-imposed March deadline (past Treaties have taken as much as 2 years to get through national ratification processes).
- Muddle through. Factiva noted 2,795 mentions of “muddle through” during the last 12 months. The term seems fairly synonymous with “kick the can” – not fixing things but not letting them worsen, either. The difficulty with both terms is that they imply a level of persistent uncertainty, which in turn will keep volatility supported. That was felt in 2011: Volatility across asset classes was at the highest levels since the 2008-2009 financial crisis. The normally quietly trending U.S. 10-year Treasury yield saw a dramatic 12-month trading range of more than 200 basis points. Meanwhile, the second-half of 2011 saw 61 days in which the S&P 500 had intraday moves of more than 2%. Such volatility has only been surpassed three times since 2000.
Political and policy uncertainty (recall in 2012 we have elections and political transitions representing more than half the world’s GDP) suggest volatility will remain high in the year ahead. With that in mind, we expect investors to increasingly consider alternatives – giving up liquidity as a tradeoff for lower-volatility returns.
- Bazooka: Factiva noted 3,667 mentions of “bazooka” during the last 12 months. In July 2008, then-Treasury Secretary Paulson told U.S. lawmakers that “if you’ve got a squirt-gun in your pocket, you may have to take it out. If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out… By increasing confidence, it will greatly reduce the likelihood it will ever be used.” The bazookas of 2011 generally referenced Europe’s crisis. Europe’s leaders hoped to lever the European Financial Stability Facility (EFSF), making it into a bazooka; funds from the IMF were also seen as a possible bazooka, as was a potential ECB commitment to stabilize peripheral bond yields. With implementation generally falling short of rhetoric and hopes in these areas, though, markets never became convinced that a bazooka existed. As of Dec. 20, the Euro Stoxx 50 was down nearly 20% for the year, versus the S&P 500 that was down less than 2%.
The term “bazooka” will likely fade from common usage in 2012, less because Euro area politicians will finally find a bazooka and more because they appear to have given up looking for one. For governments, the focus has shifted away from near-term crisis management and toward medium-term steps in the direction of greater fiscal integration. Meanwhile, ECB President Draghi, while stepping up liquidity available for European banks, has made it clear that his institution will not make sweeping, open-ended commitments, but will instead continue intervening in bond markets on an ad hoc basis, serving as a backstop rather than as a solution. Indeed, Draghi has urged governments to take the lead in resolving the crisis. This combination – politically constrained governments working to build an ambitious new fiscal architecture for the region, along with an ECB that catches the plates before they hit the ground – may serve to contain the crisis but will inevitably be accompanied by a lot of muddling through and can kicking.
- Hard landing: More than 8,300 media mentions of “hard landing” were made over the last year. While some referred to the U.S. and Europe, most were focused on China. Now the world’s second-largest economy, China was under the spotlight for its potential to help cushion the fiscally led slowdowns across developed markets. While consensus is for a “soft landing,” an annual growth slowdown to only 8-8.5% or so in the year ahead, fears of a hard landing have helped weigh on local and regional markets. Over the year (through Dec. 20, Bloomberg data), the Shanghai composite index, for example, fell by more than 21%.
While we cannot rule out a Chinese “hard landing” in 2012, especially should the local property slowdown take a bigger bite out of growth than expected, our base case is that this term will fade as the year progress. We believe China will continue to ease monetary policy (partly via further cuts to reserve requirements) to support growth. Administrative measures and even fiscal policy could also come into play to keep growth over 7% (the GDP target set out in the government’s latest 5-year plan). We would highlight that next year, China’s budget deficit is set to be only about 2% of GDP. Especially in a political leadership transition year, we believe China will have motivation, and fundamental means, to cushion growth to avoid a “hard landing,” though we may not have sufficient evidence of that outcome to motivate regional bulls until late in the first half of 2012.
- EU Summit: The last year saw more than 21,000 written media mentions of “EU summit.” With good reason – over the course of the year, there were at least five summits (February, May, July, October and December) with a lot of pre-meetings leading up to summits in between the actual events. Progress at these events was made to help peripheral countries, including the establishment of the European Stability Mechanism (ESM), new aid for Portugal and Greece, and agreement to work on a new Treaty. The time it took to reach these decisions, however, and then to implement them, left investors in doubt. Over 2011, even with these summit actions, the yield on a 10-year Italian government bond rose from 4.82% to 6.61% (Dec. 20, Bloomberg data).
For better or worse, 2012 will have more EU summits, as countries try to move beyond national political considerations to do what’s needed for the Euro area. If 2011 proves any guide, we would expect the days leading up to the events to be risk-friendly, but the weeks after the events seeing profit-taking as the reality of the challenge resurfaces. The volatility is likely to limit interest in many European assets for the near-term at least, capping potential upside despite what are increasingly attractive valuations.
- Downgrade: the most noted term on my list was “downgrade,” at more than 134,500 articles over the last 12 months. While some of these “downgrade” mentions were related to companies, the greater relative focus for markets was on sovereign credits. Through the end of November, developed-market sovereigns saw 32 downgrades (and no upgrades), including an unprecedented downgrade of the U.S. by S&P. In contrast, emerging-market sovereigns over the same period saw a greater number of upgrades than downgrades. What triggered the waterfall of developed downgrades? Much of it had to do with “kicking the can” and “muddling through” – not enough decisive action by policymakers to address longer-term debt dynamics in a low-growth environment.
As we enter 2012, it seems likely that the ratings-action divide will grow wider between developed and emerging markets. Even now, we are waiting for S&P to announce its decision on 15 Euro area countries, put on negative watch ahead of the December EU Summit.
At the margin, we believe this “downgrade” focus will influence two investment trends into 2012. First, we believe that the combination of attractive yields and fundamentals (in absolute terms and relative to developed-market peers) will support capital flows into emerging market bonds. Second, the bias lower for developed-market sovereign ratings, along with questions about the ratings process and the lack of diversification in a sovereign bond bucket could lead more investors to question their fixed-income allocation guidelines. We would not be surprised to see some deep thinking – and related action – on this front in the year/s ahead, with one probable result being a somewhat greater tilt in bond allocations towards corporate debt.
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