11th December 2011: The Cheek Of It! Red-faced Cameron Gets Humiliated By Merkel And Sarkozy As Britain Is Shunned From EU Dealing Room

Quote of the Day:

In this New Normal economic environment of slow economic growth, high volatility and enormous macro risks — some identifiable, but many unidentifiable — we don’t believe ignoring major downside risks is prudent for equity investors.

 

Neel Kashkari – PIMCO

Macro Overview

Merkel and Sarkozy Slap Red-faced Cameron…HARD!

• Britain’s Prime Minister, David Cameron, played his hand exceptionally badly through this EU crisis – he had the perfect hand from the start and yet managed to negotiate himself the worst possible outcome. In this final political climax it appears Britainwas the loser; standing to lose everything from a European collapse and gain nothing from its success. The worst part was that this was Cameron’s time, a perfect opportunity to come up with some creative solutions to the EU crisis that would have worked in the future. Instead, more concerned about his own dissenting back-benchers, he dithered in Europe, causing only anger and discontent. In the end he left with nothing more than a humiliating slap-in-the-face from Merkel and Sarkozy as he was told to “jog on” before he could make any further contribution to the proceedings.
• Now it feels like the Europeans are trying to shoot down their fiscal problems… while Britain has succeeded only in shooting itself in the foot.

Kashkari Explains Why Tail-Risks Avoidance Will Be Critical To Investors In the Future

• In his latest PIMCO piece “Life Finds A Way” Kashkari explains what is needed to produce a book with respectable returns in this new normal. The first two are obvious:

1. Buy stocks at reasonable prices
2. Buy higher-quality companies (not companies which have been riding the high-growth paradigm of the last decade or two)
• However it’s the last criteria, more to do with risk management, which may have surprised PIMCO readers: #3… Hedge the portfolio against “tail risks”

• Here is an excerpt from his piece:

Hedge the portfolio against “tail risks”

We believe investors should look all over the world for cheap hedges against left-tail events – or really bad outcomes. This could be options on equity indices, or currencies or credit instruments. Consider allocating a small amount to spend every year to buy hedges. Most drivers put on their seatbelt every time they get in their car even though they aren’t expecting to get into an accident. It’s a low-cost way of guarding against serious injury. Most equity investors know they are investing in a relatively volatile asset class. So we don’t recommend trying to hedge all volatility. But hedging extreme drawdowns from major market corrections can be a cost-effective strategy. And because many asset classes tend to become highly correlated during times of crisis, investors should look at a wide range of instruments in an attempt to find the cheapest effective hedges.

 

• My dear reader, you know all about tail risks now, it’s been a theme of mine for a while now. Increasing tail risk is not a directional call, remember, tail risks to an economy can risk significantly as the stock market is rallying hard after all we had strong rallies in the US right before the mother of all tail-swipes – The Sub Prime Crisis.

 

China Makes Huge Political Stride Towards Combating Pollution

• A “deal to save the planet” China agrees to make some significant cuts to its pollution. Many think that this is a success by Western nations to pressure China in to forcing change against its will… well, may be… this is what I wrote in one of my most popular pieces a few years ago called “The Latent Costs of Resurgent Chinese Industrialization – Air Pollution”:

Buffett was right, it’s dangerous to bet against China– “they’re going places, but it’s going to be rocky”. But the Chinese economy is one thing, the trajectory or asset prices is another. While I’m sure Chinawill continue to astound us with its growth and the dexterity of its central planning, there are legacy issues, latent costs which are expanding and heaving beneath the crust of the economy and can no longer be ignored. They present a real and present danger to the Chinese growth momentum and need to be systematically tackled today. One of these issues is the environmental impact of a gigantic fast-tracked, time-compressed industrial revolution and, in particular their immediate effects of this environmental toll on society at large. China understands this, the mere fact that they are committing themselves to some very ambitious emissions targets shows that they are sitting up and taking heed – this is no longer just and environmental argument, it has become socio-economic one.

I highlight children because a generation of the young in China are already making great sacrifice for the betterment of future generations beyond whom we have not even contemplated, this of course is one of the greatest attributes humanity. But it is also one of our inadequacies, because not everybody gets the choice.

I am convinced that the coming wave of health issues confronting the next generation of Chinese adults who will be more skilled, more educated, more aware, more politically savvy/active will be simultaneously colliding with the effects of a fast deteriorating and ageing population. China’s Communist Party will face economic, social and political challenges of astronomical proportions. And you think the US has healthcare problems? I wouldn’t bet against the China story, but if you think this is a one-way ticket to Chinese social harmony and economic nirvana… think again.

 

Market Overview

All Eyes On Europe

• By today’s standards it’s been quite dull. All eyes on the European politicians, this will get drawn out into a slow march towards fiscal union but the big moves have been made. Germanywill get what it wants in terms of fiscal union, so too will the ECB , in terms of monetary dominance. One thing for sure the European banks are not out of the woods (see chart of the day for LIBOR-OIS for Euro).

 

Chart of the Day

EUR LIBOR-OIS (Source: Bloomberg)

Events

Macro Events:

Update:

• Japan GDP slightly better than expected

Alerts:

• Japan Inflation
• India Industrial Production

 

Corporate Events:

Results:

• Nothing Significant

Dividends:

• Nothing Significant

 

Reading, Links:

Nothing Significant