Saxo Bank Quarterly Outlook Q3 2010: The Crisis is not contained

Published July 1st, 2010 - 08:19 GMT

Saxo Bank, the trading and investment specialist, has launched its economic outlook for the third quarter in 2010. It says that the crisis is not contained and that markets will react negatively to the continuation of the huge imbalances in government debt markets. The Bank maintains expectations for very low policy rates in the foreseeable future, says David Karsbøl, Saxo Bank’s Chief Economist.

The Bank predicts equity prices to fall based on the assumptions that a slow-down in China seems likely, continued destabilisation in PIIGS (Portugal, Italy, Ireland, Greece, Spain) debt markets will demand a response from less insolvent Eurozone members and cuts to Government spending will be draconian.

The earnings season is expected to be strong but only because of cost-cutting activities rather than topline growth. Karsbøl does not expect inflation and topline growth any time soon. Worries about the reset of Alt-A (Alternative A-Paper) and Option ARM (adjustable rate mortgages) in the US and a further surge in defaults and delinquencies will also contribute to a negative drift in equities.

Commenting on the outlook, David Karsbøl, said:

“The current PIIGS debt crisis is not contained and the only way to get rid of it is by cutting budget deficits much quicker and much more dramatically than what is currently being done. Profligate Government spending is crowding-out private investments and consumption, and we expect markets to react negatively to the continuation of the huge imbalances in government debt markets. The German budget cuts for example are a good start, but they are not enough.”

Karsbøl also said:

“It’s clear that macro themes have regained dominance in the equity space. We do not expect earnings to double dip but to level out, and while we see a short term recovery in risk as corporations are likely to report good earnings, we simply have not come to grips with the problems laid bare by the crisis. Volatility in FX is likely to swing sharply higher in response, so our advice to investors is to remain cautious.”

The Quarterly Outlook Q3 2010 reflects on the following areas:

General market comment
Contrary to common perception, running big deficits kills growth, and that is especially the case in the current cash-strapped environment. According to Saxo Bank, the market will have to worry about larger imbalances created by continued reckless government spending, which has happened in the sell-off in May. However, the analysts believe that there will be some optimism linked to the strengthened corporate earnings to be announced in the coming earnings season.

Macro forecast
In the US, the stimulus is already waning and will probably dry out in the second half of the year. Saxo Bank thinks that there could be a negative contribution to growth in late 2010, and investment will be subdued due to low capacity utilisation and a residential sector which has a large overhang of unsold properties. For Japan, Saxo Bank expects further growth, but the pace is likely to decelerate and Japan's export-led growth will be hurt by the Euro's weakness. Saxo Bank believes there is no doubt that too much debt is the fundamental problem for many countries in the Eurozone, but other imminent issues are restricting economic activity. Private spending in the third quarter will be dragged and the soft labour market is not helping matters.

FX Outlook
Saxo Bank suspects that the Eurozone situation and its effect on risk appetite generally will remain important. However the analysts also feel that this theme is occupying far too much of the market's attention relative to other macro themes that could come to the fore in the coming quarter, such as commodity currency countries suffering under the weight of tremendous housing bubbles, austerity and the new impetus towards public deleveraging, and the growth hopes for China and Emerging Markets being up for debate.

Equity Outlook
The analysts continue to expect further hurdles for equity markets in the second half of 2010 which will keep the risk premium higher for an extended period and lead to lower earnings expectations for 2011 and 2012. However they predict bounces in equity markets as earnings are likely to surprise to the upside.

Commodity Outlook
Risk adversity driven by worries about the level of sovereign debt and the subsequent risk of a double dip recession will stay in the third quarter. The analysts feel that the high for the year has already been made and that the risk heading into the second half of 2010 points towards lower prices. Continued dollar strength combined with the global recovery heading into slow motion will leave the market well supplied and subsequently put downside pressure on prices.

Policy rates
Saxo Bank’s Strategy Team maintains its expectations for very low policy rates in the foreseeable future.

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