The Battle of the Headlines

Globally we're looking at positive economic headline numbers and indicators around the world, while the political headline risk is much more extreme than it was in 2008.

Positive employment growth, low interest rates, and positive economic growth numbers are present in most major markets, with most attention focused on the Euro area, UK, China, Japan, and the USA.  In support of economic stability and growth, there is a sense of creditworthiness of both companies and governments.  Recently, both Puerto Rico and Greece have been able to tap the global debt markets, and France continues to be in good standing with credit agencies despite zero positive reforms since 2008.

Political risks are omnipresent, and the fate of the financial markets depend on the outcome of the current battle of the headlines.  Further Russian involvement in Ukraine is certain; the escalation of competing territorial claims by China and Japan continues; crude oil exporters are politically, and in some cases economically, unstable (Russia, Iran, Iraq, Libya, Venezuela, the 'Stans, and now, with elections and rating downgrades, even Brazil).

Current scenarios include a derailing of the Japanese economy as a result of economic sanctions/barriers to trade between China and Japan - this would be an economic shock to the Japanese economy and would totally derail Abenomics, resulting in political instability and the re-emergence of the question of Japanese creditworthiness.  A failure of diplomacy would not be as immediately dire for China, but, if Japan was to claim the loss of any internationally recognized territory to China, the USA would be forced to retaliate, and this would take the form of economic sanctions.  Full economic sanctions would cripple the Chinese economy.  Escalating political problems between China and Japan could, in retrospect, be identified as a black swan event.

The situation in Ukraine is developing in such a way that it's hard to see a positive resolution.  Gazprom, and Transneft and other Russian commercial interests are obviously damaged.  Within Ukraine there are pro-Russian "separatists" in the east, and Ukrainian nationalists favoring nationalizing Russian owned assets - both give rise to the excuse for continuing Russian incursions.  In Ukraine it could very well be that we're looking at a gigantic black swan unfolding its wings and readying for flight.  Ironically, whether the EU recovery will be crippled by these events will be decided in Zug, Switzerland - where the Nord Stream AG shareholders and board include the "who-is-who" within both the EU commercial and political elite, all headed by an ex-secret police/intelligence officer from former East Germany.

There is tremendous "positive" inertia supported by the economic headline numbers, but, equally, the realization of any of the current political risks could play havoc with markets.  To date we have seen the high momentum (technology, social stocks) plummet from their 2013 lofty valuations.  This rotation initially benefited large caps, but this last week has seen capital continue to rotate and US government bonds have become the ultimate beneficiary.  Market price action clearly informs us that we are in a "risk off" environment.

No matter which set of headlines wins this round, there will be near term (within 6-24 months) price inflation in both soft and energy commodities, higher USD interest rates across the board, and a weaker Yen.  These are all "non-binary" outcomes.  In the short term, let's hope our friends in Zug manage to keep a lid on Ukraine, allowing us leisurely contemplation of political and economic problems in all the usual places.