Dawn of a year of trading dangerously

From Reuters
Out with the old year, in with the new and for investors uncertainty is likely to be the only certainty once more.
The euro zone debt crisis is far from resolved, turmoil in the Arab world has shifted to Syria and Iran has threatened to stop the flow of oil from the Gulf if sanctions are imposed due to its nuclear ambitions.
2011 was a dire year for equities outside the United States with world stocks poised to drop by around eight percent and emerging markets faring far worse.
Crude oil has been among the best performers with a roughly 10 percent increase and gold has matched it as a loss of confidence in the euro zone accelerated a flight to bullion.
So where next? The answer to that question depends on whether you believe policymakers in Europe, Asia and America will muddle through or whether a new cataclysm is imminent.
While the global economy remains shaky, central banks will maintain ultra-low interest rates, a potential fillip for stocks as bond yields languish in countries viewed as safe havens.
Globally, inflation should subside though the path of oil prices is hard to discern given the tumult in the Middle East and Gulf.
Signs of a modest U.S. revival and China's ability to gently massage down economic growth in order to prevent inflation taking off will be key for the markets but the euro zone remains the great imponderable. Italy alone faces frightening debt refinancing hurdles in the first four months of the year.
Having proved remarkably resilient all year, the euro is ending the year on a downslope, breaking below key support levels to its lowest point in 2011. An Italian bond auction on Thursday saw yields edge down but only slightly.
"Given the scale of its funding requirements, there are still big concerns about Italy's ability to get through 2012," said Nicholas Spiro of Spiro Sovereign Strategy. "Next quarter is going to be all about Italy."
Next week sees the release of purchasing managers' indices for January and December inflation figures, a first new year gauge of the euro zone's economic malaise. In terms of debt supply, France and Germany, but not Italy, come to the market.
While there are plenty of pessimists predicting the euro zone cannot survive in its current form after its leaders failed to construct a "bazooka" big enough to scare the markets off, others believe there is potentially enough in train to take the sting out of a debt crisis now well into its third year.
The combination of the European Central Bank's provision of unlimited three-year liquidity for banks, steps towards deeper euro zone fiscal integration, the prospect of the IMF getting more crisis-fighting funds and an agreement to bring forward the currency bloc's permanent rescue fund to mid-2012 may point to some relief ahead without the need for "shock and awe" measures.
William de Vijlder, chief investment officer at BNP Paribas Investment Partners, believes the incremental progress made by the euro zone is too easily dismissed.
"The liquidity which has been put in the system via the first 3 year LTRO ... in combination with an overweight of low yielding low risk assets and safe havens create a huge pent-up demand for risky assets," he said. "The big question is when this will be unleashed. 2012 is about spotting this catalyst."
Dan Morris, Global Strategist at JP Morgan Asset Management, is essentially in the same camp.
"As long as Greece advances enough with its reform program for the IMF and EU to continue supporting it, as long as the ECB aids the banking system, and as long as Italy and Spain persevere with their own fiscal adjustment programmes, confidence should slowly return," he said.
"Those looking for another summit and a definitive resolution that 'solves' the crisis will probably be disappointed."
On the other hand, European funding of the International Monetary Fund is not yet agreed, the permanent European Stability Mechanism may not get enough firepower in investors' eyes, and ECB money may be hoarded by banks facing demands to raise capital levels rather than lent to business or invested in bonds. Possibly most crucially, the lack of a European growth strategy could condemn countries like Greece and Italy to a downward spiral of recession that prevents them cutting debt.
Plenty of experts maintain that only much more aggressive buying of government bonds by the ECB - something it is highly reluctant to do - can buy the euro zone enough time to reform.
Ratings agency Standard & Poor's is expected to downgrade any number of euro zone sovereigns in January and maybe as soon as next week, putting a big question mark over the 'AAA' rating of the bloc's existing bailout fund. However, given that threat was delivered three weeks ago, it may already be priced in.
If catastrophe is averted, equities could be the best long-term bet not least because investments in traditional safe havens will almost certainly lose money - inflation-adjusted yields on U.S., German and British government bonds are all negative.
The State Street Investor Confidence Index dipped slightly in December but showed glimmers of optimism in Europe.
"European investors are more optimistic than their North American and Asian peers for the second consecutive month," said State Street's Paul O'Connell. "It does not necessarily mean that prospects for the European region itself have improved, but it does suggest that European institutions are more willing to allocate to equities both inside and outside Europe than they were earlier in the year."
Philipp Baertschi, chairman of the investment committee at Swiss private bank Sarasin, also believes that for those in for the long haul equities could be cheap, barring a deep recession.
"Investors who believe that a long-lasting global depression is very unlikely and can tolerate fluctuations in returns should have a correspondingly high equity weighting in their long-term strategic asset allocation," he said.
In a world where sovereign debt either offers no return or has become highly risky, blue chip stocks or high-grade corporate debt, ideally of companies with hefty emerging market exposure, remain many money managers' investments of choice.
But given all the uncertainties - who could have predicted the Arab Spring this time last year or the devastation wreaked on Japan - picking the right moment to dive in will be hair-raising.
"A very nasty outcome, with a collapse of the euro zone triggering a steep global recession, perhaps exacerbated by structural problems in China, is not impossible," HSBC global equity strategists said in a note. "But, since equity valuations are inexpensive and investors already bearishly positioned, an upside surprise cannot be ruled out either."

Euro creeps higher but vulnerable into 2012

From Reuters
The euro edged up versus the dollar on Friday with risk appetite underpinned by upbeat U.S. data but with the euro zone crisis unresolved, investors were likely to sell the single currency again in 2012.
A drop in U.S. weekly claims for jobless benefits to a 3-1/2-year low and improved U.S. consumer sentiment in December boosted stocks and kept the euro afloat, though traders said flows were light as year-end holidays approached.
The single currency was up around 0.2 percent for the day at $1.3079, holding above a recent 11-month low of $1.2945. It is however down around 2.1 percent on the year.
“The dollar is still seen as a funding currency when risk appetite improves and people will sell dollars on the back of that,” said Chris Walker, currency strategist at UBS.
“But we still see uncertainties in the euro zone outweighing and look for a move towards $1.25 in the next few months.”
Traders highlighted some stop-loss orders in the $1.3120 region, which if hit could push the euro higher in thin markets.
The Wall Street Journal reported the Federal Reserve could commit to keeping rates near zero right out to 2014, saying the U.S. central bank could announce the decision at its next policy meeting on Jan 24-25.
But with the threat of sovereign downgrades hanging over the bulk of the euro zone, sentiment towards the single currency remains bearish heading into the new year, with the liquid dollar likely to be supported.
Two independent European government sources told Reuters on Friday that Standard & Poor’s is not expected to release its verdict on debt ratings for 15 euro zone countries until January.
Doubts over whether this week’s huge European Central Bank tender of cheap loans will be effective in easing the strain for troubled euro zone economies are likely to keep peripheral sovereign bonds under pressure.
Italian paper in particular is expected to come under renewed strain as the country faces a major refinancing hurdle early in the new year.
Many market participants say heavy buying of Italian and Spanish debt by the ECB is required to ease concerns over the precarious finances of the two countries.
Departing ECB Executive Board member Lorenzo Bini Smaghi said on Thursday the ECB was able to scale up its actions if needed and said quantitative easing could be an option.
“The lower-than-desired growth rates in broad money and credit and the downside risks to price stability will likely be the catalyst in driving the ECB to increase its bond buying programme early next year and will be presented as a way to counteract them,” said BNP Paribas in a note.
BNP recommended selling into any year-end rally for the euro and highlighted the $1.32-1.3250 area as tough resistance.
Morgan Stanley analysts expect the euro to be among the worst performing G10 currencies next year as the deteriorating economic outlook in Europe, continued ECB easing and liquidity measures, together with portfolio outflows, weigh on the currency.
A break below $1.2945 in the euro would open up a test of the 2011 trough at $1.2860, traders said. The euro was hovering near all-time lows against the Australian dollar on diverging economic fundamentals between Europe and Australia.
The single currency slipped to an all-time low around A$1.2841, for a loss of 1.8 percent on the week, and as the euro’s 25-day positive correlation with European stocks has weakened of late, analysts expected the euro to continue to lag the risk-sensitive Aussie should asset markets rally in 2012.
Against the safe-haven Swiss franc, the euro was steady at 1.2229 francs, not far from the cap of 1.20 introduced by the Swiss National Bank in September.
The dollar index was down 0.2 percent at 79.779, while the U.S. currency stayed supported at 78.00 against the yen. The United States is due to release personal spending, durable goods and new home sales data later in the day.

Fragile euro edges higher, helped by U.S. data

From Reuters
The euro edged up versus the dollar on Friday with risk appetite underpinned by better U.S. data, but investors were likely to sell the currency again in 2012 while the euro zone remained plagued by uncertainty surrounding its debt crisis.
A drop in U.S. weekly claims for jobless benefits to a 3-1/2-year low as well as an improvement in U.S. consumer sentiment in December boosted stocks and kept the euro afloat, though traders said flows were light as year-end holidays approached.
The single currency was up around 0.2 percent for the day at $1.3075, holding above a recent 11-month low of $1.2945. It is however down around 2.1 percent on the year.
“The dollar is still seen as a funding currency when risk appetite improves and people will sell dollars on the back of that,” said Chris Walker, currency strategist at UBS.
“But we still see uncertainties in the euro zone outweighing and look for a move towards $1.25 in the next few months,” he added.
Traders highlighted some stop-loss orders in the $1.3120 region, which if hit could push the euro higher in thin markets.
The Wall Street Journal carried a story late Thursday that the Federal Reserve could commit to keeping rates near zero right out to 2014. The report claimed the Fed could announce the decision at its next policy meeting on Jan 24-25.
But with the threat of sovereign downgrades throughout the euro zone hanging over the euro, sentiment towards the currency remains bearish heading into the new year, with the liquid dollar likely to be supported.
Doubts over whether this week’s European Central Bank tender of cheap loans will be effective in easing the strain for troubled euro zone economies are likely to keep peripheral bonds under pressure. Italian paper in particular is expected to come under renewed strain as large scale refinancing is needed in the early part of the new year.
Many market participants say heavy buying of Italian and Spanish debt by the European Central Bank is required to ease concerns over the precarious finances of the two countries.
Departing ECB Executive Board member Lorenzo Bini Smaghi said on Thursday the ECB was able to scale up its actions if needed and said quantitative easing could be an option.
“The lower-than-desired growth rates in broad money and credit and the downside risks to price stability will likely be the catalyst in driving the ECB to increase its bond buying programme early next year and will be presented as a way to counter act them,” said BNP Paribas in a note.
BNP recommended selling into any year-end rally for the euro and highlighted the $1.32-1.3250 area as tough resistance.
A break below $1.2945 in the euro would open up a test of the 2011 trough at $1.2860, traders said. The euro was hovering near all-time lows against the Australian dollar on diverging economic fundamentals between Europe and Australia.
The single currency slipped to an all-time low around A$1.2841 , for a loss of 1.8 percent on the week
The New Zealand dollar dipped briefly on news of another earthquake near Christchurch but soon steadied at $0.7738 , up from $0.7724 late in New York on Thursday.
Against the safe-haven Swiss franc, the euro was steady at 1.2229 franc, not far from the cap of 1.20 franc introduced by the Swiss National Bank in September.
The dollar index was down 0.2 percent at 79.818, while it stayed supported at 78.02 against the yen.

Asian shares up as US data spur year-end bounce

From Reuters
Asian stocks rose more than 1 percent and U.S. index futures also gained on Friday, as signs of a strengthening economy in the United States encouraged a year-end bounce for riskier assets.
European shares were also expected to open higher, helped by a 0.5 percent rise in S&P 500 index futures that pointed to further gains when U.S. trading resumes.
Wall Street stocks had risen for a third straight day on Thursday, leaving the S&P 500 index virtually flat for the year, after data showed new claims for unemployment benefit dropped to their lowest in 3-1/2 years.
The euro crept higher, but remained subdued amid doubts over whether this week’s European Central Bank tender of cheap loans will be effective enough to ease the financial strain on troubled euro zone economies.
“The highlight is the continuation of good data on the U.S. economy. China also seems to have managed to orchestrate a soft landing...,” said Ben Le Brun, market analyst with OptionsXpress in Sydney. “The problem child is still Europe.”
MSCI’s broadest index of Asia Pacific shares outside Japan rose 1.2 percent, with Australian and Korean shares both rising more than 1 percent . Tokyo’s financial markets were closed for a holiday.
Spreadbetters called London’s FTSE to open up 0.6 percent, Frankfurt’s DAX up 0.9 percent, and Paris’ CAC-40 up 1 percent.
Asian share markets, both developed and emerging, have sharply underperformed U.S. stocks in 2011, with the MSCI Asia ex-Japan losing 17 percent, and the Nikkei share average down about 18 percent, while Australia’s benchmark has lost about 13 percent. The MSCI World index fared slightly better, losing only 10 percent this year.
Citigroup equity strategists said in a note that Asia had seen its worst December fund outflows in 20 years as investors continued to pull money out of global equity funds.
The euro crawled up to around $1.3067, from $1.3050 late in New York, in thin trade.
The ECB’s first ever tender of ultra-cheap three-year loans on Wednesday, which saw 523 banks gorge on a total of 489 billion euros, has failed to win the single currency much support.
But despite the long-running debt crisis, the euro is only down around 2.4 percent for the year, having found support from higher ECB interest rates in the first half of 2011 that pushed it to a year high near $1.50 in May.
“People are diversifying away from U.S. dollars and that’s what it comes down to,” said David Scutt, a trader at Arab Bank Australia in Sydney.
“Despite the fact the U.S. economy is strengthening, there are still expectations in the marketplace that the Fed has showed it’s very keen to print at the best of times, and that’s helping the likes of the euro.”
The U.S. Federal Reserve has kept interest rates near zero for more than three years and has signalled it will keep them there through at least mid-2013. It has also bought $2.3 trillion in long-term securities to push down borrowing costs.
The New Zealand dollar dipped briefly on news of another earthquake near Christchurch, but soon steadied as there were no reports of casualties or widespread damage, unlike the previous quake in February.
It was trading at $0.7745, up from $0.7724 late in New York.
The rosier picture painted by the U.S. data supported commodities, with copper, which is sensitive to expectations of industrial demand, rising 0.5 percent to $7,575 a tonne, on course for its first weekly gain in three weeks.
U.S. crude oil edged up slightly, drawing closer to $100 a barrel, while Brent crude was little changed just below $108.
Gold inched up 0.2 percent to around $1,609 an ounce.
The precious metal has shed more than $300 since racing to a record above $1,920 in September, an appreciation driven partly on fears that the Federal Reserve’s monetary easing steps would stoke inflation against which it has traditionally been seen as a hedge, but remains up around 13 percent on the year.

As euro steadies, fund managers hedge bearish bets

From Reuters
The European debt crisis roiled markets all year, producing the most volatile trading since the 2008-2009 meltdown. That is, except in one market -- the euro.
Fund managers that bet on a volatile, wild year of losses in the euro are paring back positions against the single currency going into 2012 after its surprising resilience to Europe's sovereign debt crisis damaged their portfolios.
Many still expect market turmoil arising from Europe's debt situation and have kept options strategies that will benefit from volatility. But they have put on trades that will pay off as well if the euro zone recovers from the crisis.
While Europe's debt drama kept markets on edge for most of the year, the euro is only down 2.6 percent against the dollar in 2011.
That is not as bad as headlines from the crisis might have suggested. This slashed returns for investors who paid premiums for strategies aimed at capitalizing on a sharp fall.
"Our mistake this year, especially in the first half, was looking a lot at headlines in the euro zone and trying to read the politicians' complete nonsense," said Harald Hild, portfolio manager at FX fund of funds Quaesta Capital in Zurich, Switzerland.
Hild runs the FX Volatility fund under the Quaesta group, with assets under management of about $3 billion.
"For most of the year, we were in a risk-off mode and we were paying high premiums for downside strikes in the euro and nothing really happened. So we started to look at it from a different perspective."
Investors generally pay for downside strikes, or lower exchange rates, when they believe the currency is going down.
Hild said the fund still expects the euro to go lower in 2012, but he'd rather hedge this view using calendar spreads, which involve entering a long and short position on volatility -- a measure of a currency's moves in either direction -- but with different tenors.
This strategy essentially plays on expectations of where volatility is headed over, say, a one-year period. If an investor expects euro/dollar volatility in the short term, but sees subdued price movement in 12 months, then he goes long one-month volatility and sells one-year volatility.
So far, Quaesta's volatility program has recovered, albeit slowly. The volatility fund was up 2.2 percent in November and 1.9 percent firmer so far this year in a performance that Hild describes as "disappointing".
WRONG-FOOTED
What appears to have wrong-footed investors betting against the euro in 2011 was that European banks sold assets abroad to bring funds back home to cushion against troubles in the European financial sector. This repatriation process provided unexpected support to the euro.
Particularly in October, currency managers were caught on the wrong side of the trade as stocks and commodities rallied and the euro gained 3.5 percent.
The Parker FX index, which tracks currency managers, was down 1.3 percent in October alone and 3.11 percent lower this year until the end of that month.
Despite a slew of negative headlines this year, ranging from wrangling within the euro zone to the latest warnings of downgrades from ratings agencies, the euro has held up relatively well.
The euro had a far more dismal year in 2010 when it dropped 6.6 percent and in 2008 when it posted losses of 4.2 percent.
Implied volatility on euro/dollar, or a broad measure of uncertainty in the options markets, has also remained subdued in recent sessions relative to the VIX index .VIX, the stock market's fear gauge, and gold's implied volatility .GVZ. There is anxiety in the currency options market about Europe's debt situation, but the tension has come down a lot.
Volatility, however, could ramp up again in 2012, with six European Union summits next year, two more than normal, on top of a host of extra Eurogroup events and meetings of finance ministers as they try to hammer out a comprehensive solution to the crisis. These events, for the most part, have been a major source of uncertainty for financial markets this year and that's unlikely to change in 2012.
SMALLER POSITIONS
London-based hedge fund GLC Ltd, with assets under management of about $1 billion, believes much of the mayhem in Europe has already been discounted and markets are not well-positioned for positive news.
As a hedge against the market's volatility, the fund has been running smaller positions than normal.
Even though GLC has been disenchanted with the way European leaders have handled the crisis, it believes the euro will survive and the situation in Europe's debt markets will improve, though in a volatile manner.
"Europe's policymakers, however, have left it too late to avert recession and much of the rest of the world is also suffering from an economic slowdown," said GLC in its latest note to clients and investors.
MARKET TURMOIL
FX Concepts, one of the largest currency hedge funds with assets under management of $4.3 billion, is still long volatility, calling for a U.S. recession and a breakup of the euro zone. But as a hedge to the firm's bleak view of the economy, "we have introduced models that have actually a positive tail," said Ron DiRusso, managing director of FX Concepts' Volatility Fund.
Positive tails suggest an upbeat outcome arising from either a resolution of Europe's debt crisis, or a more brisk pace of the U.S. economic recovery.
"So even in periods where mood is risk-on, or if the carry trade comes back, we have parts of the program that would make money in that environment," DiRusso said.
In several interviews with Reuters, FX Concepts chairman and chief investment officer John Taylor had painted a gloomy scenario for the global economy -- one in which the S&P 500 would precipitously drop to below 1,000 points and the euro would slide to parity against the dollar.
However, there were several months in the year, particularly October, when volatility declined and most risk markets and currencies such as the euro, Australian dollar, and emerging markets recovered.
FX Concepts' Volatility Program was down -0.88 percent so far this month and 5.85 percent weaker this year. The firm's Global Currency Program was down more than 19 percent as of December 22.
Bottomline, most fund managers are taking an "either-or" approach -- either the euro zone breaks up or everything is fine and well. And as the year winds down, more and more managers are looking at the latter scenario.
"Europe is not finished. We're not talking about Zimbabwe here. The euro is not a currency that will suddenly become worthless," said Simon Smollett, senior currency options strategist, at Credit Agricole in London.