Commentary: Revisiting the Bull

Borders is selling out. The demise of the traditional bookshop has been predicted since Amazon started to become a household name. However, it took quite a number of years for this to happen.

Yesterday as I put my newfound friends in my bag, I had some mixed feelings. On the one hand, I was happy to be able to increase my already impressive stack of "things that I still want to read before I die" at a discount of 30 percent. On the other hand, it is always sad that yet another landmark is disappearing. I guess this is Schumpeter's creative destruction at work. Out goes the old and in comes the new. And we call it progress.


Observing markets, economies and social trends it never ceases to amaze me that these things always take more time than we (collectively) think. It took quite a while before Netflix could replace Blockbuster. And how long we are talking already about the end for the traditional video rental shops.

Back in Belgium there are quite a bit of them left in my neighborhood. Humans see an imbalance or perceive the beginning of a trend. And they think that the imbalance needs to be corrected right away or the theme has to play out by the start of the next business day. However, that is not the way it works. Schumpeter is great, but not as fast as we think.

Revisiting the Bull

Just ask the analysts and strategists that called the end to the internet bubble a bit too early, say at the end of 1998. It is clear that you look like an idiot for a while, and very often for quite a while. Trends tend to run longer than most people dare to imagine. And while they do, you are perceived as being wrong, or too cautious, or too bullish, or too whatever.

These were the thoughts that were running through my head as I stood face to face with the golden bull in downtown Manhattan, near Wall Street. Last time I was there, the two towers were still standing at what we now call ground zero. The world has clearly changed since then.

It was clearly time to revisit the bull. The mighty beast has been overrunning the bears since Ben Bernanke started talking about the second round of quantitative (QE2) easing back at the end of August last year.

We are currently still in the midst of a (cyclical) upswing driven by the most aggressive pro-cyclical fiscal and monetary policy the world has ever seen. If the world view changes (largely because of this) from deflation to inflation the logical reaction is to take money out of cash and bonds and put it to work in more risky assets like stocks, commodities and emerging markets.

It is also reasonable to assume that if the marginal dollar of QE2 has found its way to these asset classes, they look the most at risk if that liquidity dries up.

Mr Trichet has over the last couple of days taken some radical steps in that direction. In the US however, the Federal Reserve is not yet thinking about ending QE2 or hiking interest rates. This means that liquidity conditions are worsening, but that US liquidity is still flooding the world. Translated in market terms: the trends that started in August could still run for a while but the risk level has increased and we should expect more volatility.

Breakfast at Tiffany's?

All this monetary positioning has also not missed its impact on the dollar exchange rate. It is clear that the ECB will start its rate hiking cycle soon, while the Fed will be on hold until at least the second half of 2012. Therefore the rate differential plays in favor of the European currency.

Add to that optimism about an extension of the EFSF, (which would be an important step towards a more permanent solution to the problems in the euro zone), and some heavy Chinese buying of euros, and you have a powerful cocktail to drive the single currency higher.

In fact it is so powerful that even tensions in the Middle East and selling of local currencies could not drive the greenback, which traditionally benefits from every flight to safety, higher. Eventually this trend will have to be reversed as the Fed starts it inevitable hiking cycle and troubles within the euro zone resurface.

However, this current trend may once again run longer and further than we think. In the meantime I am not complaining as hotels, food and books that you pay for in dollars are quite a bit more affordable than when I was last time in New York.

Get Some Money Home

At the end of the day, it boils down to the simple fact that the US does not mind that the value of its currency goes down. They like it as it improves their competitive position. History teaches us that you can get away with quite a bit if you are the lucky "owner" of the world reserve currency.

This brings me back to one of my strongest feelings on the markets. Besides the fact that the US holds the world reserve currency, the country still has quite a number of aces up its sleeves. First there is still the military power, the importance of which is often forgotten during periods of "relative peace".

When you visit New York you should dedicate a couple of hours to visit the US navy air carrier Intrepid and take a guided tour. It is amazing how fast the US was able to build a naval fleet during the Second World War that not only secured its victory in the Pacific, but now enables it to control the world superhighways, the Oceans.

Despite efforts by the Chinese this force is still unrivaled as is very well described in the excellent book by George Friedman "the next 100 years". And then there are demographics that will, over the next 10 to 20 years, clearly play to the advantage of the US. The next couple of years will be tough as the debt problems are massive. Eventually this country will probably be ok, and make it, as they always seem to do.

In terms of longer term allocations it may be time to start thinking about this massive overweight that every one has on the emerging market theme and get some money home to the Western markets. Research shows that if inflation picks up from a relatively low level (like in the West) it is traditionally positive for equities, while as it picks up from a higher level (like in the emerging markets) it has historically been negative for the (relative) performance of equities.

However, beware when considering this that trends tend to run for longer than you can probably imagine. That is what the bull in downtown Manhattan would say if it could talk. Or would he just do a Cramer imitation and say: buy, buy, buy?

The author is Philippe Gijsels, head of research BNP Paribas Fortis Global Markets