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EFTA01171739 | EFTA01171742 Asia ex Japan Trailing 12 month total earnings.Local currency, Thousands 300 1970s post-recovery equity market wilderness S&P level (Blue) Germany - DAX level (Brown) 180 - 250 160 • 200 140 • 1 1 1 800 Period of extrememonetaty 1 and fiscal unceitainty 1 120 - 150 700 600 100 100 500 80 60 50 400 40 - 0 1996 1998 2000 2002 2004 Source: MSCI, J.P. Morgan Securities LLC. 2006 2008 2010 20 1972 300 1974 1976 1978 1980 1982 Sou ce: Bloomberg. To be clear, any portfolio investment strategy that is not 100% cash is predicated on the notion that the European Monetary Union will not collapse in disorderly fashion, with Southern Europe defaulting/devaluing, or Northern Europe departing. We have been among the most despondent observers of the EMU since the crisis began exactly 2 years ago, with Greece's disclosure about its hidden budget deficits. But even we have trouble assuming that this kind of disastrous, poorly managed outcome should be the base case assumption for 2011-2012. If we are wrong and such an outcome does happen, the lonely strength of corporate profits will likely be insufficient to prevent another substantial decline in global equity markets. Our portfolios are ultimately positioned for a severe, lingering drag from the European mess, but not its implosion. Even if US profits do continue to rise, it will be difficult for markets to pay much for them, given their reliance on the lowest labor compensation relative to revenues we have seen in a long time. This dynamic results in the need for outsized government transfers to households to sustain consumption, which in turn raises the following question: why are markets so calm about the US running a 6%-8% (e.g. Ecuador-style) budget deficit in 2012? See next section. &wer-Committee prospects: dissension on the team persists Demand from banks, households and the Federal Reserve are part of the picture, but the central factor behind the stability of the US Treasury market is the ongoing purchases by Asian and other emerging economy Central Banks. The phenomenon of Central Bank reserve accumulation began around 10 years ago. Despite well-researched and welldocumented explanations as to why it was doomed to failure as a model for developing countries, it has allowed countries like China to keep exchange rates cheap and foster export-led growth without paying too heavy a price in terms of their own inflation. So far so good, except the U.S. no longer controls its own fiscal and economic destiny. The so-called Super Committee is tasked with regaining control of this destiny. You have seen the chart below from us before. As per Phase 2 of the Budget Control Act, the Super Committee is trying to find $1.2 trillion in deficit reduction over ten years, which moves the projected debt-to-GDP ratio from the Italianesque green dot to the Gaullist brown one (around 80% of GDP). I will not burden you with the procedures involved, other than to say that if the Super Committee does not come up with a recommendation by Thanksgiving, it looks like mandatory expenditure cuts will kick in starting in 2013, unless of course recent proposals by Republicans and Democrats defuse the sequestration robot, like at the end of Michael Crichton's Andromeda Strain. The most bullish outcome I can think of is a bit more stimulus for 2012, and $2-$3 trillion in long term deficit reduction (not subsequently unwound by Congress). To do it, they will need to overcome the vested interests of large constituency and advocacy groups. Hanover Investment Group in D.C. recently estimated the budget advantages by sector, as a way of thinking about whose oxen will one day have to be gored; healthcare and industrials lead the pack. EFTA01171742 Epstein Web iOS app on the App Store.
May 12, 2026 at 3:12 PM