Dear Reader, a funny thing happened on my way to Damascus - the US dollars in my pocket started vanishing. That rendez-vous with Ananias is on hold.

Exhibit 1: GBPUSD spot rate, 2002 to date (weekly data)


Apparently, during Thanksgiving this dollar-drop was “technical” and caused by thin volumes. However, since then the celebratory carve-up continues - although the dollar is still not trading below its December 2005 troughs of $1.956 (sterling) and $1.367 (euro). And, curiously, neither recent EU or US macro data have been clear-cut enough to account for the shifts underway.

Exhibit 2: EuroUSD spot rate, 2002 to date (weekly data)


Some reasons explaining why the dollar cannot fall significantly (as in much and persistently beyond those troughs) are around: logistically it is difficult for foreign central banks to diversify their fx holdings, whatever China announces; and, similarly, there are just not enough large liquid, stable equity/debt markets like the US into which surplus capital can be diverted.

This leaves only the broader global economy to put in context. As in the previous post, the bet is how deep will the US slowdown extend; and how far will it be offset by domestic demand elsewhere (both emerging and EU economies). Which is another way of asking is this all a helpful settling cyclical adjustment within a robust global economic expansion or reflective of a profound approaching US-led global slump.

Dollar action is, perhaps more than any concrete data can explain, beginning to play out trader sentiment between these two outcomes. But it is most probable upon the vast expanse of grey in between that the pendulum will come to rest.

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For the market neutral, or negative, the story of Saul on the road to Damascus may be beginning to resonate. Whilst perhaps not yet struck blind by a bolt from the blue and converted, doubters can not help but be surprised by the strength in equity markets.

The economic story supporting markets is foremost about ample liquidity. Secondly it concerns the rise of Asia as an aggregate industrial power capable of developing internal domestic demand. Lastly there are the commodity exporters. Whether this mix is defined as a “new paradigm” as advertised or as a new twist to an old economic story does not really matter. It is what it is: generous liquidity -> global growth -> low inflation -> low rates -> generous liquidity.

How long that circle will continue is not knowable. However, that most large economies are peaking/have peaked is clear (Julius Bär's latest thinking on that illustrated below). On the other hand, whether 2007 will be a mid-cycle correction rather than a recession is unfathomable.


Exhibit 1: Image courtesy Julius Bär. Sign indicates shorter-term outlook.


Consensus, though, is for a mid-cycle correction and equities are cheerfully, and somewhat maniacally, pricing this in. Equities also appear set to enjoy some real-time support from seasonal strength through to end Q1 2007. In this situation eager "complacency buying" may prove to be the largest impoverishing threat, especially for retail investors.

Fetch me Ananias.


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M: “I want you to take your ego out of the equation”
James Bond: “So you want me to be half monk, half hitman”

Casino Royale

As it happens, that is an apt description of those of Her Majesty's Treasury (HMT) officials charged with monitoring government spending departments. It's also decent philosophy for equity investors.

On 17 November Casino Royale opens. Notably, this episode of the Bond saga has a starring role for an official of HMT, portrayed by Eva Green. And Ms Green puts on a first-class performance as a Treasury woman. Or at least as it might be imagined by those Treasury men whose favourite lunch time activity remains the strolled tart-of-the-day spotting contest in St James' park whilst en route for a pint at the Two Chairmen public house.

But why quibble? Ms Green brings long overdue glamour to HMT's work. There was always the thrill of working behind bomb-proof curtained offices; the mystery of ancient wall safes whose combinations have long-been forgotten; the warren of below-ground rooms from which historic items are periodically retrieved and displayed in HMT's entrance hall (swords were a favourite during this scribe's tour); and, not to be forgotten, the excitement of preparing and delivering ministerial briefings (exemplified by useful contributions from the Foreign Office such as describing a visiting overseas finance official as being “tall for an Asian”).

Now the world knows, too, that HMT personnel also hit the streets. Thanks, Ms Green. Even your correspondent can say, without remotely risking running foul of the Official Secrets Act, that he had occasion to enter the MI6 building south of the river (with the Bond theme tune running through his head and his heart beating quicker). Nice views.

Unfortunately, Ms Green lets the side down in one respect. She falls prey to “agency capture” for HMT-style monkdom is not for everyone (especially when compared to Bond-style monkdom).

A good controller - and investor - must maintain a careful detachment. Just never apply this to making a Bond film.

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Quantifying and assessing the impact of potential economic shocks is an inexact undertaking. Going the whole hog and assigning them a probability whilst cloaked in the garb of academia, though, makes the exercise much more impressive. And often more inexact.

In 1987 this scribe had an undergraduate course with an internationally known historian and expert on Nazism and contemporary European politics. Deeply knowledgeable, the professor opined that Germany would not be reunited in his lifetime (he was a young chap then). Well, he's still breathing and junior readers may need to google historic artefact “the Berlin Wall 1989” for more information. A forecast, expert or not, hazarded upon a chaotic (as opposed to linear) environment is a hostage to fortune.

Which is what makes reading the Oxford Analytics Global Stress Points table (above left, click for larger image) such wonderful entertainment. Released in January it from the start contained a mix of de facto events not warranting a probability rating (“civil war” in Iraq pre-dates 2006, and just how much more nationalist could Mr Putin's regime be?) with standard tabloid fare (dirty bomb, avian flu, oil shock). There is also a 4am-and-the-beer-keg-just-ran-dry choice (“collapse of the euro”); and anyone who has spent more time than they care to recall reading about avian flu will wonder how the “scholar-experts” came up with a 55% likelihood of it hitting this year (it must be an interesting formula).

Nonetheless, two overlapping items merit special attention: an “oil price shock” and a “US strike on Iran”. It is curious there is no “Israel strike on Iran” option for the Israeli government has been talking openly about it since 2002 with an eye to conditioning sympathetic listeners to such an eventuality.

In either event, timing a US and/or Israeli strike as a function of Iran's point-of-no-return in acquiring nuclear bomb-making knowledge (but not the weapon itself) has brought the matter to a head: if the 2007 Global Stress Points table carries similar scores for a strike as in the 2006 edition then the “scholar-experts” will be rating the likelihood of the risk too low.

And if ever an international diplomatic triumph was required it is on this issue.


NB: All graphics courtesy of the AON Political Risk Map commissioned in association with Oxford Analytics

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One US odds maker put the over/under line for the first three-day takings of the new Borat! film at $11m. This is the comedy in which Borat praises President Bush’s “war of terror”.

Under normal circumstances a foreign filmmaker taking the proverbial piss on American patriotism like this might spell commercial US disaster. However, the production ended up taking well over $26m in its first three days.

Democrats were forecast to gain 15 seats and control of Congress by most professional pundits in yesterday's US mid-term elections. The Borat result was an unscientific anecdotal reason to take the over; and so it has proved with Dems taking the House, as this is written, with a shade over 20 seats added (and it may finish with over 30 net adds). The Senate, somewhat unexpectedly given the few constituencies (33 of 100) contested, is within 2 seats of Dem hands also.

The result most desired by the markets is gridlock, thus preventing the emergence of grandiose legislative plans - ie no change keeps current trends as is. Unfortunately, that inexplicable expectation is a pipe dream: divided government has nearly always proved cheap as both sides act as spoilers to the spending plans of the other.

So expect a period of fiscal restraint should the Republicans cling on in the Senate; and coupled with anti-war sentiment it may be the Pentagon that ends up taking the brunt of said restraint, albeit over time. That appears likely to translate into a significant fiscal drag on the winds currently helping sail the US economy.

Of course, Democrats might end up taking both Houses. That sharpens the focus on more than dwindling war funds and simple control of the legislative agenda: it brings into stark relief the potential Dem agenda items of minimum wage hikes, protectionist measures and drug price-controls. The extent of their impact on the slowdown that is approaching (anyway) is more difficult to gauge; but it does not look positive.

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Can’t a fellow spend a few days away relaxing without the Government of Canada reneging on a tax promise? Those royalty trusts really tied the income portfolio room together, man.

Slings and arrows; and nonetheless a break in the Cévennes was a fine idea. Trees, balmy weather, good walking, trees, autumnal colours, happy children, trees, friends, wine, trees, roasted chestnuts (ah, thanks to those trees) and so on.

Also it was an excuse to check out the timber plantation opportunities (did I mention the trees?) Jeremy Grantham keeps banging on about in his quarterly letters (free registration required).

Sustainable forestry is of course bio-friendly, touchy-feely, oxygen producing and soul-soothing. Cash, on the other hand, is liquid and unconstrained by the vagaries of green politics (cross-reference Canadian tax politics). It’s not certain this scribe’s environmental credentials will be enhanced by the choice at hand: more study required.

NB: No, I did not make up the name of the wine; and lest Seigneur d'Arse wishes to complain, a rose by any other name would smell as sweet. Really.

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