If you feel in need of peace and quiet after the festive
frolicking you could do worse than to move to Ciudad Valdeluz.
This new city, 60 kilometres northeast of Madrid, was supposed
to house 30,000 people. Its current occupants number 600. For
those who bought off-plan at the height of the Spanish property
boom in 2007, Valdeluz (an invented word approximating to
valley of light) has turned into Valle de Lagrimas a
vale of tears.
This is a diorama of the
lingering economic crisis afflicting much of the developed
Spanish banks lent more than 300 billion to real estate
developers, and in 2007, loans to individuals in Spain, many to
fund property purchases, were growing at an unprecedented 30%
annualized rate. Many of those loans have turned bad, first
infecting the banking system, then the real economy and
latterly the perception of the solvency of the Spanish state
and even the efficacy of the entire eurozone.
It is not just the
residents of Valdeluz who are feeling unhappy with their lot
this new year. Markets are determined to see the glass
half-empty. On the day it was announced that
Europes banks had borrowed 489 billion in
three-year money from the European Central Banks
long-term repo operation, equities fell.
The LTRO solves a
liquidity problem when the big issue remains solvency, and the
eagerness to access central bank money reflects the poor
quality of bank assets and the willingness to use them as
collateral. However, that does not make the ECBs actions
wrong or unhelpful. With bank debt refinancing set to spike in
early 2012, a potential credit seizure has been averted.
Twilight of the
Perhaps the most
remarkable fact about the global economy in 2011 is that it
grew at 3.5% despite much of the western financial system
remaining highly dysfunctional. In 2012 there will be little
respite in credit conditions. European banks need to boost tier
one core capital by 106 billion by the middle of the year
and refinance 1.7 trillion of debt by the end of 2015.
Faced with a sceptical investor base, banks will continue to
shrink their balance sheets, shuffle risk-weighted assets and
is easy to rattle off horrible things that could go
wrong in 2012. But positive surprises are also
Unconventional tools such
as the LTRO and quantitative easing have pushed central banks
into the limelight as the traditional actors in the financial
system skulk in the wings. Interest rates cannot full further,
hence the focus on bond yields. Large corporations with direct
access to capital markets can fund more cheaply and numerous
credit-easing initiatives are offering support for small
In effect, banks are
being disintermediated as they delever and rebuild their
balance sheets. The fragility of markets reflects the untried
status of the current policy prescription: engineering economic
recovery in a highly credit-constrained environment. But there
are tentative signs it might be starting to work.
The first economy to pull
the quantitative easing lever was the US. Its growth, although
anaemic, outstripped the eurozone and the UK in 2011.
By flooding the system with money, the Federal Reserve has
also ensured its banks are farther along the road to recovery.
Most already have reasonable capital buffers in place. US
growth bounced in the second half, and leading indicators, such
as consumer confidence, are turning. Economists who have rushed
to downgrade consensus growth forecasts for 2012 might begin to
rethink, which will put a floor under US equity prices.
However, the biggest
support for risky assets in 2012 is valuations. The last and
only time in 40 years that the yield on the 10-year Treasury
bond fell below the dividend yield of the S&P500 was the
nadir of the stock market in March 2009. The markets that
suffered most in 2011 are, by some measures, even cheaper
The Stoxx Euro 600 is
down 12% and on a price/book basis is better value than the
2009 low. With the Nikkei 225 down 14%, Japanese equities are
trading at less than one times their price/book ratio. With
reconstruction following the devastating earthquake and tsunami
in full swing, the economy should also return to growth.
Over the past decade
equity investors in the US, UK, Europe and Japan have been
rewarded with volatility and little else. But the alternatives
are equally unattractive. Anyone tempted to buy UK gilts at
current levels would do well to remember that the last time the
10-year yielded around 2% was in 1946. Bonds then lost 75% of
their real value over the next three decades.
It is easy to rattle off
horrible things that could go wrong in 2012. But positive
surprises are also possible. A reversal in US property prices
and the sub-prime debacle of 2007 were the first dominoes to
fall in the crisis. US house prices continue to decline, but
sentiment among homebuilders is improving, as are sales. A 1%
rise in US house prices is a $160 billion positive wealth