Can global markets keep climbing beyond the fiscal cliff?
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Can global markets keep climbing beyond the fiscal cliff?

There was a lot of talk last year about global markets climbing a wall of worry, as credit underwent a spectacular rally and equities too climbed beyond most people’s expectations.

The obvious question now, as we enter 2013, is how far and for how long can markets continue to climb, and what’s the drop like on the other side?

The answers to both questions could hinge on whether US politicians resolved what is known as the fiscal cliff ahead of the December 30 2012 deadline.

If they have, which is the hope, global markets will likely be enduring a relief rally, extending the impressive gains in equity and, especially, credit markets recorded last year, and giving the markets the best start to a new year they could have hoped for. If they haven’t, global markets have likely nose-dived, making the outset to an already pretty dark year even darker.

As Euromoney went to press, either outcome was possible.

Curiously, equity and credit markets do not seem to be reflecting that. Indeed, and perhaps more worrying, is the fact those markets have been racing ahead despite the prospects for the global economy being bleak.

The IMF and the OECD have downgraded their outlooks for 2012 and 2013, with sharp cuts for much of Europe as well as for Brazil, China and India. Nevertheless, by mid-December the S&P500 was up around 13%, US stocks up 11% and Germany’s DAX up a staggering 27% year on year.

And investment-grade and junk bond yields in most advanced economies, as well as yields on emerging market sovereign and corporate bonds – both denominated in local or international currencies – and mortgage-backed bonds have all crashed to their lowest levels since before the 2008 financial crisis, and in some cases the lowest levels ever.

It’s a peculiarity that is of concern – asset prices rising against a weakening economic backdrop – that the Bank for International Settlements warned about in its fourth-quarter report in December, although it stopped short of describing what’s happening in bonds as a credit bubble.

Hedge funds, however, believe that the next bubble, if it hasn’t already formed, is in the credit markets. Of 168 hedge fund managers, representing about $900 billion in assets, a majority said current valuations in credit were of most concern, according to a survey by advisory firm Aksia.

The results echo Goldman Sachs’s outlook for 2013; this noted that the risk-reward for corporate credit next year will be less lucrative, to put it mildly.

Ironically, should global growth pick up – and as difficult as that might be to believe – some warn that the trillions of dollars that have flowed into fixed-income funds in recent years might start to flow back out and into equities.

Arguably, that has started to happen, hence the rise in equity markets, but a big shift will not occur overnight.

In the meantime, global markets could be expected to keep on climbing should the US’s fiscal cliff be resolved and at least until another one of the many macro risks out there – the US economy, the Italian elections in February, China’s growth trajectory, geopolitical risk in the Middle East, and on and on – potentially kiboshes confidence.

In light of this, debt capital markets bankers, as ever, will press issuers across asset classes to get their funding out of the way as early as possible, equity capital markets bankers will try to resuscitate the flagging IPO market as best they can, and M&A bankers will continue to live in hope that business can and will pick up from its lows.

The good news there is that it won’t take much to improve on last year’s ECM and M&A revenue numbers.

According to Dealogic’s preliminary full-year 2012 figures, ECM revenue fell to $13.3 billion last year – the lowest since 2003. M&A revenue was $17.3 billion in 2012 – down 15% compared with 2011.

By comparison, DCM revenue hit $21.1 billion, up from 23% in 2011.

Nonetheless, total global investment banking revenue was $63.6 billion in 2012, down 9% from 2011 and the lowest total since 2009.

Should markets continue to climb and confidence hold, ECM and M&A could start firing again. As for the drop on the other side – it’s too gruesome to contemplate.

Happy new year.

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