Wednesday, August 31, 2011

Market Capitulation

Markets capitulate when all policy options run out, and it becomes clear that a definite new policy direction must be undertaken. We are getting quite close to that point in the current market volatility. As various commentators take the economic temperature after their return from some agreeable foreign holiday, it is becoming clear that we are close to a major failure of confidence. The inter-bank market is beginning to freeze again, and the implications are plain: banks are finding it ever more difficult to finance themselves, and governments and central banks are running out of options to support them.

Clearly governments are finding it more and more difficult to get their sums to add up, as the nascent economic recovery stalls. However, perhaps paradoxically, the failure of confidence may end up reducing uncertainty: it will be clear that the crisis continues, and that therefore the policy prescriptions will be clearer too. In other words, I think we are on course for a classic market capitulation.

Equity markets, after the August debacle, are indeed looking relatively attractive, yet there is still the lurking problem of the banks: buying the market at the moment leaves you exposed to what are very likely to be further losses in that sector. So, selective purchases of good quality non financials? That is certainly worth considering- it all depends on the collateral damage from the next fall.

Market capitulation is tricky to manage, even if you expect it to happen.

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