MAXIMUM UNCERTAINTY

Volatility is defined as the "uncertainty of path" and as such the second half of 2011 will be volatile and the uncertainty almost as great as during the financial crisis.

The 2008/09 financial crisis was an opportunity missed for the policymakers and politicians alike as only in times of distress is there consensus for change and doing the right thing. Instead politicians took the lead and kicked the can down the road by effectively piling more debt onto debt and merely transferring risk from the financial sector to the public sector under the illusion it would be easier to finance under such regime change.

Now, two years later, and almost to the day, such policy and economic errors have compounded with almost nothing to show for in terms of key parameters for long-term economic growth, like housing and employment. Meanwhile, the social dimension has taken an even greater role, not only in the G-20 but also in the Middle East and North Africa (MENA) and Asia.

Generations X and Y are clearly unhappy with the status quo and demonstrations in the centres of Madrid, Athens, Lisbon and MENA are clear signs that something needs to be done to realign implemented policies with the required need for structural change. What the world needs to move forward is an agenda on growth and jobs, not on how to buy more time.

This may be the key change looking into Q3 of 2011, as the opportunity cost of doing nothing - always the preference for members of legislatures - is on the verge of being far too costly.

Big picture
The recent batch of weaker-than-expected economic data has jolted the markets into risk-off mode. Understandably, uncertainty is running high, but from a fundamental perspective our views are mostly unchanged since the Q2 outlook report. We stated then that slower growth, but not a new recession, was ahead and we stick to this belief. Our economic forecasts, which are already below consensus, are hence only slightly changed from a quarter ago.

The world's largest economy, US, remains mired in private sector deleveraging, which is stifling the involvement of the consumer in the current expansion. Since the peak in Q2 2008 households have deleveraged by 4.3 per cent, or 1.4 per cent annualised, a feat that was repeated again in the first quarter of 2011 at a two per cent annualised rate. When compared with a 10 per cent annualised growth rate in balance sheets in between the two recessions of the 'noughties', the picture of a stifled consumer draws itself.

With that said, however, just a deceleration in the deleveraging process is enough for consumption to add to growth. With the savings rate down to 5.1 per cent in Q1 2011, having averaged at 5.8 in 2010, consumers are slowly recovering and, helped by the effect of temporary factors such as the fading surge in energy prices, should drive growth in the second half of the year - ending the year at a yearly clip of 2.4 per cent.

Europe's noteworthy economic growth of 2.5 per cent year-on-year in Q1 2011 helped cover the cracks in the euro zone economy. While Germany is doing a fine job of dragging along the rest of the monetary union, it will not last indefinitely. Austerity will be a mainstay of most member nations' fiscal policy this year, but nevertheless the euro zone has found a way for the public sector to contribute 0.2 percentage points to the 0.8 per cent quarter-on-quarter growth; a feat that will not likely be continued in the coming quarters.

Additionally, the ECB, with its rate hikes, is doing all it can to make life miserable for the struggling peripheral economies, which will only further prolong the pain as long as the countries are not allowed to restructure their debt. Hence we maintain our case for significantly slower growth in the second half. This view rests on a weaker contribution to growth from foreign trade in the Northern countries and austerity measures in the South - joining forces to slow growth to 1.5 per cent.

The fact that China dethroned Japan of its status as the second largest economy in the world last year is telling of where the two economies are at present. The former is a booming (bubbling?) economy which we expect to grow eight per cent this year, while the latter is struggling with twenty years of failed economic policy and a disastrous earthquake to boot.

China seems intent on making 2011 another good year, no matter the cost. Money remains readily available for lending with money supply still rising fast, new investment projects as far as the eye can see, and real interest rates in negative territory - all fuelling speculation. Not that the authorities are not taking corrective measures, because they are, including attempting to tame the real estate animal.

We expect these, however, to result in nothing more than a minor slowdown in growth this year, to eight per cent, though we are far below consensus. Looking further ahead, China faces severe problems, but they will not likely materialise in 2011, making us comfortable with our call.

Scenarios
The macro picture leaves us with three major themes: The EU and US debt issue - time is up - decisions are needed; Asia/China growth slow down as they turn to fighting inflation in earnest; social tension needs addressing - otherwise not only do we lose the young generation but we also fail to provide inclusiveness, the very basis for sustainable growth, peace and prosperity.

Against this backdrop we need to maintain a defensive allocation outlook. Our two main risk models, the valuation model and the tactical asset model both indicate risk-off as we look into Q3 - whether this is a mean-reversion move, where growth and solutions on the above challenges are found, or a more deep correction beyond the 10 per cent correction we called for in May, is the key question.

In times of uncertainty, and certainly in times of what we call maximum uncertainty, we operate with three main scenarios.

Quantitative easing or Operation Twist to Infinity is our high probability scenario with 45 per cent odds. (Operation Twist was a late 1950s and 1960s Federal Reserve policy of supporting the US dollar and the housing market simultaneously by outright buying of 10-year Treasury bonds while financing it by selling Treasury bills in the short-end.)

This is the "buying more time - more of the same, kicking the can down the road" scenario. We realise and calculate that doing nothing, or more of the same, always is the policy choice of preference. But we have lowered our odds from 65 per cent in Q1 and Q2 to 45 per cent for Q3 and Q4 due to an upside correction to Crisis 2.0.

Crisis 2.0 is now our second most likely scenario with 30 per cent probability, but one which is rising in probability (from 15 per cent) due to the almost total standstill on debt in Europe and the US and continued rising inflation in Asia. This is a scenario where the bill needs paying. We have a short relative deep correction, not only in the stock market but also on higher unemployment and interest rates, which create a sense of urgency, and crisis, which could be used to facilitate both the political and structural changes needed.

A historical fact remains: only in the deepest times of trouble does mankind become truly rational and constructive. We think a quick crisis 2.0 could create a political environment for change, and this is an important start to one of the best periods in our history, as we, after the crisis, would have better leverage in society, more sense of urgency, agendas for balanced growth and a need to employ people. Crisis 2.0 is a bad short-term step on the way towards something good and necessary to move on from.

Finally, our last scenario is the 1970s, with odds of 15 per cent. It entails big government, stagflation, high energy prices and rising interest rates. Stock markets going nowhere, not falling too much either as the micro level works its wonders on the macro level, not necessarily the worst scenario but one which will challenge the social construct.

We expect the world to extend the stimulus across the global economies as the most likely outlook for Q3, which means we will have acceptable growth but an increased burden on fiscal payments and a need for structural changes. The world is now closer to some kind of a solution. But whether voluntary or not, the solution is increasingly more volatile, so defining the theme for the coming quarter as one of "maximum uncertainty" seems quite apt.

Elana Trading forecasts slow growth for Bulgaria
We confirm our forecast from earlier this year for moderate economic growth, the main driver of which remains the export-oriented sectors of the ecomy. Despite the decrease in inflation at the middle of the year, consumer prices will continue to rise.
We note the start of increased lending, led by the increased number of investment loans and short-term loans in leva, which are habitually used to bolster cash flow. But because income growth lags behind inflation, the level of consumption is unlikely to change much and, even though Bulgaria's economy is exiting the downturn, consumers will start feeling the effects of economic growth only in 2012. 
Several main factors that will influence Bulgaria's economy in the second half of the year bear additional mention.
The number of bad loans will stop growing by the end of the year, but the improvement in the portfolio of Bulgarian banks will not be instantaneous and wlil be felt in 2012 at the earliest.
Bulgarian banks will not be affected by the financial crisis in Greece. It is possible that some banks owned by Greek financial groups will change owners, but that will not affect domestic operations.
Real estate prices will remain low because of weak mortgage lending and the high price of homes compared to household incomes.