The euro zone doesn’t look as scary today as it did a few months ago. It’s not that austerity measures are fully developed.  It’s not that the stress test convinced everyone that the banks are sound. It’s not that the bailout is filled with shock and awe.

It’s that the whole situation together is now judged to be less likely to begin a worldwide panic than it was before. In the past, we pointed out that when the euro was $1.20/€1, the whisper number was parity, because at that point, pessimism was dominant, and no one expected a Euro rally.  Now at $1.30/€1, most people are no longer discussing parity.

The reigning pessimism on Europe has been displaced by focusing on the possibility of deflation and a double-dip in the United States.  We believe that there is more discussion in the media and the investor community of deflation now than there was in early 2009.  However, in early 2009 there was a possibility of a depression, and no evidence that a recovery of any kind would ensue.  Now, we have lived through several quarters of improvement in the economy, and yet, there is less confidence in future than there was before.  

Observers point out that this is not a normal recovery because of the impact of housing, debt repayment, and bank capital building.  They discard evidence of slowdowns in past recoveries and specifically explain why the U.S. is doomed to a worse-than-normal outcome.

At best, the consensus is looking for the U.S. to muddle through. Many are still expecting a double-dip accompanied by significant deflation.

This conjures up a similarity to the recent Japanese experience. However, differences with our situation and Japan abound. Their central bank was slow to act. The Fed acted quickly and continues to focus on recovery. Their banks were exceedingly slow to write down bad loans and rebuild capital. Our banks were struck by lightning and have responded with a quick rebuilding process. Japan’s business structure is exceedingly bureaucratic and layered. Our business structure has been almost totally reengineered over the last three decades and is exceedingly productive.  If you discuss this with investors, the response to any bullish logic is a resounding “I don’t care”.  

No one is now expecting a normal recovery.  Mention a “V” and you will be laughed out of the room.  Most investors believe it is a much better bet that 10-year Treasury yields will hit 2% before they hit 4%. Is that possible?  Of course it is. Yet, it’s our experience that when everyone is looking for something to happen, the chance that the opposite will occur becomes much greater. 


Fred Fraenkel is Chairman of the Investment Policy Committee and Vice-Chairman of Beacon Trust Co. He was a Managing Director and Director of Global Research at Lehman Brothers in the early 90’s, where he oversaw more than 100 analysts in New York, London, Tokyo and Hong Kong. Fraenkel has more than 30 years of investing experience, including membership in Barron’s year-end roundtable from 1982-1985.

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