Brief excerpt from the commodity expert, followed bu fill document in scribd.
Since mid-May, we have been growing increasingly bearish about the stock markets and the economies of Europe and, to a somewhat lesser extent, the USA.
In our Conference Call on August 12, we moved Recommended Equity exposure to the bottom of our 40 – 60 pension fund range.
Our core concern has been the breakdown of public finances, particularly in the eurozone, which is undermining the traditional Capital Asset Pricing Model. European banks are collectively heavily over-levered, and any “haircuts” to the valuations of eurosovereign bonds could be devastating to the financial system. In a momentous paradox, the epicenters of European risk today are not toxic mortgage securities or junk bonds, but the debts of overindebted and underachieving eurozone nations. The financial crises in the eurozone are rooted in the breakdown of the Risk-Free Rate of Return on government bonds, which exposes many European banks—particularly the major French banks—to towering levels of risk, thereby rendering Basel III valuations near-useless.
The Atlantic has not proved to be a secure moat for financial models in the United States: Collateral Debt Swap pricing for Treasurys now costs slightly more than the pricing of prime corporate debts, and major American banks and money market funds have huge exposures to struggling European banks.
The once-impregnable Efficient Frontier is becoming the Deficient Frontier, pushing pension fund risk/return projections into no-man’s-land.
There would never be a good time for an implosion of the risk models that have served banks, pension funds, and other financial institutions so well for so long. But a time when economic weakness is intensifying and spreading across the OECD is a uniquely grim time for an existential challenge to risk management systems.
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