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UBS Answers "What Could Go Wrong"

While certainly a revision is pending after today's latest, disastrous Eurogroup meeting after which the two sides are further apart from reaching a deal than a week earlier, here is the latest set of questions asked by UBS clients on the topic of "what could go wrong" with the biggest Swiss bank's mutedly optimistic outlook on the "global recovery" (aided no doubt by the biggest intervention of central banks in history) which is characterizes as "uneven", especially when one considered that even UBS itself admitted last week that a "dislocation" in the market (which is "underestimating Grexit Risks") is necessary in order to overcome the Greek impasses.

From UBS:

Question: What could go wrong?

 

As we have highlighted many times before, markets respond well to moderate growth, low inflation and supportive monetary conditions, as is now the case. But the global recovery also remains fragile and hence vulnerable to shocks. Here's what could go wrong:

 

Renewed political uncertainty. Fragile growth, particularly in the Eurozone, remains at risk to bouts of political uncertainty. Last year’s midyear slowdown mostly stemmed from unease over the growing conflict in the eastern Ukraine. With no solution to the latest re-escalation of the conflict in sight (at the time of writing) and with the impasse between Greece, the troika and virtually all other Eurozone member governments threatening to usher in a new chapter in the Eurozone crisis, Europe’s ‘green shoots’ of recovery could quickly wilt again. And note that, as Europe goes, so go global growth impulses. The Eurozone is the world's largest economic aggregation and biggest export destination for many emerging economies, which are increasingly reliant on (net) exports for growth.

 

Rapid and disruptive Fed tightening. As noted above, we expect a faster pace of Fed tightening than is now priced into markets. Typically, 'carry' positions are most vulnerable when the Fed initiates unexpected rate hikes. In macroeconomic and market terms, those most exposed to the unwinding of 'carry' include countries  financing external deficits via short-term portfolio inflows, such as Brazil, South Africa or Turkey. Credit fixed income markets are also potentially vulnerable,  particularly given their susceptibility to illiquid trading conditions.

 

Excessive dollar strength. Thus far, broad-based dollar appreciation has not been particularly problematic. But further gains might become disruptive. At some point, political pressure against dollar strength may build in Washington, particularly as the 2016 elections approach. But vulnerability to dollar strength is arguably greater outside the US, including in commodity-producing industries and countries, where a strong dollar tends to depress output prices. Countries and corporates reliant on dollar financing, but with revenues derived in weaker currencies (e.g., in many emerging economies) could also feel the pinch in a stronger US dollar environment.

And a bonus point from UBS on rates:

when looking further over the horizon and assuming that major policy, political and currency shocks can be avoided, investors may have to consider the next iteration of the 'new-normal'—low discount rates. One by-product of the ECB's QE is its impact on global bond yields, including US  Treasuries. If, as seems likely, the ECB pursues QE for longer, Fed rate hikes may not lift US and global yields by as much as in past such cycles. The by-product would be much flatter yield curves and lower long-term interest rates than in prior episodes of US full employment, non-inflationary growth. Accordingly, at some point style shifts could dominate equity returns, with investors taking advantage of unusually low discount rates to bid up the prices of assets with annuity-like and attractive long-term cash flows.

This supposedly excludes the #Ref! P/E Nasdaq, which is on pace to surpass its dot com 1.0 nominal record in a few weeks at most.