The electorates of Europe are just starting to realise the reality of the coming austerity measures. Conjecture about cuts amounting to billions of $, £ or € and tax increases are now becoming a reality. Significant reductions in policing and schools are happening, pay cuts to fund (reduced) pensions and tax rises that make a difference to everybody are now coming home to roost. The private sector is also starting to realise how big a client government is – and how generous it has been in the past in its behaviour as a customer. It seems almost inconceivable to us that this does not precipitate the much-feared double dip recession.

So are European Governments tightening too early as the US has been saying? The answer is a resounding no. There is never a ‘good’ time to go cold turkey – in this case on debt – but the longer you leave it, the worse it is. The politician’s favourite fable of a vigorous recovery that leaves economies in a position in a year or two to take a major fiscal tightening on the chin and not go down is wishful thinking of the worst kind. It merely adds more debt in the interim and if there has been any kind of recovery in that period, dilutes the political will to make the difficult choices that have to be made. While the Germans are donning a hair shirt with possibly too much relish, the Americans seem behind the curve, lulled into a false sense of security by their ability to print reserve currency and a sense that any kind of tax increase is tantamount to wholesale adoption of European communism – sorry, socialism, but hey, what’s the difference? We note with interest that the Californian City of Maywood has just disbanded its police force and fired all its employees in order to contract out services and preserve cash. It is unclear to whom they plan to contract out. The resignation of Peter Orszag as US budget supreme is also an indication of political procrastination. Obama needs to renege on his ‘no tax increase for sub $250k households’, but is lacking the political capital to do so. Something major will have to give and at that point US treasuries will cease to look like such a safe haven. We don’t know when, but it will happen. The premium accorded to safer Asian credits will rise.

In Australia, the demise of the Socceroos in the World Cup has been eclipsed by a crunch match in Canberra: Mining Cos 1: Labor Party 0 with K. Rudd shown the red card. It was always going to be hard for Labor to push through controversial legislation after the spate of recent gaffes, and the companies did a good job of highlighting the potential employment issues of a penal tax rate on a low rate of return in a highly capital intensive industry. Julia Gillard is aware that she needs an early resolution to have any hope of success at the ballot box in a few months time, so compromise is coming and will involve some commodity exemptions, a higher permitted return and legacy projects in at ‘market’ value. This last point may be contentious as to how an unlisted asset is valued, but there will be time to worry about that later. In the near term the market seems more worried over a mid-year slowdown in Chinese growth and its effect on commodity prices. We would not be surprised to see some more cooling of the Chinese economic statistics over the coming months as the reduction in real estate activity feeds through to the broader economy, but would stress again that some reduction in growth is desirable anyway in order to pre-empt more draconian tightening measures. We remain relaxed about the ‘commodity currencies’ due to their superior fiscal positions and do view the mining sector as undervalued (along with the rest of the Aussie market). However, in the light of the likelihood of near-term poor newsflow, we continue to be absent from (but not short) the general mining sector. We remain long of gold, platinum and rare earth – where prices continue to rise.

The long awaited change of Chinese currency policy finally came and to describe it as a damp squib would be unfair to squibs, whatever they are. Yet it does herald a longer term appreciation and combined with the much publicised increases in manufacturing wages (catalysed by the spate of suicides at Foxconn) is supportive of our strategy which focuses on Asian domestic demand stories rather than the export sector. It certainly heralds the end of the era of manufacturing cost decline and in concert with our downbeat and now more consensual view of western demand gives us some comfort on our positioning in low beta utilities and non-life insurance, a sprinkling of secular (mainly healthcare) growth stocks, minimal exposure to mainstream technology and capital goods. We remain zero weighted in banking.

Sentiment has flipped from glass half full to glass lying smashed on the bar room floor in short order. As the stark reality of the West’s parlous economic position has become uppermost in trader’s minds capital has fled risk assets and value has now appeared in many equity markets. We believe that in the near term markets are sufficiently oversold to make the risk/ reward of being liquid unattractive and as a result we have increased our net exposure materially over the last few weeks. This may turn out to be a relatively short term trade, but as mentioned above we have no problem in buying a lot of Asian equities at current prices for the long term anyway. However, we will not be too greedy either and when the technical position has normalised we are likely to revert to a more cautious attitude again.

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