As good as it gets

Risk assets and high-beta currencies are off to a flying start in 2012. For many of the major equity markets, last month’s jump was the best January for nearly twenty years. Both the DAX and the Hang Seng are already up 12.5% for the year to date, the Bovespa is nearly 14% higher, the Sensex is up 13% and the NASDAQ is up almost 10%. High-beta currencies have also enjoyed an encouraging few weeks – a number of Asian currencies registered three-month highs overnight and the Aussie is already up more than 5% this year.

For many investors and traders, this surge in risk appetite has caught them flat-footed. In the second half of last year, fear of the single currency’s demise and the potentially catastrophic chain of events that might unfold triggered a quite unprecedented flight from risk assets and currencies in favour of safe-haven currencies, US treasuries and bunds. In effect, fear had become so endemic that it only required a slight deviation from this pessimistic world-view to unleash a short-covering rally. Yesterday for example there was encouraging news on manufacturing out of Europe, the United States and China, as well as strong auto sales from America. Also, the European Central Bank’s generous provision of liquidity continues to work its magic - alongside their SMP – and Portuguese 10yr yields fell 150bp yesterday.

After such a powerful move to the upside, some are still suspicious that it is purely a relief rally rather than anything fundamental. However, the difficulty for the risk bears is that there is still an enormous cash stockpile on the sidelines, investors and traders are still quite short risk, European governments and policy-makers have taken very positive steps to attempt to rectify the debt and banking crisis and moreover, the major central banks (such as the Fed and the BoE) are fully prepared to print more money to get their economies moving towards a more sustainable recovery.

Right now, standing in front of this moving train could be very painful.