David Morris
A LITTLE over a year ago, Greece was in the headlines as the parlous state of its public finances became apparent. At the same time, the US Federal Reserve was planning an exit strategy from its first round of quantitative easing (QE), and there was a major volcanic eruption in Iceland.

As the speculation grew as to how quickly the Fed would unwind its balance sheet, which stood at $2.1 trillion back in June last year, investors began to reduce their exposure to risk assets. Equities fell broadly. The dollar rallied and commodity prices, led by oil, declined. Precious metals held up well, in stark contrast to their poor performance during the financial crisis, while US Treasuries also pushed higher. The fact that Treasury yields fell in the face of reduced Fed support was counterintuitive. But it reflected a flight to relative safety given the European debt crisis, and the risk of capital losses in equities.

As baseball legend Yogi Berra said: “It’s like deja vu all over again.” One year on and equity investors are beginning to reduce their overall market exposure as the European debt crisis clicks up several gears. Not only is the situation in Greece reaching a critical state, but now Italy has been thrust into the spotlight following S&P's decision to place the country on a negative outlook. On top of that, Spanish protests and the defeat for the incumbent socialists at the weekend’s local elections have heightened the tensions in the Eurozone. There is an ongoing flight into the Swiss franc which has taken the currency to a fresh record high against the euro.

As the Fed’s current asset purchase programme draws to a close, its balance sheet is now approaching $2.6 trillion. Yet despite the unprecedented and coordinated global monetary and fiscal stimuli, concerns are growing again about the fragility of the world economy. GDP growth forecasts are being massaged lower while inflation expectations are increasing. The unemployment situation remains bleak across the major economies, with jobless claims trending higher. Last week’s US housing data was dismal, and PMI data is deteriorating. As happened a year ago, investors are increasingly moving out of cyclical stocks and towards defensives, or heading to the sidelines completely. Without the tailwind provided by QE, this trend looks likely to continue.