The Squid's Top Trades for 2012

So, GS’ Global Research crack team released their top trades for 2012 list earlier this week and I have to say, it’s a pretty interesting mix of ideas. It’s mostly bearish though, with themes ranging from further deterioration in the EU, sub-par growth in China, to the Fed, the BoE, and possibly the SNB firing up the printers quite soon, so if you're looking for a pick me up this probably isn't for you.

Anyway, if I remember correctly, last year’s list pissed off a lot of clients when their recommendations turned south, so I figured we should put this year’s list under a little monkey scrutiny. What do you guys think? Is QE3 coming? Are Canadian equities a safer bet than Japanese? I think the latter (including their long ICE Brent idea as well as the Swissy and the Dollar short) is pretty much spot on at the moment.

List after the jump.

1. Short European High Yield credit (Buying protection on the iTraxx Crossover index), for a target of 950bp (opened at 770bp) and a potential return of 4.5%, stop at 680bp

The credit quality of European non-financial firms has not recovered to its pre-crisis level. The credit quality of US firms, by contrast, is at its highest level in 25 years. Thus a recession in Europe—our forecast—could put considerable pressure on European high yield firms in 2012. We see mostly downside risk to this growth forecast, with very little upside…

...Tightening credit conditions in Europe—with meaningful risk of a very sharp tightening—are likely to fall disproportionately harder on high-yield borrowers. European companies in general rely much more on bank loans than bond debt in their capital structures (by a ratio of roughly 4-to-1, according to our estimates). Thus, we think companies in Europe are more exposed to a contraction in bank balance sheets in 2012 than US companies were in 2008…

...Owing to the enormous pressures on fiscal budgets, financially distressed companies in the private sector are much less likely to receive sovereign assistance today than they were in the past.

2. Short 10-yr German Bunds for a target of 2.8% (open at 2.3%) and a potential return of +4.5%, stop 2.0%

…funding pressures and the deterioration of the economic outlook will act as a ‘forcing mechanism’, leading to an agreement on a deeper fiscal integration of the Euro area, possibly in stages, involving budgetary rules supported by effective sanctions. Such an agreement on the regulation of fiscal flows should in turn pave the way to a partial ‘mutualisation’ of the existing debt stocks…

…this would result in a one-off transfer of credit risk to the ‘core’ countries, and a relaxation of systemic tensions which have led to a very pronounced flight-to-quality. Once a deal on fiscal flows is reached, we would also expect the ECB to adopt a more forceful response aimed at reducing funding costs and support the deleveraging of public and financial sector balance sheets.

3. Go long EUR/CHF for a target of 1.35 (opened at roughly 1.2260) and a potential return of 11% including carry, stop at 1.20

First, continued weakening of Swiss activity, possibly linked to a deepening in the Euro-area crisis, could force the SNB to ease even more aggressively via a raised intervention level, which we now project at 1.30. Second, the (partial) resolution of sovereign tensions could trigger the reversal of some safe-haven flows into the CHF. Overall, it appears there are several scenarios, which could lead to a notable move higher in EUR/CHF, while the downside risks appear limited.

4. Long Canadian equities (S&P TSX) vs Japanese equities (Nikkei), FX unhedged for a target of 120 (opened at 100) and a potential return of 20%, stop at 90

With a bullish view on the commodity complex, and energy prices in particular, the Canadian equity market ought to be a clear beneficiary given its significant energy and materials weights (both a bit less than 25%)…

5. Long a Global Rebalancing Basket (CNY, MYR versus GBP, USD) for a target of 107 (opened at 100) and a potential return of 7%, stop at 98

Large current account surpluses, and related signs of excessive FX reserve accumulation, are an important feature of persisting global imbalances. In particular in Asia, a number of countries record large surpluses in combination with heavily managed exchange rates and persistent inflation pressures. The currencies of these countries remain strong candidates for additional nominal appreciation. The CNY and MYR are typical examples, with the latter adding commodity exposure to the appreciation pressures.

Another feature of global imbalances is that a number of developed countries struggle to support domestic demand since the global credit crisis. In response, some of these countries have shifted towards extremely accommodative monetary policies and substantial QE, which exerts downside pressure on the respective currencies. The Fed and the Bank of England have been particularly proactive and hence the USD and GBP could remain under downside pressure. Both countries also continue to record current account deficits.

6. Long July 2012 ICE Brent Crude Oil futures for a target of $120/bbl (opened at $107/bbl) and a potential return of 12%, stop at $100/bbl

As the downside risk from the European debt crisis has intensified, so has the oil market’s incentive to draw down inventories ahead of the threatened global economic recession. In particular, in its attempt to price in the potential that the European debt crisis may trigger a new global economic recession, the oil market continues to set crude oil prices too low to clear the tight physical markets, leading oil inventories to reach exceptionally low levels for the time of year…

…the upside risk to oil prices has also increased as the low level of inventories and currently tight supply-demand balance is leaving the oil market exceptionally vulnerable to supply disappointments or better-than-expected demand. Interestingly, while the oil market has spent much of 2011H2 drawing parallels to 2008H2, the more relevant parallel may prove to be between 2011H2 and 2007H2, when extremely tight physical markets set the stage for crude oil prices to rise by almost 50% in 2008H1 to a record high over $145/bbl even though the US economy had fallen into recession, much as we think the European economy is doing now.

What do you think monkeys? Any of you guys jumping on these trades?

Have a good weekend WSO.