Introduction to Chaos Theory

Everybody is biased, it is important to remember where the annual forecasting recommendations are coming from. Investment banks are naturally optimistic and have already provided their version of Dr Pangloss’s Guide to 2012, “it is proved that things cannot be other than they are, for since everything is made for a purpose, it follows that everything is made for the best purpose”. They acknowledge the risks to the global outlook in the first quarter led by events in Europe, but believes that European politicians will work for the best purpose of the financial markets to resolve the sovereign debt crisis, which the nascent recovery in the US will continue to gather pace as the year progresses, in the absence of a major European default, whilst emerging economies may experience slower growth in the first half of the year necessary policy stimulus will propel recoveries in the second half of the year.
The Ignis Rates team is naturally bearish, comprising of miserable measures of Scottish gloom, Welsh melancholy and Canadian existential nihilism (admittedly limited to just one observation but clearly someone who wanted to be American but could not take the relentless optimism of that nationality). Consequently, Doctor Pepper’s Guide to 2012 attempts to concentrate on the worst that can happen in these particularly trying times, but does not seek to be exhaustive. The Year of the Dragon is likely to breathe fire over financial markets but our central view is that the global economy will avoid recession by a whisker, but that emerging market economies will join the major industrialised economies in experiencing growth-recessions. Nevertheless, it will be the fourth year in our lost decade of deleveraging, we have passed the end of the beginning, which took place in spring 2011, but we are a long way from the beginning of the end.

These deleveraging trends create plenty of opportunity for mischief in the global economy and in honour of the Mayan prophecy; we have looked at the misers’ guide with reference to the four horsemen of the apocalypse. While Dr Pepper’s guide is designed to identify what’s the worst that can happen, we have absolutely no fear about the Mayan prophecy. This vision of the apocalypse is based on the Mayan long count calendar, which resets to zero every 1,872,000 days. According to some calculations this reset is December 21st, but fortunately it is not the end of the world. Inevitably, apocalypses prophecy appeals to the primeval fear of death and are a recurring theme throughout history.

The four horsemen; white, red, black and pale riders representing conquest, war, famine and death represent three bullish and one bearish risk for developed economy government bonds. Viewed in conjunction with our central view of a series of prisoner’s dilemmas, these tail risks maintain our bullish view of global bonds.