Editor’s note: Charles Nenner, a figure in the US investment industry and who also regularly appears on television and at conferences, gives his views here on market developments. A distinguishing characteristic of Nenner’s approach is his exploration of various market “cycles”. He uses his analytical framework to examine movements in bond, equity, currency, commodity and other markets. (To view an article about his work, click here). In this article he looks at both segments – traded markets and economics. As always, this publication does not necessarily endorse the opinions carried here, but it is grateful to Nenner for sharing his outlook in these pages.

We have been writing about the 60 year interest rate cycle for some time and it continues to influence the financial world. The cycle shows a low around 2010, high 1980, low 1950, high 1920, low 1890, and high 1860. Politicians are part of the problem and seem to have no clue about history. Let us explain.

It seems that every cycle has led to the same mistakes. A fear of deflation in the 1930s led to overstimulation and overspending in the 1950s. This only led to high inflation starting in the 1970s. After that, the fear of inflation increases the risk of deflation. Especially in Europe, they still seem to fight the last war.

The question is the following: do policy makers have any influence? For example, Paul Volcker is accepted as the “killer” of super inflation. We ask: Did he do so, or would it have happened anyway, since the inflation cycle was right at the top when he started? The answer is that - probably - he was just an instrument in the cycle patterns.

We write about this phenomenon in order to provide some understanding about what is going on in the world, so we will not be surprised.

There is still the fear of inflation in Europe, which we feel should still be fear of deflation, since the financial system is still at risk. The Europeans came up at the wrong time to demand from the banks an increase in the capital ratio from 7 to 9 per cent. Since they cannot go to the stock market in this environment, it will lead to a further shrinking of their balance sheets.

Credit default spreads in the German bunds [bonds] are spiking. In spite of all the rhetoric, we feel that there is not enough money to bail out Italy and Spain. The European Central Bank balance sheet is expanding - but too little and too late.

There is the possibility that all of this is deliberate – in order to force the weak countries to put things in order. However, it is a risky game. We feel that fiscal austerity right now is the wrong policy, as seen in the UK - where they already cut spending and imposed new taxes.

More reflation

In the US, however, profits look good. If the world can get its act together, the bull market is not over yet, although the risk of fiscal tightening next year is a real problem. Last week, seven central banks eased - including China.

Is there a master plan? We doubt it - but our indicators predict a round of “reflation”. It will probably start by the ECB, followed by the US Federal Reserve and by China.

This will mean “risk on” again, and will explain why our cycles project a stronger Australian dollar and Canadian dollar soon.

To recap, the story will be a big reflation trade Q1 of 2012.  Look for strong commodity currencies as well as strong grains, metals and crude. Long term, cycles show new highs in the Aussie [dollar] and gold. The general outlook is that volatility will pick up over an array of assets in the next couple of weeks.