By Jeremy Gaunt, European Investment Correspondent
LONDON, Jan 14 (Reuters) - Chronic uncertainty over the impact of massive government stimulus efforts to battle the global recession is creating a new kind of political risk for investors and discouraging financial market recovery.
Different from the traditional concern about government stability, this new risk is about dealing with increasingly more hands-on governments.
It has made financial market players more cautious than they already were, keeping money out of the very assets that governments want to see refloated, such as the equities that took a historic hammering last year.
There is also widespread concern about the so-called law of unintended consequences, the notion that actions to achieve one goal often end up doing something else -- and not necessarily a positive something else.
"We have considerable uncertainty about the political initiatives that will be taken over the next few months," said Andrew Milligan, head of global strategy at Standard Life Investments. "For the moment, it is postponing some of the big decisions."
First the credit crunch and then the global economic downturn have prompted governments and central banks across the world to nationalise banks, slash interest rates to next to nothing and impose new regulations on the financial sector. It has also brought a flurry of stimulus packages -- with easily more than $1 trillion alone in the works in the United States.
Although many investors welcome such measures in the face of the worst economic downturn in decades, there is widespread concern that few people know what it all means.
"Governments are not economists," said Gary Dugan, chief investment officer of Merrill Lynch's wealth management arm. "They don't always work things through."
The result for investors? "You just take so much less risk in your portfolio," Dugan said. That may be one reason for the struggle equities are currently having to keep up a rally that began in late November. Once up 26 percent from a 2008 low, the MSCI all-country world stock index <.MIWD00000PUS> is now up only 17 percent.
MACRO AND MICRO
On one level, the risk thrown up by governments is simply a question of the efficacy of their proposals.
Asked recently for his outlook on oil and commodities, for example, Standard Life's Milligan was unable to take a firm stance because he could not predict the economic climate.
If government stimuli work, then an economic recovery may get under way relatively soon, raising demand for commodities and other asset prices along with them.
But if they don't, if policy errors appear, then investors and economists may be clamouring for further packages before the year is out.
Related to this is the question of what will actually happen to the stimulus plans. Their announcement has generally been accompanied by vague targets, such as infrastructure spending or tax cuts, without any details.
But there is also a new, unfamiliar ground being prepared on the micro level for specific assets.
Consider, for example, the HBOS/Lloyds
Investors wanting to take advantage of the difference in prices between the two shares could not easily hedge their bets because of the ban, imposed as a reaction to tumbling financial sector shares. So their risk profile had to rise.
Sovereign debt, meanwhile, is being boosted by a wall of fresh money being released by central banks, making yields artificially low. While this might be what authorities are after, the rush for relative safety is draining investments from other assets and arguably setting up troubles for investors in the future.
The cost of protecting U.S. and British debt, for example, has soared recently, suggesting that governments are seen as a growing source of risk.
GOVERNANCE GAP
On top of all this, investors are also having to deal with a new form of country risk.
This is not the traditional risk of, say, rising unemployment threatening government stability. Rather it is the risk of an array of different countries responding to a global crisis in different ways and at different speeds. For investors, there is complexity at best and danger at worst in the scatter-shot approach of unlinked local responses to interlinked global problems.
In its annual take on global perils, the World Economic Forum designated this as one of the key risks facing the world as it struggles to get out from under the severe global economic downturn.
It concluded that the absence or lack of effective and inclusive ways of dealing with risk was a risk itself. [ID:nLC526639]
(Editing by Richard Hubbard)