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The value of investments can fall as well as rise and past performance is not a guide to the future.  The information contained within this document is for guidance only and is not a recommendation of any investment or a financial promotion.

SkerrittsView - March 2012

Greek Fatigue?

After more than five months of negotiations, the inevitable happened.  Having realised that the country simply didn’t have enough money to service its debts, its creditors agreed to taking a 50% “haircut” – loss to you and I – on what they were owed and agreed to extend the period of the loans by some 30 years to help spread the impact.  You think we’re talking about Greece don’t you?  Well, what we’ve actually described are the terms of the London Agreement of 1953 in which Germany was allowed to restructure its debts having got itself into an inescapable position due to events between 1919 and 1945.  And guess who signed up to it?  Yes, Greece. According to some Greek politicians, what they wrote off would be “worth 70 billion Euros today” [The Bank Credit Analyst March 2012].   Whether Greece will keep to their side of the bargain now is something that the rest of the world can only guess at, but it seems a little hopeful to think that they can, or will.  The feelings of the Greek people towards the Troika (the European Commission, the ECB and the IMF) is probably reflected in the open letter published by the union representing Greek police officers wherein they threaten to arrest any representative of said Troika unless the demands for austerity are dropped.

But is the recent rally in global markets a sign that the world has reached a stage of “Greek Fatigue?” Now that the ECB has steered the European banking system away from the edge of the abyss with its LTRO programme, does what happens to Greece actually matter much to anyone else any more?  The world has other things to mull over.  In the meantime, markets have breathed a collective sigh of relief and have embarked upon one of the longest rallies for many a month. It’s amazing how quickly sentiment turns.  Is it justified, and will it last?

Will It Last?

Your answer to this depends, we guess, upon whether you’ve caught the bounce in markets or whether you’ve missed it.  If you’ve missed it, you are likely to be one of those commentators who is ringing the warning bells and forecasting a rapid return to whence we’ve come. If you’ve caught the upturn, you’ll be one of those commentators hoping to hell that the rally continues.  We’ve mentioned before in this newsletter that experts are often seen to say the “think” something will happen, when in reality the mean they “hope” something will happen.  If you are an optimist you will currently be pointing towards the better data that has been emanating from the United States, an apparent Chinese soft landing, bank liquidity in Europe that is effectively unlimited, and interest rates in the US and the UK that are assured to stay low probably into 2014 at least (the Governments have told us).  If you are a pessimist you will shake your head at the futility of the above, preferring to point out that the debt crisis has not gone away, that the price of oil is now reaching levels to knock global recovery off its path, that this rise is a consequence of tensions in the Middle East that could lead to military intervention, nuclear or otherwise, in Iran by Israel and the US, and that Europe is likely to be in recession for the rest of this year. On top of this, all our Champions League contenders have been knocked out before mid-March.

Keeping things simple, it seems to us that if the risk of banking Armageddon has been removed, and interest rates and gilt yields are going to remain below inflation for the foreseeable, then money will seek a return from somewhere.  On balance, we’d rather be in the market than out at the moment, accepting that a number of risks lay ahead. In even more simple terms, if you were taking a 10 year view and could afford to ignore short term fluctuations, what seems intuitively to be the better deal at present? To hold a gilt which is going to pay you about 2.75% interest a year, then give you your money back, or an equity income fund paying you around 4.5% a year from a basket of shares some way below where they were 10 years ago? It would be lovely to fast forward 10 years to see if it really is as good as it looks.

Risks a Plenty – But Opportunities Too:

BCA Research makes a good case for the Greek debt crisis following two possible routes. One is that Germany bites the bullet and decides that higher inflation is a price worth paying to prevent the disintegration of the Euro. Unemployment in Germany is now at 5.5%, down from a recession peak of 9.4%.  This is pretty close to full employment and wage growth has already begun to show signs of returning over there. Outcome number two is that Greece leaves the Euro – voluntarily or forcefully – and that they actually come out of it better than if they stayed in.  This would make Portugal, Ireland, Italy and Spain (and perhaps even France) question why exactly they are still in it too. Taking Asia as an example in 1997, Thailand were the first to devalue their baht currency, which triggered similar action by Indonesia and Malaysia to name two. Similarly, when Brazil devalued their Real, Argentina’s dollar peg broke as well. Can we say that these economies are worse for it? Not at all.

Are these scenarios going to play themselves out in an orderly fashion, against a backdrop of steadily rising equity markets and a haven of international cooperation?  There is more chance of Stephen Hawking representing the United Kingdom in next year’s Eurovision Song Contest. As has recently happened, markets will force action upon the various parties and there will be more summits than the Alpine Range before events crystallise. It may not happen tomorrow, but we can be fairly certain that the Eurozone play has not yet reached its final act, and it will not be a particularly smooth ride until it does.

Other factors to keep the glass half empty brigade busy include the VIX index and Director dealings recently. Without going into extensive detail, the VIX index is a measure of confidence and volatility. It has currently fallen below 20, a level that has consistently preceded market corrections over the past few years. Alongside this, the current rally has occurred on very light volume of trades. The average volume of S&P 500 company shares traded is apparently 20% down in the past 3 months compared to the corresponding period last year. According to BCA, historically market rallies on light volume have run out of steam quickly. With regard to director dealings, or corporate insiders as BCA refer to them, these have sold 5 times as much as they have bought in February alone.  Such a high sell-buy ratio has occurred less than 50% of the time since 1983.

After a rally such as we’ve had, a slight correction is a different thing entirely to a full-blown crash initiated by a banking crisis.  So, for the half full supporters, where looks most likely to benefit from a prolonged rally?.  Some like Japan.  James Ferguson in MoneyWeek pinpoints to “two momentous shifts [in policy] in the last month that could well be the catalyst” to turning “the potential of a really cheap valuation story into an actual humdinger of a market”. Others take a brave view on Europe having turned a corner against the backdrop of low valuations and significant unpopularity amongst investors. We tend to align ourselves behind those seeing the emerging markets as a profitable place from which to capture gains.  We call them emerging markets but that’s a bit disparaging now to be fair.  Compare the Developed World characteristics of high debt levels, political instability and currency crises with those of the Emerging World and their low debts, stronger currencies and, in some cases, stable governments. Add to this their younger populations, less welfare and lower taxes regime, and generally smaller governments, plus the fact that they still trade at a discount to the US even though they have better growth prospects, and scope to ease fiscally and rapidly should an adverse situation develop, and you can probably see why these markets still appear to us more attractive on a longer term basis.

The value of investments can fall as well as rise and past performance is not a guide to the future. The information contained within this document is for guidance only and is not a recommendation of any investment or a financial promotion. 

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