Round and round the garden

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*This blog was printed in Portfolio Adviser and available online http://www.portfolio-adviser.com/comment---analysis/the-risk-on-is-cheap-dilemma-for-investor

A ring, a ring o' roses,

A pocket full o’posies

Atishoo, atishoo we all fall down!

When I was a young child my grandparents used to recite this nursery rhyme to me. A while later, when they assumed I was old enough to understand, they  told me that its origins stemmed from the Great Plague which took place in the 17^th century. They explained that the ‘ring of roses’ referred to the red rash that heralded the disease, posies were carried for protection and the sneezing was the sign that death was imminent. Small wonder I brought up my children on the less grisly ‘Round and round the garden.’  I don’t believe that this rhyme has a similar ‘horrid history’.

A ring, a ring o' Euros,

A pocket full o’i.o.u.s,

Greece, Portugal, Ireland too

Italy, Spain, the Eurozoo

At issue, at issue, we all fall down!

Perhaps in years to come our ancestors may be singing a rhyme based on the plague of sovereign debt crises threatening to bring down the whole of the Eurozone. In this plague the common symptoms are high borrowing costs, an unpopular government, a severe austerity plan and a lack of economic growth. The authorities are aware of the epidemic and are searching for a cure. In an attempt to prevent contagion, they have tried handing out billions of Euros to the sickest patients on the periphery of Europe. Interest rates have been cut and the European Central Bank (ECB) has helped to refinance banks by lending a trillion Euros at low interest rates. However, although the prescribed treatment has brought sufferers some short term relief, a long term cure has yet to be found. The long term refinancing operations programme, introduced late last year and earlier this, was received with much optimism, but this has waned with the recent elections in France and Greece.

With no long term resolution forthcoming, the treatment remains the same, although the Euro dosage grows bigger and bigger. Surely the issuance of Eurobonds, a measure backed by all Eurozone members, would serve to stop the Euro falling? This would sharply reduce the cost of borrowing to the weaker nations, although the core of Europe would pay more. However, this is a tough decision for Germany which has the most to lose from a potential downgrade. The alternative is to let the weaker nations leave the single currency. In the case of Greece, the short term would be painful but beneficial in the longer term under its own fiscal and monetary steam. The likelihood of this happening is increasing. 

Fundamental analysis in these markets has proved futile of late. Politicians have been driving the market. Valuation has often been disregarded with uncertainty leaving the investor a binary choice, either “risk on” or “risk off.” However, here is the dilemma for long term investors.  Those asset classes which most participate in the “risk on” trade look cheap, whilst defensive assets are expensive.  ‘Round and round the garden’.......or should that be ‘up the garden path....?’

John Husselbee

Chief Investment Officer, North
25^th May 2012

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*This blog was printed in Professional Adviser and available online http://www.ifaonline.co.uk/professional-adviser/feature/2179192/rocky-eurozone

The Rocky Eurozone Show

The French Presidential elections resulted in voters taking “a jump to the left”, as President Sarkozy failed to win a second term without the support of those “taking a step to the right.” Francois Hollande is the first socialist president of France since Francois Mitterrand swept to power in 1981. Mitterrand was elected on a promise of change and remained in power for the next fourteen years. Hollande has campaigned in a similar tone, with change being more economic growth and less austerity. With French unemployment running at 10%, clearly the majority of the population have decided it is time for a different approach and rejected President Sarkozy. However, the options for change maybe fairly limited for the new president as France continues to face up not only to domestic economic challenges but also those of the Eurozone too. Hollande will soon be able to judge the size of the challenge with his first official engagement with German Prime Minster Angela Merkel.  

A resounding message of change was also delivered in the Greek parliamentary election - a further protest and rejection of tough austerity. The vote was always expected to be fragmented with neither of the major political parties, the conservative New Democracy nor the socialist PASOK forecast to gain a majority. The expected, and the most market friendly, result would have been if the two major parties, which have dominated Greek politics for many years, had been able to form a coalition with a sizeable majority. Both these parties have fully signed up to the conditions of the second bailout and remain committed to keeping the Euro. With smaller parties, from both political extremes, winning such a large majority of the vote this coalition hasn’t been possible. Therefore leaders of the New Democracy party have attempted to form a wider coalition with the common goal of realigning the bailout conditions. After much negotiation these attempts have failed, and fresh elections will be held at some point next month. In the interim Karolos Papoulias, the President, will oversee the forming a caretaker government.

The future of Greece in the Euro is uncertain, which is unsettling financial markets. The Euro has weakened to a four month low against the US dollar and government bond yields are rising again. Increasingly investors’ attention will turn to the other periphery nations of Portugal, Ireland and particularly Spain. The cohesion of the Euro lies in the fact that there is no provision for any member state to leave or be pushed out. Once investors believe this is a possibility this is likely to lead to a capital flight to safety without massive intervention by the ECB. Nothing has changed for all these countries and others, a brutal adjustment is needed to restore public finances and competitiveness whether they remain inside or outside of the Euro. Structural reform particularly around labour markets is urgently required, not an even more bloated public sector or increased infrastructure spending. We have been here before and the long term solution hasn’t changed. It seems the new political cast of The Rocky Eurozone Show will be singing “The time warp” before too long.

John Husselbee

16^th May 2012

No time for a Mars bar!

*This blog was printed in Portfolio Adviser and available online www.portfolio-adviser.com

The Governor of the Bank of England told us that the road to economic recovery would "zigzag." The preliminary news that the economy contracted by 0.2% in the first quarter of this year, and that we have technically fallen back into recession, rather suggests a wrong turning. With economic growth essentially flat over the past twelve months,  the UK finds itself in a slow moving traffic jam  and the chances of seeing open road any time soon doesn't look promising. Many commentators are predicting that the Diamond Jubilee Bank Holidays will disrupt growth in the second quarter. It seems that it’s ‘work’ rather than ‘play’ that is more likely to restore our errant recovery.

That the UK has technically slipped back into recession comes as little shock to many businesses and households.  Few feel we ever left. The financial markets’ reaction to the news was rather muted considering they had been expecting a small rise. Perhaps their thinking is that this preliminary number will be revised upwards, certainly based on recent business surveys which reflect a healthier environment. That must also be the hope of the Coalition which has chosen to stick to Plan A - one of austerity. Indeed, a few days earlier the Government had hinted at further cuts, only one month after the Budget - one which is being remembered for its tax break to the rich and the hike in price of hot sausage rolls and pasties. 

The UK economy grew consistently from 1992 and until 2008 the UK had enjoyed a sixteen year period of unbroken economic growth. A repeat of this any time soon seems highly unlikely and whilst this may frustrate the Coalition, their options seem limited. Like many of our Eurozone neighbours the UK is engaged in a tough austerity programme aimed at reducing debt rather than fostering growth. At the same time, bank lending is still contracting and stubbornly high inflation continues to gnaw into household incomes - in total, a recipe for rising unemployment, weak consumer demand and stagnant growth.

Whilst the economy may be struggling to gain traction, the markets have until recently, been making progress. The contrast between UK economic growth and the recent impressive results from Apple couldn't be starker. Investment managers should remind their clients and themselves of this point.

We are investing in companies, not the economy. There will be winners and losers in all stages of the economic cycle - today is no different. Take Burberry and Aquascutum as an example. Both have a similar heritage and both are famous for their beige trench-coats. However, we recently learned that whilst Burberry is thriving, Aquascutum is heading into administration. There will be many similar stories in the coming years and the UK presents the active fund manager with plenty of opportunity. As we are continually reminded, this is not a normal recession and in this environment, a good stock picker should be able to achieve above market returns.

27^th April 2012

April is the cruellest month

*This blog was printed in Professional Adviser and available online www.ifaonline.co.uk “

APRIL is the cruellest month,

breeding Lilacs out of the dead land,

mixing Memory and desire,

stirring Dull roots with spring rain.

Winter kept us warm,

covering Earth in forgetful snow, feeding

A little life with dried tubers.”

Whilst I very much doubt TS Eliot was writing about the financial markets, he could have been. In April 2010 and 2011, the market started to correct and on both occasions investors saw ten percent or more wiped from their portfolio valuations. Markets have sold off again in the first few weeks of this month and the question now is whether 2012 will see history repeat itself.

Let’s consider the activity of equity and bond investors. Until recently, equity market investors have broadly remained in ‘risk-on’ mode, although the blanket euphoria witnessed earlier in the year was replaced by investors becoming more selective - the first sign of fatigue perhaps. For example, last month there was a divergence in performance of developed versus emerging market equities. This we attributed to two factors. First, the increasing price of oil, which is probably impacting emerging market corporate profits rather more than in developed markets, where spare capacity is greater. Furthermore, energy costs represent a greater proportion of the inflation basket in emerging economies - hence investors’ expectations of monetary loosening have been tempered. Second, a continuation of strong news flow from the US contrasted with the perceived deterioration of data emanating from the emerging world, especially China.

Whilst equity investors have been selective, bond investors have been acting somewhat erratically. By mid March, both US Treasury and Gilt yields had reached year to date peaks, driven by further confirmation of a sustainable recovery in the US - and as such, less likelihood of further Quantitative Easing. However, by the month end, yields had collapsed as Federal Reserve Chairman, Ben Bernanke, reiterated his willingness to pump further stimulus into the economy should the improvement in the job market prove not to be sustainable. Realistically, there seems to be little chance that central bankers, especially Bernanke, will risk killing off the recovery by raising interest rates too soon. For the record, just because interest rates will remain anchored at rock bottom for the foreseeable future, it does not mean government bond yields cannot move higher. With budget deficits only worsening, inflationary pressures failing to abate and central banks becoming the largest owner of their respective sovereign bond markets, the factors are in place for yields to rise. Whilst a return of risk aversion may result in some ‘safe haven’ buying, the risk return in owning gilts, bunds or treasuries remains highly unfavourable.

With equity investors becoming more selective and bond markets behaving erratically, there are strong grounds for caution. As the perennial stockmarket adage “Sell in May” begins to appear in market commentaries, it does seem that each year investors are preparing for the lower volume summer months earlier and earlier.

Three well known concerns remain – the Eurozone, US Economy and Emerging Market slowdown. None are fully played out, but as they become better understood by both the policy makers and their central banks, shallower corrections result.

20th April 2012