From Greece to Italy

Two thousand years ago, the world was ruled by the Romans.  Across Europe, from East to West, into Africa, and even including England, it amounted to roughly 1 in 4 people alive on the Earth who lived under Roman Law.  The Roman Empire was one of the largest and most enduring.  It is not only because of this central position that Rome played that we have the saying about all roads leading to Rome.  Their engineers were in fact one of the greatest road-builders in human history, building over 80 000km of roads.

So it saddens the history-loving heart to witness what has become of this once great Empire.  Reduced to petty political squabbles, and being amongst the most indebted countries on Earth, forced to defend its best intentions and actions from the marauding bands of bond vigilantes.  To say nothing of course of the plight of their creditors, who sit quivering at the looming prospect of Italy not being able to fund itself.

Yes, in this great financial crisis, it will be in Italy that the endgame will be fought.  So perhaps it is fitting that the saying “being thrown to  the wolves” also originates from the activities held in the Roman Colosseum.  Perhaps we should rather point to another idiom, that of the chickens coming home to roost.  The famous question will perhaps one day be asked : Why did the chicken cross the (Roman) road?  “Why, to get a haircut, of course!” will be the answer.

Source: Atlantic Asset Management

Eurozone deal – the good, the bad, the ugly and the unknown

The Good

The most important aspect is that Eurozone leaders finally recognized that the current trajectory of Greece’s public debt is unsustainable, and that wave upon wave of harsh austerity measures will not change it (in fact it can only worsen it).  Bondholders (mainly banks) will thus write down 50% on their current holdings of Greek debt.  This should bring the Greek debt-to-GDP ratio down to 120%, down from roughly 160% - still high, but more manageable.  Greece will also have access to €130bn in bail-out funds to help keep government operations afloat (and, yes, to make interest payments on the remaining 50% of its bonds).  While the 50% haircut has been called ‘voluntary’, it could still trigger payouts on insurance contracts against default (credit-default swaps or CDSs), if the International Swaps and Derivatives Association deems a “credit event” to have taken place.  The complex web of CDS payments triggered by the Lehman Brothers collapse was part of the reason for the financial chaos in 2008.  So far ISDA says the deal unlikely to trigger CDS payments.  But this will also lead to many questioning the usefulness of CDSs in the first place; if they can’t protect you from a 50% sovereign haircut, when can they cover your losses?  This could lead to longer term instability in that market. 

The Bad

At €440bn, the current bail-out fund (European Financial Stability Fund) is too small to support Italy and Spain should these countries come under speculative attack (or if the market simply loses faith in their solvency).  Italy’s public debt pile alone is close to €1.9 trillion.  The EFSF relies on the AAA-rating of the countries behind it.  But these countries will not (in the case of Germany) or cannot (France’s AAA rating is already at risk) increase their contribution.  Germany has also blocked moves to allow the European Central Bank (ECB) to stand behind the EFSF (the ECB of course has unlimited firepower, since it can print money).  Thus, to increase the firepower of the EFSF leverage is required.  One option is for the EFSF to guarantee only the first 20% loss of any new government bond, effectively stretching the €440bn fivefold.  But what happens if the losses exceed 20% (as in the case of Greece)?   Alternatively, special purpose vehicles (SPVs) could be set up, where the EFSF guarantees the first ‘tranche’ while other investors (sovereign wealth funds or the Chinese for instance) buy the other tranches.  If this sounds a lot like the financial engineering that caused so many problems in 2008, that’s because it is.  Leverage can work in both ways - it can also concentrate risk and spread problems from the PIIGS back to the countries backing the EFSF (especially France).  And will other investors want to buy into these tranches? 

The Ugly

The €106bn recapitalisation of Europe’s banks will help them absorb the losses on Greek (and potentially other) write-downs.  The deal requires European banks to raise core capital reserves to 9% by June 2012.  However, while recapitalization should make banks safer, it will also lead to a reduction in lending, potentially starving Europe’s struggling economy of credit. 

The Unknown

Finally, the plan does nothing to address the fundamental imbalances within the Eurozone, and the uncompetitiveness of the peripheral countries.  Germany will continue to run trade surpluses with the likes of Greece, effectively stealing demand from them. Greece, Portugal and to a lesser extent, Ireland, remain trapped in a currency that is too strong for them, meaning that the only way to regain competitiveness is via a painful ‘internal deflation’, i.e. pushing down prices and wages.  All the while, receiving no assistance from the central bank (unlike the US or UK, where the central bank has done all it can to ease the pain.)  Italy and Spain, the third and fourth largest eurozone economies, are not bankrupt (despite their high debt loads) as long as the interest rates on their debt remain low.  If the market frets about default, it will push yields up and potentially force the very event it fears.  While the EFSF has been increased (through leverage) to prevent this eventuality, no one wants to see the EFSF tested.  Finally, while the pieces of the puzzle are starting to fall into place in terms of a long-term solution to Europe’s woes, one cannot help but be a bit skeptical.  This was the third ‘comprehensive plan’ so far this year, following the 14th summit in 21 months.  Following the 21 July summit, it took European parliaments three months to approve changes to the EFSF, because they all went on holiday!  In this market environment, a day is a year and three months a lifetime.  European leaders need to provide detail on this plan and soon.

With acknowledgement to Fairbairn Capital

How much is enough?

How much is enough?

There is a famous story about the author Joseph Heller, attending a party given by a billionaire. Another illustrious author, Kurt Vonnegut, informed Heller that the host, a hedge fund manager, had made more money in a single day than Heller had ever earned from his wildly popular novel Catch-22. Heller responded: "Yes, but I have something he will never have… 'enough".

 

What Heller is talking about is knowing what really brings you happiness. No matter how much we accumulate, there will always be someone who has more. We need to be thankful for what we already have - a job, a home, friends, family, and food on the table.

The idea of "enough" is worth thinking about. There are times where we often feel pressure to spend and accumulate more "things". We feel bad if we can't give our loved ones the gifts they want and often feel obliged to buy gifts for other people so we appear generous. Perhaps we should focus more on generosity of spirit, on giving of our time rather than from our credit cards. 

At some stage in your financial planning, you need to ask yourself how much money is enough? How much time with your family is enough? How much time to pursue your passions is enough? Also ask yourself how you can balance all this to achieve a true sense of fulfillment.

This is as important as asking how much you need to be saving because saving is the flip-side of spending. Does all that "stuff" you spend your money on actually bring you happiness? We tend to buy things to fill our home that do not bring us any real joy beyond the few minutes we spend actually buying them. We may find saving for a dream far more emotionally satisfying.

I recently came across an article in Time that really brought the "stuff" we accumulate into perspective. In the article, organizational consultant, Peter Walsh says, "It's not necessarily about the new pots and pans, but the idea of the cosy family meals that they will provide. People are finding that their homes are full of stuff, but their lives are littered with unfulfilled promises."

Take a moment when you are with your family and friends to discuss what exactly it is that brings you happiness, whether you have "enough" and what "enough" means to you. You may be surprised by their answers as well as yours.   
 
   Source: Liberty

Offshore Investments

High Volatility - Who wants to time the market?



                           

ALSI: 1 month to 12 Sep 2011

Dow Jones Ind: 1 month to 12 Sep 2011

Price of gold - From 2000

Today's chart provides some long-term perspective in regards to the gold market. As today's chart illustrates, gold has been in an extremely strong bull market since 2001. The pace of that upward trend has increased over time. There was a slight increase in slope both in 2001 and 2005. Following the financial crisis of late 2008, however, gold significantly increased the pace of its ascent. Recently, gold made new rally highs but has pulled back after approaching long-standing resistance (red line) of its current accelerated trend channel. Despite the pullback, gold currently trades for over six times what it did when the rally began back in 2001.

The Current Market Sell-off - by Coronation

The Current Market Sell-off

The ongoing sovereign debt problems of the Western world suddenly erupted into a full scale

panic in financial markets in the first week of August 2011.

The proverbial straw that finally broke the camel’s back was a combination of the problems

experienced in raising the US debt ceiling, the lack of a clear and strong enough policy

response to the Eurozone’s debt problems by the ECB and the EU, and the release of poor

economic indicators across a number of countries. Investors have lost confidence in the

authorities’ ability to support the recovery in the US and to deal with Europe’s funding issues.

In response there was a massive spike in risk aversion and indiscriminate selling of risk

assets. To top it all, rating agency Standard & Poor’s lowered the US’s credit rating from

AAA to AA+ - its first ever down-rating – adding further fuel to the fire and the extent of panic

selling.

South African equities and the rand weakened substantially as investors sold en-masse.

Safe haven plays like gold, the Swiss Franc and somewhat perversely even US treasuries

were the winners in this flight to perceived safety.

What can one expect now?

A far stronger policy response from, in particular, the EU and ECB is required. Large

countries such as Italy and Spain cannot be allowed to flirt with defaults on their bonds. If

such an event were allowed to happen it would deal a lethal blow to European banks and

may spell the end of the Euro. No matter how politically unpalatable it may be for the Italians,

Spaniards, Greeks and others, some form of greater fiscal union (or a mechanism forcing

increased fiscal accountability) in the Eurozone is likely to result from this crisis.

Coronation is in no position to predict what macro outcome will result - as events of the last

few years have taught us all that no-one can foretell what the future will bring. But what we

can say is that we will, as always, stick to our valuation based investment approach.

Preceding the crisis we found global equities to be reasonably attractively priced. We also

thought most global bonds were terribly expensive. The panic selling of good quality shares

has made the value in these stocks even more apparent, and the flight to US treasuries has

in our view only made an expensive asset even more expensive.

In the South African market the cyclical stocks such as Anglo American and BHP Billiton sold

off more aggressively than the defensive shares such as British American Tobacco and

SABMiller. The relative price moves were extreme and we used the opportunity to switch

from the defensive counters to the more cyclical ones.

We acknowledge that the loss of confidence in the ability of policymakers to steer the correct

course is a blow to growth prospects. And as commodity prices weaken, South Africa will

earn less for its exports and will run a higher current account deficit unless spending on

imports also declines.

The lower than expected economic growth does however mean interest rates will stay low for

even longer. A period of stagflation (stagnant growth combined with some inflation) is

becoming an ever greater probability for the globe and South Africa.

In such a scenario, negative real returns on cash and bonds are common. In previous

episodes of stagflation, equities proved to be the only asset class to give investors a real

return. We also remain very comfortable with our high holdings of inflation-linked bonds

across all our balanced and bond funds.

We are likewise pleased not to own conventional government bonds. Our equity holdings

have certainly suffered as prices collapsed but we view the sell-off as an opportunity to take

advantage of the compelling long-term opportunities that so often present themselves in

times of crisis.

Our funds have weathered the sell-off well so far, with price behaviour of all the funds in our

flagship unit trust range remaining comfortably within their respective risk budgets.

Karl Leinberger

Chief Investment Officer

Coronation

10 August 2011