Good morning,
As promised, we would like to expand in some detail our current view on the market, and the resulting actions taken Thursday and Friday this week. At times share trading can be about capital preservation, and in part that is what we are trying acheive.
Thursday, positions were sold in HVN, NAB and QBE, followed up with a sale of LLC on Friday. This leaves 95% of the portfolio now in cash with one remaining investment in Quickstep Holdings.
We have been reading extensively regarding the situation in Greece and have some serious concerns. In short, (talking only OECD countries) Greece has, along with Iceland, Italy and Japan an extreme level of public debt as a percentage of GDP (over 100%). The big different for Greece over those others is that it's budget deficits are also very high, at over 12% of GDP per annum, and so the speed with which the debt is growing is fast.
Greece is now at the point where it can no longer service it's debt and this is creating a panic of sorts. As a member country of the single EURO currency, defaulting on public debt would have disastrous consequences for other member countries and the currency itself.
We should note here that Ireland, Spain, the UK, Portugal and the USA have budget deficits of 10% or higher as well, and are forecast to continue these for the foreseeable future This will bring those countries to 100% debt to GDP ratios or above, and well above comfortable levels.
That said this is (most likely) how we see the scenario playing out: The strongest European Countries such as Germany will structure some kind of rescue or restructure package to reduce near term debt obligations and to reduce funding costs for Greece. It would be catastrophic if Greece defaults, because some level of contagion spreading to other Euro countries is inevitable. Because of the clearly negative results of an outright default, Germany is most likely to support the rollover of Greece's debt in the near term (there's 8.5 Billion Euros worth just in May '10).
Financial commentators (so far) for the most part aren't worried.
So here's the problem we have: no matter how much we read, or who you might talk with or listen to, no-one can tell you exactly what the financial consequences of a restructure of Greece's debt might be, or why bond investors should continue to lend to other countries who are, in all forecasts that are available, on exactly the same path that leads to where Greece is now at.
What we have seen is that as soon as the equity markets were given specific data (S & P Downgrades) which enabled them to more accurately measure the impact of the crisis, it was immediately reflected in lower equity market prices. We feel there is a very real chance that once markets are able to calculate the costs (once a bailout is announced) they will move sharply lower to reflect the actual cost of the crisis globally.
We are all agreed that debt cannot continue to be taken on board forever, that at some point it has to be re-paid (or defaulted). We are all agreed that a Government should not simply print new money to re-pay debt. This is especially so for Euro currency member countries, yet this is exactly what the UK and the USA are doing right now, innocuously named 'quantitative easing'.
The fact of the past two years is that unsustainable levels of private debt in the USA (which caused the GFC) have been transferred to the government's balance sheet, with the remainder being printed in the quantitative easing program. There is much debate on whether this will absolutely definitely lead to inflation and another unwanted recession, but most economists agree that some level of higher inflation in the future is inevitable.
Our job is to look for catalysts for possible share market moves, and given the above there is a possible related move in equities coming quite soon. We've been consciously aware of a looming debt problem with the USA for ten years now, in fact since massive budget deficits became the new normal.
But clearly trading equities for a share market reaction to that debt for ten years wouldn't have yielded very good results! In our view today, the Greece problem is a real and present catalyst for a downward share market move because:
1. Financial commentators by and large are writing recovery stories, none are analysing in any real detail what Greek debt contagion issues there might be. Commentary is 99.9% backward-looking because these guys are journalists, not economists.
2. The Greek debt 'problem' just won't go away. After first being reported the issue was apparently 'fixed' and our market went to new highs around 5,000 points. Today new levels of risk awareness are being priced into financial markets. This tells us it will likely be some time before this fully plays out and one of our favorite share market rules is 'the market hates uncertainty'.
3. Greece is symptomatic of an issue that is now common to quite a few, much larger, OECD countries. All of the countries discussed above will be in a similar debt position (very high public debt levels combined with very high budget deficits) within the next three years. Whilst there has been some discussion of the most at risk countries such as Italy, Ireland, Spain and Portugal in the press it is difficult to discuss potential problems with the UK, Japan and the USA without sounding like a crackpot conspiracy theorist. See point number 1.
4. Hedge funds have been targeting the Greek bond market and having an absolute field day. Two days ago the two year Greek bonds were yielding 24%, today that figure is just 13%. There's money to be made targeting other vulnerable countries' markets such as Portugal or Italy or both they will do so.
If there's a continuing problem in the Government bond markets, for the medium term, investor's appetites might just dry up a little.
If 'safe' assets such as treasury-backed bonds are rebranded 'risky' assets as has happened with Greece, the cost of funding debt for Governments will rise as did private debt funding two years ago. There will also be a corresponding sharp fall in the amounts of money that can reasonably be borrowed.
There is a slim possibility that things go badly for world markets, in which case we're now unconcerned and you're money is safe. The likelihood is that it will be contained, however it is more likely than not that markets will see lower levels before that time anyway and we can buy back our positions at lower levels. That or the market will trend sideways and we will have been protected for no opportunity cost. In the worst case scenario the market continues to charge higher in which case we will have traded quality positions for cash, currently yielding 4.25%.
Each time this issue rears it's head it appears to be getting worse. In our view you can't simply transfer unsustainable levels of private debt to the public balance sheet and go on your merry way. In our view the only really prudent measure given this catalyst is to exit the market for the time being and wait for opportunities to present themselves as events play out. One of the benefits of our trading strategy is that we don't have to be invested in stock all of the time. In point of fact, cash is an investment in itself and our current position is now cash.
If you would like to talk to me about anything at all, please call the desk.
As promised, we would like to expand in some detail our current view on the market, and the resulting actions taken Thursday and Friday this week. At times share trading can be about capital preservation, and in part that is what we are trying acheive.
Thursday, positions were sold in HVN, NAB and QBE, followed up with a sale of LLC on Friday. This leaves 95% of the portfolio now in cash with one remaining investment in Quickstep Holdings.
We have been reading extensively regarding the situation in Greece and have some serious concerns. In short, (talking only OECD countries) Greece has, along with Iceland, Italy and Japan an extreme level of public debt as a percentage of GDP (over 100%). The big different for Greece over those others is that it's budget deficits are also very high, at over 12% of GDP per annum, and so the speed with which the debt is growing is fast.
Greece is now at the point where it can no longer service it's debt and this is creating a panic of sorts. As a member country of the single EURO currency, defaulting on public debt would have disastrous consequences for other member countries and the currency itself.
We should note here that Ireland, Spain, the UK, Portugal and the USA have budget deficits of 10% or higher as well, and are forecast to continue these for the foreseeable future This will bring those countries to 100% debt to GDP ratios or above, and well above comfortable levels.
That said this is (most likely) how we see the scenario playing out: The strongest European Countries such as Germany will structure some kind of rescue or restructure package to reduce near term debt obligations and to reduce funding costs for Greece. It would be catastrophic if Greece defaults, because some level of contagion spreading to other Euro countries is inevitable. Because of the clearly negative results of an outright default, Germany is most likely to support the rollover of Greece's debt in the near term (there's 8.5 Billion Euros worth just in May '10).
Financial commentators (so far) for the most part aren't worried.
So here's the problem we have: no matter how much we read, or who you might talk with or listen to, no-one can tell you exactly what the financial consequences of a restructure of Greece's debt might be, or why bond investors should continue to lend to other countries who are, in all forecasts that are available, on exactly the same path that leads to where Greece is now at.
What we have seen is that as soon as the equity markets were given specific data (S & P Downgrades) which enabled them to more accurately measure the impact of the crisis, it was immediately reflected in lower equity market prices. We feel there is a very real chance that once markets are able to calculate the costs (once a bailout is announced) they will move sharply lower to reflect the actual cost of the crisis globally.
We are all agreed that debt cannot continue to be taken on board forever, that at some point it has to be re-paid (or defaulted). We are all agreed that a Government should not simply print new money to re-pay debt. This is especially so for Euro currency member countries, yet this is exactly what the UK and the USA are doing right now, innocuously named 'quantitative easing'.
The fact of the past two years is that unsustainable levels of private debt in the USA (which caused the GFC) have been transferred to the government's balance sheet, with the remainder being printed in the quantitative easing program. There is much debate on whether this will absolutely definitely lead to inflation and another unwanted recession, but most economists agree that some level of higher inflation in the future is inevitable.
Our job is to look for catalysts for possible share market moves, and given the above there is a possible related move in equities coming quite soon. We've been consciously aware of a looming debt problem with the USA for ten years now, in fact since massive budget deficits became the new normal.
But clearly trading equities for a share market reaction to that debt for ten years wouldn't have yielded very good results! In our view today, the Greece problem is a real and present catalyst for a downward share market move because:
1. Financial commentators by and large are writing recovery stories, none are analysing in any real detail what Greek debt contagion issues there might be. Commentary is 99.9% backward-looking because these guys are journalists, not economists.
2. The Greek debt 'problem' just won't go away. After first being reported the issue was apparently 'fixed' and our market went to new highs around 5,000 points. Today new levels of risk awareness are being priced into financial markets. This tells us it will likely be some time before this fully plays out and one of our favorite share market rules is 'the market hates uncertainty'.
3. Greece is symptomatic of an issue that is now common to quite a few, much larger, OECD countries. All of the countries discussed above will be in a similar debt position (very high public debt levels combined with very high budget deficits) within the next three years. Whilst there has been some discussion of the most at risk countries such as Italy, Ireland, Spain and Portugal in the press it is difficult to discuss potential problems with the UK, Japan and the USA without sounding like a crackpot conspiracy theorist. See point number 1.
4. Hedge funds have been targeting the Greek bond market and having an absolute field day. Two days ago the two year Greek bonds were yielding 24%, today that figure is just 13%. There's money to be made targeting other vulnerable countries' markets such as Portugal or Italy or both they will do so.
If there's a continuing problem in the Government bond markets, for the medium term, investor's appetites might just dry up a little.
If 'safe' assets such as treasury-backed bonds are rebranded 'risky' assets as has happened with Greece, the cost of funding debt for Governments will rise as did private debt funding two years ago. There will also be a corresponding sharp fall in the amounts of money that can reasonably be borrowed.
There is a slim possibility that things go badly for world markets, in which case we're now unconcerned and you're money is safe. The likelihood is that it will be contained, however it is more likely than not that markets will see lower levels before that time anyway and we can buy back our positions at lower levels. That or the market will trend sideways and we will have been protected for no opportunity cost. In the worst case scenario the market continues to charge higher in which case we will have traded quality positions for cash, currently yielding 4.25%.
Each time this issue rears it's head it appears to be getting worse. In our view you can't simply transfer unsustainable levels of private debt to the public balance sheet and go on your merry way. In our view the only really prudent measure given this catalyst is to exit the market for the time being and wait for opportunities to present themselves as events play out. One of the benefits of our trading strategy is that we don't have to be invested in stock all of the time. In point of fact, cash is an investment in itself and our current position is now cash.
If you would like to talk to me about anything at all, please call the desk.
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