“All of the problems we're facing with debt are manmade problems. We created them. It's called fantasy economics. Fantasy economics only works in a fantasy world. It doesn't work in reality.” Michele Bachmann-
As 2011 trundles on the annus horribilis as predicted seems to be going from bad to worse. The Greek rescue bailout plan has been approved but there’s no guarantee that Greece has the ability to pay the extended overdraft so the likelihood of a sovereign default is still intact (S&P are suggesting this). Many observers are predicting severe pressures on Spain and Italy later this year but of course the exposure of banks in France and Germany to Greece etc are the real concern as the Eurozone itself looks destined for severe disruption. One thing that is clear is that events will likely unfold where investors least likely expect. The whole problem with the DEBT subject is that no-one in government, the central banks (the ECB and IMF appear in disarray too), the regulators seems to want to wake up to the fact that sovereign and municipal debt needs to be paid down rather than be extended. It’s rather like the bank manager lending to a client, extending the facilities and then coming to the realisation that the client can never repay. The conclusion is always repossession except in the political landscape developed world tax hikes and asset sales can muddy the picture. There is also the appalling situation in regard to pensions and the aging population that requires medicare. In essence the outlook is dire unless SME’s and self-employed are looked after but to date ‘big business’ is ticking over and non-doms are living the dream. What concerns me is the fact that whilst factoring in all the ‘whammies’ the capital markets seem to be in a fantasy world regarding valuations. In UK mid-teen p/e’s are the norm. I speak regularly to retired brokers who think that single digit p/e’s are likely hereon so a FTSE100 10-30% correction from the 6,000 level could be on the cards. The hedge to these calamities has been to remain LONG of oil, oil stocks, precious metals, precious metals stocks and agri-commodities but remarkably a disconnect has occurred between the raw prices and stocks in oils and miners. The Glencore (commodities trader) flotation drained capital from these sectors and institutions and hedge funds have (apparently) stayed LONG of the commodities and shorted the sectorial stocks. This has resulted in a mini-bear market in these sectors but I think that the investment case today is arguably greater than it has been in previous years. Cash institutions are loading up in both sectors and whilst there are capital raising issues abundant this is being reflected in the markets. Sooner or later the reverse will occur as the shorts will get closed and I suspect when (not if) a default does occur then Gold will rise sharply to $1,600-1,850 range, possibly much higher as contagion expands. The other major factor that will determine market direction is global inflation and with China at 5% and most western economies at similar levels any indication that this might rise hereon then I think the central banks will have to raise rates. One of the extraordinary side effects of Credit Crunch 1 is that the UK property market has remained somewhat intact compared to US. I don’t think this disparity can continue and with the UK government bank holdings being under water I think UK tax payers are facing a reality check as the ConLib coalition too faces challenges to its austerity plans. The latest Cleggism regarding bank share issuance is quite ludicrous as was the whole (Labour) rescue plan in 2008/9. There are a few market commentators still predicting Credit Crunch 2 or a Bank Bailout 2 which could make the earlier efforts look like a walk in the park but one thing that market history has taught us is that NO BUSINESS IS TOO BIG TO FAIL. It is only a matter of time before politicians, central bankers and regulators are retested. Interest rate changes and timing remain the key to any true recovery and it is comical to suggest that any rise could lead to a double dip recession when globally millions are being made redundant and millions more are struggling to make ends meet. These are just numbers and regrettably the west is in a dead zone as a little tinkering here and there doesn’t get to the root of the problem. The imbalance between private and public sector employment and reliance can only only be rebalanced if the smaller businesses are given huge incentives to employ rather than being encumbered with excessive legislation.
In regard to stock selection I still continue to recommend Royal Dutch Shell (under £20) and like many are bewildered by BP cum-asset sales where I prefer to wait until the Rosneft/TNK situation sorts itself out. The new Tony Hayward/Nat Rothschild £1.3bn cash vehicle Vallares looks as though it could be in the frame to benefit from BP’s demise and I suspect Hayward the former BP CEO has his sights on some core assets in the sector. Vallares (VLRS) could be a great investment at around the £10 placing price. Elsewhere Cairn, Soco and Heritage look due for a rebound from here. The latter has been buying in it’s own stock heavily the past quarter. Amongst gold miners African Barrick although disappointing still appears more attractive than Randgold and Centamin on valuation grounds but like everything in the sector has been effected by shorting. The exception has been Anglo Pacific (yield 2.85%) which appears to be maintaining its fanatical following. Other miners such as Yamana, Norseman, Chaarat, Mariana, Orosur, Patagonia, and Peninsular have had a negative quarter but should be retained as brokers remain positive. My favourite, Shanta Gold reported spectacular ore grades for its principal Luika operation recently and an upbeat Chairman’s statement underlines the strength of the opportunity as Shanta has an extraction cost of around $500pto and Singida is due to update shortly. In FTSE100 I am extremely cautious although I continue to await a fallback in BAE Systems nearer 300/310p, GlaxoSmithKline nearer 1200/1250p, Sainsbury nearer 300/320p, De La Rue nearer 700/720p and HSBC nearer 600/620p. Elsewhere I am reiterating Tullett Prebon (now 374p yield 4.20%) and continue to accumulate the biotech stock Vectura now at 91p from 63p last review date (brokers are bullish up to 120p). Current investment trusts that should be looked at on any pullbacks are JPMorgan Claverhouse (3.77%), Henderson Far East (4.39%), Schroder Oriental (3.46%), JPMorgan Global Emerging Income (5.27% estimated) with the following general UK trusts, Scottish American (3.78%), Securities Trust of Scotland (3.98%) and Merchants Trust (5.40%) for risk averse investors (all discounts permitting). Otherwise I am still avoiding retail (eruptions on the High Street), property (a pullback is expected), utilities (poor management and questionable accounting techniques) and just about anything consumer related at current valuations. Many PCIAM’s are still adopting a HOLD strategy for the UK economy and market whereas I’m not tempted to change my oil/precious metals stance. These are extraordinary times and some patience is required as the liquidity picture is constantly shifting. Coming up through the rear mirror, of course, is the US debt issue (near $15trillion) and the coming weeks should prove interesting as Congress grapples with the extension dilemna.
In my view equity investments today represent high(er) risk and there seems to be a regulatory desire to measure risk based on pre-Credit Crunch values. It’s clear that the world is in a different universe now which is why I advocate much higher exposure to precious metals and oils to other PCIAM’s. As Ms Bachmann suggests western markets are indeed promoting “fantasy economics”. In 1729 Voltaire said “Paper money eventually returns to its intrinsic value-ZERO” which is somewhat applicable to the plight of the US dollar and surely the Euro today.
Have an enjoyable summer!
