Investment Opinions 26 October 2012

Money won’t buy happiness, but it will pay the salaries of a large research staff to study the problem. – Bill Vaughan 1977

Europe has found another cause for concern. This time it is Spain and the Spanish banks. France’s economy is struggling and the banking union being pushed forward by the French will undoubtedly help the French banking system without adding to the already very high French national debt burden.

Western Banks are still not lending, either to companies or private individuals. The proposed banking union will not help this situation; it will simply mean that more money can be pushed to the European banks without it impacting on the local government’s overall debt position. The banks are still likely to deposit their monies directly with their own central banks until they are confident their required capital ratios have been safely met. No agreement has yet been reached on the supervision of individual banks; the need for major capital increases to protect against loan and trading losses is about the only thing that is certain and a more general supervision will almost certainly be applied at some stage.

Concerns over the Southern European political situation still have the investment markets in thrall. Greece will probably leave the Eurozone with as much dignity (and other state’s money) as it can muster. Rumour has it that Spain, with its weak economy, might seek economic aid from the rest of Europe. Does any of this really matter? In Greece’s case probably not. In Spain’s case, it will shake the foundations of the European experiment. The Government bond markets and any funds focusing on this region must be avoided.

Germany is trying to insist on the need for austerity from other European countries. There is some smugness in this, as Germany has itself now been down the austerity route. German industry is profitable, even if the banks are inefficient and the leading economic indicators are showing manager’s confidence in the future, albeit with some navel-gazing resulting from the impact from the economic weakness in the Club Med states. The reality is that the German economy is riding high and the equities of many companies are now sound investments.

There are companies in all European countries which are attractive and there are excellent fund managers with proven track records in the European Equity markets to undertake the investments. These will know when to strike.
Government bonds of all investible countries now have such high prices that their yields are below any rate of inflation. The risks associated with an investment in government bonds is simply not reflected in the returns.
In the US, the hate between the Presidential Office and Congress is akin to the final stages of a particularly nasty divorce. Who gets to keep the house and the children and who gets to pay the debts? And that’s without the animals. The fiscal cliff – a throwback to the panic measures of the Bush era, which President Obama has been blocked from doing anything about – will probably be reached and fallen off before any steps can be taken. US Treasury yields are still far too low for all this risk, and the falling value of the US Dollar, makes investing in US Treasuries for any investors other than US institutions, nonsense.

US equities, especially from first class profitable companies have fallen in price with the investment market uncertainties and make a lot of sense to invest in now. Equity prices will probably wobble when the fiscal cliff is reached and fallen over, but this should be short term.

The same credit decisions used for investing in Corporate Debt is used for investing in Corporate Equity. There are many excellent companies in which one can invest profitably. It just needs careful analysis and decision making. An experienced fund manager has the analytical tools and can decide whether they feel comfortable with the prices currently being traded. Private individuals trying to do the same are merely gambling.

Emerging Markets in both Equities and Bonds are worth looking at selectively. There is concern over China and the perceived lack of stimulus for the domestic economy. Chinese economic policy is dominated by the figures 8 and 3. A targeted annual growth rate of around 8% and a targeted inflation rate of around 3%. The People’s Bank of China has already stopped taking the heat out of the market and an annual growth rate of some 7.5 to 8% is once again on track. Anywhere else in the world, such growth would be greeted with cheers. Again there is a need for experienced analysis and fine feeling. Experienced fund managers, backed by strong credit analysis teams will know where to invest.

Elsewhere in South East Asia, especially Indonesia, Thailand and the Philippines, some equity markets are showing excellent actual growth and strong potential. Some investors are being tempted by the local currency markets where yields can be high, but this is a high risk sector for proven managers of the risk.
Corporate Equity from companies around the world which have paid regular dividends show great medium term potential. Dividends, especially when paid from earnings and not out of reserves or worse, debt, are a sign of a company’s health. Debt raised by companies at the behest of short term hedge fund investors simply to pay extraordinary dividends are a recipe for disaster.

Companies are raising money on the high yield paper markets, which bearing in mind the high quality of the debt paper on offer, will quickly lose its high yield status. The essence is to invest when the price is comfortable for the investor and not to blindly follow a trend.

Now is a time for investing with a medium term outlook and an understanding that there will be volatity. There is little point in short term trading as bad news has generally had an effect before it reaches the screens.
In short:

1. Avoid government bonds; the yields do not justify the risks of an investment..
2. Equities from companies that have a record of paying dividends from income have a strong medium term attraction
3. Corporate Debt in the form of high yield bonds have credit risks often better than many European countries and yields which are far higher.
4. Emerging markets are selectively strong; China, South Korea, Vietnam and the Philippines are bright spots.
5. NOW IS THE TIME TO SEE THE VALUE IN EQUITIES, they will show growth when all else is weak.

Past performance is no guarantee of future profitability.