Cyprus is in the headlines; it has been for more than a week with the Cypriot government twisting and turning at every suggestion of any disciplined measure except free money.

The committee of lenders (misunderstanding their position as committees so often do) initially suggested that a surcharge on all bank deposits, both small and large, should be imposed. This nonsense was then swept away as it became clear that all bank deposits under 100,000 Euros with European banks were effectively guaranteed anyway and the mere suggestion to raid these was a disaster for a whole market.

That there are some Russian depositors, with deposits in their tens or hundreds of millions of Euros, has enraged the European authorities, with the German Finance Minister asking (with some justification) why the German taxpayer should subsidize and protect Russian money launderers. Interestingly, there is anecdotal evidence that some of the most influential depositors were forewarned of the impending crisis and managed to extract their own money to somewhere slightly safer, or at least out of Cyprus.

All very interesting and important to Cypriots and residents of Cyprus. In the rest of Southern Europe there is a feeling of ‘there but for the grace of God go I’ but what are the implications for investors?

1. Just as it was felt to be safe for investors to add financial company risk to their portfolio, it is suddenly abundantly clear that bank depositors and shareholders, especially in the south of Europe can no longer be secure that their interests will be taken into account. Placing money with these banks is once again under the Economics so forcefully put forward by Mrs. Thatcher a question of ‘Caveat Emptor’ or buyer beware. If one is offered higher than normal returns, one should expect higher risks, sometimes much higher risks. Therefore don’t invest with banks that seem superficially attractive.

2. The problems of Southern Europe – The Olive Oil States- are far from gone, they have merely been swept under various carpets waiting for the next German cleaning lady (Die Putzfrau’) with a degree of self-righteous pomposity, to unearth them again and hang them out for the world to see and wonder at. Government bonds issued by southern European states will suffer again and this will include French Government Debt.

3. The implications of this new reality have not been lost on the European equity markets which have suffered somewhat under the uncertainty. The larger markets in Northern Europe will soon stabilize especially Germany and the United Kingdom. The southern states will continue to be unstable, this despite the fact that there are so many excellent companies there.

4. Now is the time to invest in top quality equities; the brave and those who believe they know the markets can consider investing directly. The rest of us should make the effort to find the most capable fund managers, those able to manage risk and to use their services. This will result in lower losses in bad times, while still giving up only minimal profits for the skills of the fund manager.

5. The rest of Europe still expects the European Central Bank to foster growth by reducing interest rates still further. This will encourage the profitability of the best companies as well as downstream investment by their suppliers.

The United States have developed a new weapon that destroys people but it leaves buildings standing. It’s called the stock market.” – Jay Leno.

2012 became a profitable year for investors in equities. Pushed by their banks however, investors were and are still being encouraged to stick to the same strategies as in the past. This is useful for the banks but not helpful for the investor portfolios which suffer as a result.

The reality is that markets almost inevitably want to see price levels rise as long as there is no logical reason for this not to happen. Left to their own devices, investors, both institutional and retail instinctively need to see growth in their investments. It is only the fears of adverse conditions that get in the way. In time however the upward trend always resumes, even if it takes a while.

In Europe, Greece has effectively been written off. Mr Draghi’s statement that ‘we will do everything it takes and believe me it will be enough’ did not include Greece and probably won’t include Cyprus. Spain is still in a difficult position with its banks, but still has many effective industrial companies but insufficient government effort to encourage growth.

Last week’s decision that the European countries did not want to devalue the Euro is logical; against which currencies would one want to devalue the currency in the first place? The southern European countries (the olive oil or club med states) need to devalue their currency against the northern European states such as Germany, the Netherlands, Finland and Poland, but no-one is (yet) suggesting that the Eurozone be split this way.

Great Britain will have a referendum on remaining in the European Union after the next general election. This was a decision taken for domestic political reasons; 2017 is so far away it could well be in another lifetime and the suggestion could well be ignored by whichever political party is in power at the time. In the meantime, the mere suggestion puts pressure on the remaining Europeans and brings the press commentators into a lather of indignation, all of which can be safely ignored. What is potentially worrisome however is that when Europe negotiates with the USA over a free trade agreement, those areas that are important to Britain such as finance and banking could be sacrificed by the European negotiators at the request of the Americans in order to achieve better positions in other areas. There won’t be much that Britain can do about it.

One should be aware that while some developing countries are growing so fast that they can no longer be truly called developing, some developed countries, such as Greece and Portugal could slip down the ladder in the opposite direction as their economies shrink and political lack of courage and incompetence make them ever weaker.

Where to invest next? The equities of efficient companies, found and analysed by competent analysts for hard-nosed fund managers has to be the next step to an effective investment portfolio.

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.