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It's now or never - dont change sails during a hurricane
There is an age-old adage that says one shouldn't throw good money
after bad. This phrase has become painfully accurate when referring to the
numerous bailouts taking place across Europe. The problem with Europe
is that while they share a currency, they are - unlike the US - not part of
the same fiscal union. So while investors in US bonds can rely on the fact
that surplus taxes from Texas will be used to fund California and New York,
investors in Greek bonds have no such comfort and have to rely on the
welfare of countries such as Germany for survival.
For too long now bailouts have been about plugging the immediate capital
needs of the various countries in trouble, while they in turn agree to cut
spending and raise taxes by as much as they can get away with without
antagonising protestors too much or destroying their economic growth. It's a
fine line, and too much austerity medicine too quickly runs the risk of pushing
economies back into recession, which will result in taxes falling and austerity
becoming even harder to implement. Solutions thus far have been designed
to try and plug the hole without anyone having to compromise their lifestyles
too much.
Sadly, however, debt is debt and adding more debt to existing debt is
not going to remove debt and fix problems unless people in the affected
countries significantly change their "siesta" lifestyles. The problem is that
those whose behaviour most needs to change are the most reluctant to do
so. Effectively, everyone has been in denial as to the gravity of the situation
and this worries markets. While there has been much discussion about the
European Debt Crisis there has been very little action and until there is clear
evidence that banks are going to be recapitalised and the European Financial
Stability Facility is worth trillions and not millions of euros, things are going to
remain bumpy.
Denial appeared finally to make way for reality last weekend when finance
ministers largely accepted that Greece is going to default. This means
investors in Greek debt stand to lose between 20% and 50% of their
investment. This could be just the shock that the Europeans need to finally
get some action going. Up until now they have been indulging themselves
in intellectual economic hypothesising while the situation got worse, and
markets have fi nally had enough. While default will reduce Greece's debt
burden it is going to make it very difficult for them to borrow again in the
future (just ask Argentina, which defaulted in 1999 and still struggles to raise
capital in the open market). China, on the other hand, is sitting on over $3
trillion of hard-earned reserves, earned as a result of exporting far more than
they have been consuming. Whilst they are understandably reluctant to get
involved, they may have to, as the EU is their biggest trade partner, and if the
EU were to collapse and stop buying Chinese goods, the Chinese economy
would suffer.
The recent downturn in markets is their way of signalling further weakness ahead. The global economy is slowing;
there are significant fundamental issues that need to be resolved; interest rates are at all-time lows; central bank cash
is running out, and the ability to stimulate is limited. We may well see a double-dip recession in several developed
market countries going forward. At this stage, it shouldn't be as severe as the credit crisis of 2008, however if the
European economies start defaulting in quick succession, anything is possible.
So, while the problems in the Eurozone are far from over, finally reality seems to be dawning and plans are being put in
place. Let's hope they work because a world of European countries defaulting like dominoes, followed by a European
banking collapse and recession destabilising the entire global financial system, including China's growth, is a world too
scary even to contemplate. President Obama was right when he said "the Eurozone is scaring the world."
So what should investors be doing?
The simple answer is nothing. As we have said before, you can't change sails during a hurricane, i.e. the time to adjust
your portfolio is when markets are calm in anticipation of weather coming ahead, and not when you're in the eye of the
storm. If you wanted to lighten your equity holdings or switch out of the rand, you should have done that a while ago.
Not now, after the rand has weakened.
Tinkering with your portfolio at this time will most likely see you making emotional rather than fundamental decisions.
Yes, the rand has taken a smack, as have markets; and yes, they may still both weaken further, but given that this
weakness is in reaction to global events and emerging markets such as Brazil and India are being punished just as
severely, our currency and market should retrace some of the losses and you run the risk of being caught on the wrong
side of that.
What you need to do is correctly identify your risk profile (sometimes a third party such as a financial adviser can do
this more accurately than you can), create a portfolio appropriate to your risk profile and let it ride out any volatility
markets present.
Courtesy Jeremy Gardiner, Investec Asset Management
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