It is unlikely to have escaped your attention that the markets for shares and some government debt have lurched sharply downwards over the course of this week. Here I will give a brief outline of the issues and how we are dealing with them.
The widely-cited spark for the latest round of selling was a letter written by European Commission president José Manuel Barroso to European leaders. In it he criticized the size of the bailout fund that was put in place only a matter of weeks ago, whilst also gave leaders a ticking off for being “undisciplined” in their communication on the matter.
Whether or not this is the true cause of the sell-off, it is my opinion that there is not really any new economic news in this. We have known for some years now that the Eurozone has significant sovereign debt problems and that large swathes of the West have structural growth issues. This is a direct result of us having to pay down our large debts (“deleveraging”) rather than spending our money on goods and services. We are pretty sure that this process is going to take several more years to sort itself out fully.
What is new is that Italian and Spanish bond yields, the interest rates that these countries pay for borrowing, have risen. To borrow for 10 years Italy must now pay 6.6%, and Spain 6.0%. A figure of 7% is touted in the press as the point beyond which real trouble starts, as the cost of borrowing becomes too big a burden. As I write however Spanish yields are falling following a successful issue of bonds, a good sign.
The selling that we’re seeing seems to be predicated on the idea that the Eurozone will have to break up. This would be a very extreme event, and is still one that there is enormous political will to avoid. Of course, mere will alone is not enough. It is possible that there aren’t sufficient funds in the currency union, or from other countries or institutions such as the IMF, to ensure that the larger nations such as Italy can be propped up. I think that there will have to be a day of reckoning, and that sovereign bond investors will have to share the pain. But I think the problem will stop short of the return of the Mark and the Franc.
So what to do? Broadly speaking we have been positioning our fund and client portfolios predominantly into high quality equities and certain types of fixed income investments that protect against inflation. The latter is mainly for clients who don’t want to take on too much market risk, i.e. being exposed to the falls we’ve seen this week. The sort of bonds we use have been big beneficiaries of the turbulence as investors seek “safe havens”, so they have been doing their job. We also have client exposure to commercial property, which acts as a diversifier and looks reasonable value at the moment.
For those with longer-term investment horizons and those who can absorb short-term losses we have been recommending only high quality equities. The reasoning is that this is where we see the best medium-to-long-term returns. We go for quality companies usually, and particularly at the moment, because we are very aware that the economic situation is fragile. We want companies that can perform even in these types of environment. This helps to protect against downside risk.
Nonetheless it is impossible for investors in shares to avoid market falls entirely, and it is my opinion that timing a market consistently is very difficult. Our investors are seeing real falls in their portfolio values, which is uncomfortable to say the least. We think though that by hanging on to high quality companies you give yourself the best chance of decent returns in the long run. Now is not the time to sell the sort of companies we invest in.
Tony and Hugh will be writing in more detail on market conditions and the value we see in high quality companies over the next couple of days.
If you have any questions or comments please do contact your usual adviser.
Please note, the above contains the personal opinions of Ben Peters at 5th August 2011 and does not constitute investment advice