Market View - July 2011

This time it is different is an all too familiar phrase in investment and economic circles!

In John Mauldin's excellent book Endgame (The End Of The Debt Supercycle and How It Changes Everything) the author warns "Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long run sustainable levels and make banks seem more stable and profitable than they really are.

"Such large scale debt build ups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced. Debt fuelled booms all too often provide false affirmation of a government's policies, a financial institution's ability to make outsize profits or a country's standard of living.

"Of course debt instruments are crucial to all economies, ancient and modern, but balancing the risk and opportunities of debt is always a challenge, a challenge that policy makers, investors and ordinary citizens must never forget. Perhaps more than anything else, failure to recognise the precariousness and fickleness of confidence – especially in cases in which large short term debts need to be rolled over continuously – is the key factor that gives rise to the ‘this time is different' syndrome.

"Highly indebted governments, banks or corporations can seem to be merrily rolling along for an extended period, when bang! – Confidence collapses, lenders disappear and a crisis hits".

Written in October 2010, Mauldin's words continue to appear prophetic as global markets continue to worry about sovereign debt issues. In June the MSCI World index fell 1.73%, with the FTSE 100 down 1.74%, the S&P 500 down 1.83%, the FTSE EuroTop 100 down 2.49% and MSCI Emerging Markets also down 1.86%! Bond markets fared a little better with the JP Morgan Global Bond index rising marginally 0.19%.

The picture overall this year to date however remains relatively healthy with the MSCI World up 3.99%, marginally more than the JP Morgan Global Bond Index which is up 3.89%. During 2011, the FTSE 100 has risen 0.78%, the S&P 500 is up 5.01%, but the FTSE EuroTop 100 is down 0.95% and the MSCI Emerging Markets is also down slightly 0.45% thus far.

As the Sovereign Debt crisis in Europe returned to the forefront, the interest rate demanded by investors on Spanish and Italian government bonds rose to their highest levels in seven months during late June.  A new austerity plan proposed by the Athens government on the 29th June to support a second bailout package from the IMF, ECB and Eurozone authorities looked likely to avert (at least for now) a renewed threat of Greece defaulting, although an article in The Economist newspaper (A bank bail-out by another name) was rather scathing of the terms suggesting that "In the circumstances, the deal is a good one for the banks as it reduces the potential loss they might suffer were Greece to default and lets them take some money out now".

The article concludes "For Greece the bargain is far less compelling as the 30 year plan does nothing to reduce their debt burden and could complicate any eventual restructuring. Since Greece would pay interest on all of its borrowings but could only use part of them, its cash interest rate over 30 years would be about 10% - 11%. Some rescue"

"More pain than gain in innovative noughties" was the headline in one of FTfm's articles in late June in reference to a global survey undertaken by Citigroup, Principal Global Investors and Create Research to discover which of the innovative investment ideas or themes introduced in the last decade had succeeded or failed the most. Based upon feedback from more than 500 participants (including pension plans, consultants,  asset managers, and distributors) in more than 30 countries, emerging market equities, emerging market bonds and high yield bonds were the clear winners, while leverage, structured products, currency funds and potable alpha ("there wasn't enough alpha to port") all rated miserably!

The findings did not surprise anyone at Ash-Ridge Asset Management, as experience has long since taught us that the investment strategies most likely to reward investors with the optimal return for a given level of risk, are the more traditional and unsophisticated ones with simple objectives. The more sophisticated investment products and strategies that all too often appear to require a PhD to understand are the ones which historically have all too often lost investors money, and we are reminded of the adage, "If you can't explain it on the back of an envelope, then best steer clear of it altogether"