Market View - August 2011

Much ado about nothing, or is the brinkmanship playing out on Capitol Hill the beginning of the Endgame for the American superdebt cycle, heralding a possible run on US Treasuries and the end of the mighty greenback as the world's reserve currency?

These are indeed worrying times for Western governments as the "debt can being kicked down the road" switched in July from the battered European bond markets of Greece, Portugal, Ireland, Spain and Italy to Uncle Sam's backyard!

While the three major rating agencies were threatening to strip the USA of its AAA status, Egan Jones the Philadelphia based agency had already done so earlier in July and the Chinese based Dagong Global cut America's rating to AA as long ago as July 2010, and then again to A+/negative last November stating "the US government's actual ability to repay its debt would tend to continuously decline". Many renowned commentators see the recent developments as no surprise with legendary investor Jim Rogers when interviewed on Bloomberg in late July being unequivocal "Everyone already knows that the U.S. has lost its AAA status. Anyone who knows what is going on already knows that the U.S. is now the biggest debtor nation in the history of the world. It's only S&P and Moody's that haven't figured out what is going on"

Dr Ron Paul, the Republican Representative from Texas (who has consistently criticised both national government and the Federal Reserve for their profligate strategies over many years) when interviewed by Bloomberg last week warned that "Default will be painful, but it is all but inevitable for a country as heavily indebted as the US. Just as pumping money into the system to combat a recession only ensures an unsustainable economic boom and a future recession worse than the first, so too does continuously raising the debt ceiling only to forestall the day of reckoning and ensure that when it comes, it will be cataclysmic."

Still we live in hope since as Churchill famously said "You can always count on Americans to do the right thing after they've tried everything else"! During the first half of July all eyes had been focused upon the eurozone sovereign debt issues albeit a deal of sorts seemed to placate the markets at least temporarily!

However The Economist newspaper's Buttonwood column (Firefighting), warned against complacency when using the analogy of the famous seventies Hollywood blockbuster "The Towering Inferno" in which a small insignificant cupboard fire is ignored and allowed to eventually engulf the whole skyscraper! Worryingly "when Greece's debt problems emerged last year, some dismissed them as trivial, given the country's 2.5% weight in the euro area's GDP just as similarly problems in the subprime mortgage market were once regarded as too obscure to affect the entire American economy"

Buttonwood draws comparisons with the failure of the Exchange Rate Mechanism in the early nineties before the birth of the Euro when other European countries pegged their currencies to the German Deutschmark, but like dominoes each fell in turn after the UK was unceremoniously forced out on Black Wednesday in September 1992. This time as the Buttonwood article warns "the choices are a lot starker as instead of tightening monetary policy to defend the currency, governments have to tighten fiscal policy to try to keep the lid on their borrowing costs which will involve years of painful austerity."

With sovereign debt woes on both sides of the Atlantic, and European bond markets more volatile than ever, it was surprising that global equities managed to end the month relatively flat (although daily patterns were considerably more volatile) overall, largely due to the realisation that corporate fundamentals remain strong. However against a backdrop of weak GDP growth numbers both in the US and UK, combined with a stubbornly high unemployment rate and worryingly worsening housing data in the States, the challenge of determining the optimal asset allocation exposure does not get any easier.

Ash-Ridge Asset Management continue to believe that blue chip companies, providing sustainable and growing dividends will stand investors in good stead regardless of how choppy the economic background becomes. It also makes sense to retain a reasonable exposure to debt free emerging market economies. The selection of complimentary safer assets within portfolios is however becoming more difficult to establish as cash instruments continue to yield less than inflation and, once solid, AAA Western government debt becomes ever more risky. Clearly time frame is all however; we may now look to proposing an increase in allocation to selective precious metal and commodity funds as a means of providing an appropriate longer term portfolio hedge.