Still turbo-charging equities
Another good month and a strong quarter, with the portfolio gaining by 3.5% and 15.2% (net) respectively, outperforming the rises in the index of 1.8% and 14.0%. Conspiracy theorists could be forgiven for believing that most political/central bank action is designed to support equity prices. The Cyprus fiasco is an example: whatever the legal frameworks, from government guarantees of bank deposits to the repayment of sovereign bonds, all are merely non-binding statements of intent, thus a wake-up call to buy real, income-producing assets.
IMF technocrats and EU politicians decided that they could play cute with insignificant Cyprus and bend all the rules, behind a publicity smokescreen of hurting black market money-launderingfrom Russia, and hunched that as the Cypriot economy collapsed into an inevitable depression, few of their own domestic voters would care. In this they are right. Yet investors also noted the comments by the Dutch Finance Minister and Eurogroup Chairman, Jeroen Dijsselbloem. To paraphrase, he was clear that future bank failures should be paid for by depositors and bondholders - as was standard global practice until this century -rather than taxpayers; and that countries with large financial sectors should beware, citing Malta and Luxembourg (the real message being the UK and Switzerland). These comments were howled down by EU spokespersons. Unusually, most senior elected politicians were mute on his views. Another wake-up call.
The real purpose of the ‘Cyprus solution’ was to hold a gun to the heads of the Spanish and Italian governments: obey IMF/EU strictures or face a similar gruesome economic fate. There are many problems with this approach. Spain’s government is so mired in corruption scandals that it is not listening. Economic recovery has been postponed again as GDP is expected to contract 1.5% this year vs. official forecasts of 2.5% growth only18 months ago. Unemployment continues to soar (over 40% for the under 30s). A shrinking economy makes debt repayment even less possible and eventual sovereign default more probable. Italy actually lacks a government, so there is no-one to threaten. Its politicians are jockeying for position before the second general election of the year as its economy also contracts.
Investors have been listening closely however. Mediterranean banks are weak. It is too early to appear in the statistics, but fromSpain’s Banco Santander (once the largest in Europe and still No.16 globally by market cap.) to the world’s oldest and recently humbled Banca Monti dei Paschi di Siena, founded in 1472, the guess must be that their deposits are flowing north and overseas to perceived safety. Once bank deposits start to move, the nightmare of a financial implosion looms. Thus Cyprus’s mark on world finances is far in excess of its tiny size and will accelerate the move from deposits and government bonds into hard assets -equities.
Globally, economic activity remains almost perfect for higher equity prices – not too hot or cold (see the March Bulletin) – hence governments will maintain ultra-low interest rates, money printing and asset buying policies. Whilst there is always too great a focus on immediate data, the trends are clear. Surveys of both America’s Institute of Supply Management (ISM) and China’s Purchasing Managers’ Index (PMI) show a steady decline since mid-2010 with little chance of reversal. (See charts 2 & 3 on page 4.) The average PMI for emerging markets has shown a similar decline to 51.5, suggesting sub-par growth. Germany’s PMI at 49.0 means its economy is contracting, thus affecting the eurozone as a whole. The risks of these governments tightening policy, thus removing support from equity markets, remain negligible.
In the East, Shinzo Abe, the new Prime Minister of the world’s No. 3 economy, is now openly emulating the ‘three arrows’ policy of Kwerekiyo Takahashi, Finance Minister 1931-36. These threearrows were the devaluation of the yen (Japan came off the gold standard and the yen fell 50% within three years), monetary easing and massive public bond issuance. The result was the reversal of deflation and stagnation. The world’s No. 2 economy, China, under its new leader, Li Keqiang, is angsting how to manage slower economic growth (officially expected to fall to 6%over the next decade), whilst reducing overspending on infrastructure and property and meeting higher demands for welfare, yet simultaneously deflating the gigantic bubble of unofficial lending. Downsizing is never easy; should growth fall to5%, bad debts in the shadow lending market would rip apart bank balance sheets. The reaction would be immediate: monetary easing, devaluation and bond issuance. Hence the East is also, by accident, striving to promote equity-friendly policies.
Our contention remains that exceptional and often bizarre government policies will continue not only to underpin equity markets, but that valuations will remain relatively elevated. This applies especially in developed markets where, although at the higher end of long term averages, these valuations are not extreme. Despite perennial rumours that the various stimulatory measures will be withdrawn late 2013 or early 2014,in practice the leading central banks and their political masters have no intention of doing so even in the medium term. Meanwhile, no investor has any yardstick for what happens to valuations under such conditions. Yet, on the simple basis that most equity markets yield more than their government’s 10-yearbonds, there remains significant scope for further gains.
© Bedlam Asset Management
