Tuesday, June 16, 2015

What if Greece defaults...?

The Wikipedia entry for a Pyrrhic victory is "a victory that inflicts such a devastating toll on the victor that it is tantamount to defeat". The collision of opposing interests between a Greek government (which possesses a popular mandate to push back against more austerity), and its creditors (who want to assurances that their loans will be repaid) seem likely to result in just such an outcome. 

It's obvious that without substantial debt relief, there is no way that Greece will be able to repay any of its debts, with the current debt to GDP ratio at 175% and rising. Without such relief, the nuclear option of default almost looks like common sense. 

Conversely, it is equally obvious that without the Greeks agreeing to significant cuts in spending and changes to their tax system, there is no way that any self respecting lender should or would agree to throwing more money at their government: doing so without such a program in place would merely guarantee a repetition of the current arguments in the next 6 - 12 months when the next loan repayments come due.

Logic suggests that a compromise of some debt relief and some spending cuts should produce a deal that results in equal amounts of satisfaction or dissatisfaction for both sides.

However, a collision of this type between politics and logic was never going to be pretty: both sides seem to view the current negotiations as a zero sum game in which one side or the other has to achieve total victory even at the cost of actual disaster.

If we then assume that the Greeks' least worst option is to default: what next?

A huge mess.
Default by Eurozone member was never envisaged when the brains behind the Euro project dreamt it up originally. Such grubby practicalities would have got in the way of the grand dream. That lack of foresight is now proving costly for all concerned. The Greeks seem keen to remain within the Euro, but without the painful restructuring that has to go with that. However, it also seems that there is no mechanism to force them out against their will. But - if they don't exit the Euro, they will be stuck in a currency that is too expensive for their own good and will have been cut off from all sources of debt financing for a decade. The cuts in spending that the lenders have been asking for would be inevitable and probably more brutal. Greece would sit within the Eurozone as a failed state.

If Greece did exit the Euro and reinstated the Drachma, they would devalue and gain some competitiveness benefits. Unfortunately, these would be limited given Greece's fairly small export base. Tourism might benefit significantly, but the offset to that would be whether or not tourists would want to visit a country which would be facing social melt-down. The further downside of re-instituting the Drachma  would be that debt to GDP would rise even further (because the loans in Euros would compare with a significantly devalued Drachma priced economy), unless the Greeks declared a unilateral write-down to more manageable levels(probably by something like 75%).

From the lenders' perspective, it becomes a question of whether or not you agree to a partial write-off and extended repayment terms on the rest, or force Greece to default on everything. That would be painful for the various Eurozone governments who between them have provided Greece with about half of its total loans. Even Angela Merkel might have trouble explaining how she managed to lose EUR56bn...

 In this instance, we would assume that Mario Draghi will charge in with the ECB and print money like its going out of fashion to underpin the European bond markets, which otherwise would be in turmoil. The Euro would have been proved to be a two way street, so Greece would be cut loose and left to swing in the wind but with its (Drachma based) pension intact. The remaining Euro members would want to ensure that life for Greece outside the Euro was so painful that no country would ever contemplate exit again. What this would mean for the EU project of "ever closer union", and ahead of a UK referendum in 2016/17 is unclear.

So, common sense would suggest a deal between Greece and its creditors is the most logical course. However, whether or not politics and egos get in the way and result in a "Victory" that creates more damage than a "Defeat" is another issue entirely. Over to you Angela.

e-mail: steve.davies@javelinwealth.com

contact: +65 65577186

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Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Thursday, April 30, 2015

Sell in May...?

It looks as though we're entering the May doldrums smack on schedule. Somewhat sluggish macro data from the US combined with lacklustre Q1 earnings numbers are all pointing towards a continued flatline for the US market and perhaps, by extension, most others too? The sharp weakening in the USD over the course of the second half of April seems to reflect this with the USD index falling by 3.5%, and the EUR rising back over the 1.12 level by month end.

There is no doubt that markets are not as cheap as they were. US corporate earnings have not accelerated as fast as their QE inflated share prices, so valuations have risen, and this rise in valuations has been reflected in the fact that, after a strong 2014, the US market is little changed from its start point at the beginning of 2015.

Elsewhere, however, the picture is rather different. In Japan, corporate earnings look headed for another strong year, and the market continues to look good value: Japan remains one of our core market picks for 2015, particularly if you hedge out the risk of a what we think will be a continued depreciating Yen. In Europe, too, notwithstanding deserved concerns about the future of Greece as a Eurozone and EU member (we still feel that despite Athens' rhetoric a pullback by the Greek government from its anti-austerity position is unavoidable and inevitable), the earnings picture is improving. The UK faces an uncertain political environment, but at a company level, the earnings outlook is still favourable.

Asian and Emerging Markets have also done well this year, assisted by a (mostly) stronger USD. The surge in China's markets (up 40% in 2015 thus far) has been little short of remarkable from the lows of March 2013 (the predicted China market crash - a favourite theme of many US hedge funds last year - seems to have mysteriously failed to appear thus far). We continue to like these, although acknowledge that any global market volatility would likely have a negative effect in the short-term.

So - in general terms we remain long equity. Our moderate risk portfolio has an equity allocation of 65%, and is neutrally weighted towards the US, whilst being overweight Japan, China and India. 

However, we acknowledge that in the short-term we could be looking at some profit taking which could result in a 5% or even 10% pull-back. For the nimble with perfect foresight, it might make sense to try and capitalize on this. 

For the rest of us, experience has shown that such pull-backs are over almost as quickly as they begin. Timing those perfect entry and exit points will be almost impossible, and it's important to reflect what the alternatives are in the meantime. Would we recommend sovereign bonds at these levels? No: negative yields strike us as having negative attraction. Commodities? No: whilst there has been some recovery in some core industrial commodities, inflationary pressures and fairly low demand seem unlikely to get these motoring any time soon. Cash? Only on a short-term basis and only when biased towards the USD (its recent weakness notwithstanding). 

That leaves us with equities as the default option for investors, as they have been since 2009. 

Our view on this is not swayed by continued predictions by many pundits that markets are heading for a substantial fall - they've been saying the same thing since 2009, and as they have continued to say while markets have risen through successive all-time highs ever since. If they've been as short as they have implied, then they should have gone bust some years ago: either they are keeping quiet about this or their actions differ from their words.

Our simplistic view is that there remains too much cash sitting around on the sidelines not to have this deployed on any marginal pull-back to make this likely, even though we acknowledge the short-term risks that would be created by a rise in bond yields should US interest rates rise more sharply than expected. Recent US data and subsequent pronouncements from the Fed suggest that this is unlikely: "lower for longer" or "lower for ever"...?


e-mail: steve.davies@javelinwealth.com

contact: +65 65577186

Find us on Facebook: http://www.facebook.com/JavelinWealth

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.