 | Paul Gambles | Recognized as a regional financial expert, Paul is a regular speaker at industry events on market forecasting, financial planning, investing and legal issues for foreigners living or doing business in Asia. Besides Paul’s blog, Paul previously distributed his ‘almost-daily’ email – “Daily Updates”, where he gave his views on timely issues affecting financial markets, macro economics, micro economics and everything in-between. Born in South Yorkshire, England, Paul graduated from the University of Warwick with an Honours degree in English and European Studies. He began his financial career in the early 1980s as a technical inspector at HMIT with Inland Revenue. Following a successful career change to the Bank of Scotland in 1987, Paul moved to Bangkok in 1994 to help set-up an investment counseling practice, which today is known as MBMG International. www.mbmg-international.com |
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10 February 2012 Who's Supporting Who? One widely held misconception right now is that Germany is carrying a broken Europe on its back. I explained to all the participants in wednesday night’s inaugural MBMG ‘Squawk Back’ that the reality is very different – a theme that I had previously outlined to CNBC’s Squawk Box team last month.
“So we have the EFSF rescue fund going to the market with some six-month bonds. I think yields can be manipulated to remain within reasonable levels, but it depends who's actually pulling the trigger and who's doing the buying. One thing that I think is very interesting is that the EFSF is starting to look more and more like a sub-prime CDO these days. In the years running up to 2008, we had all this junk, and you could put BBBs and CCCs together and call them AAA. S&P clearly learnt the lesson from that and they're not going to get caught in the same way again. Sadly, Fitch's and Moody's seem to be a little bit slow to pick up on the same thing, but the EFSF is just starting to look like a sub-prime CDO.
I don't think the AAA governments want to put any more into this. I think they've made that very clear. I think again, going back to December 9th, going back to the Euro deal that was done, Germany wants to have absolute control of what goes on in the Eurozone. It wants fiscal control without the fiscal compact. It wants to set all the rules; it wants austerity, but it doesn't want to ultimately carry the liability, so I think the idea that Germany is going to put more into the EFSF is unlikely, but it may, behind the scenes, do much of the buying.
I think the collective fiscal resolve people talk about is the last thing we need. What that's going to do is to reinforce the fiscal policies of the last ten years of the Euro and what we've got in Europe (and Nouriel Roubini probably explained this better than most) what we've got is a symmetrical problem. Germany is producing all the growth; it's got all the competitiveness; it's where all the wealth is going to. That's being funded by the periphery with all the debt they are having to take on board, so a lot of people have got a mistaken view on Europe. It's the periphery that's been carrying Germany for all these years, not the other way round. We either need a transfer of wealth from Germany to Greece to allow that kind of transfer of competitiveness back to Greece, which isn't going to happen in a million years, or the only other option is to break the system and start all over again, and to us that means the peripheral countries leaving the Euro.
A few things are happening. One is it the ratings downgrade was heavily telegraphed and therefore people were expecting it; it wasn't a massive shock. And the other thing is this division between the ratings agencies, and the fact that Fitch's came out and said they guarantee that France will be given a AAA rating for 2012. That is absolutely bizarre to me. How any ratings agency can say that I don't know. What's Bill Gross's comment, that ratings agencies are full of people with MENSA IQs of 160 and common sense IQs of about 60? Unless they've got a crystal ball, how can they say France will be AAA?
The EFSF's AAA guaranteed 271 billion Euros is probably enough to come to the rescue of Greece in the next couple of months. It's probably enough to rescue most of the periphery over the next couple of months. It's not enough to go beyond that. We've been saying all along, what you need to make Europe solvent is a transfer of about four to five trillion Euros. That's what it takes to recapitalize the banking system so it's capitally adequate. That's what it takes to fix the broken sovereigns so that they get to a level where they are sustainable and they are repayable. We're not seeing permanent capital of four to five trillion. The EFSF was never that. It was only ever a stop-gap measure. The stop-gap's got a little bit smaller. I don't think there's any way to raise four to five trillion. The question is how long can they keep raising interim money that keeps the game going before the whole thing falls apart?
Germany's worry is about being sucked down by defaults and recessions across the Eurozone. If you take away that source of revenue, that source of exports, you take away all the things that have boosted the German economy for the last ten years then all of a sudden it's looking pretty naked. A muddle through scenario is possible for a while but then in a year or so, we've got austerity in all these places, and austerity in the periphery isn't going to help; we need growth in the periphery or else the periphery falls apart, and if the periphery falls apart, that's what brings Germany down. To see the original interview, please visit http://video.cnbc.com/gallery/?video=3000067656
07 February 2012 Credit Where Credit's Due? It’s a few weeks now since I compared long suffering US Treasury Secretary Tim Geithner to a transvestite athlete but it seems to have caused quite a stir so for anyone who missed it, here’s what I said to Money Channel’s Banphot Thanapermsuk when he asked me about the recent performance of credit ratings agencies:
Quite apart from just looking at the individual actions that the credit rating agencies are taking, which are very interesting in themselves, I think there's also a bigger picture here that's to do with the whole investment market, the whole economy and even everything to do with human behaviour.
When you play golf, if you take one shot more than you're supposed to take, they call that a bogey and the reason for that is that centuries ago in Scotland, people used to imagine that they were playing against an imaginary opponent, a bogey man, and if they got one shot less than the bogey man, they won the hole, so they had someone to blame, basically, if they lost, and I think one of the questions about the ratings agencies is do they just exist so that there's somebody there who can quantify things that really are measurable? That's how credit rating agencies really started out in life. At that stage, they were working for investors. Investors used to ask credit agencies to assess individual securities and the agencies would come back with reports saying “yes it appears their credit is good and their business model is good” but they were paid by investors to do that work. The other thing is maybe we're expecting these guys to go and measure things that really aren't quantifiable at all. We're asking them to give ratings on things that you can't measure.
Nassim Taleb has written a couple of books about the fact that we all want to create order when actually things are completely random. Both ‘Black Swan’ and ‘Fooled by Randomness’ explain this concept that we all try to arrange things into patterns when patterns maybe don't really exist at all. I think one difficulty for ratings agencies is that in 2011/12, we don't really know what they are. We don't really know exactly what job we're expecting them to do. They're no longer just working for investors. If investors want to get information about a particular stock or bond, they don't really base it on what a particular credit rating agency says, and they don't really have that direct relationship any more. The credit agencies aren't really working for them. In 2008, we became very uncomfortable with the fact that the credit rating agencies had been working for the companies whose sub-prime securities they had been rating. That made us very worried about conflicts of interest. We're not really sure what credit rating agencies do and who they do it for.
If I can use another sporting story perhaps - when we saw Secretary Tim Geithner famously go on TV to say it was a terrible decision for S&P to cut the US credit rating from AAA, we were reminded of a couple of female athletes in the 1930s, Stella Walsh and Helen Stephens. In the 1936 Olympics in Berlin, Helen Stephens beat Stella Walsh to the gold medal. Stella Walsh and all her fans were so upset that they accused Helen Stephens of being a man. As a result, Helen Stephens had to undergo a lot of testing, and it turned out she really was a woman. She may have been bigger and stronger than most but she really was a woman. The allegations were completely unfounded.
About 50 years later, when Stella Walsh died, it actually turned out that Stella Walsh, the woman who had accused Helen Stephens of being a man, who had been making all these unfounded accusations, really was a man. There seems to be an eerie echo of this when Secretary Geithner turned around and said the downgrade was a bad decision by the S&P. After all, the main reason why the US rating was downgraded was because of what Tim Geithner’s predecessor, Hank Paulson, had been doing when he was Treasury Secretary, and what the FED under Ben Bernanke had been doing. They had been pursuing this totally irresponsible monetary policy that had created so many Dollars in the system, and so many liabilities that we still don't know how far they go. So blaming S&P smacks of hypocrisy. We have the phrase 'a pot calling a kettle black' which means trying to get the attention off you by blaming somebody else. There's no doubt that ratings agencies did a terrible job all the way up until 2008, but we have to be careful now about who's criticizing them and why they're criticizing them before we can say whether that criticism is actually valid. To be fair, if S&P did make a bad decision in downgrading US debt, I think that the problem with the decision is that it should have been done sooner, and maybe it should have been an even starker downgrade than it was because it's very unclear to us that the US deserves its current credit rating. There's a whole bunch of systemic risk in the US system that means, to our mind and certainly to the Chinese and independent rating agencies such as Egan Jones, there's a lot more risk in US sovereign debt than a AA rating would even imply. We have to look at why they're giving these ratings and really what is a fair basis of criticism or not. One thing that strikes us that when we're creating portfolios, we don't really take into account what S&P, Fitch's or Moody's might think about a particular security. As president Roosevelt said, “There's nothing to fear except fear itself.” What actually happens is that no competent professional managers actually pay any attention to the S&P, Fitch's or Moody's ratings, but what happens when they get downgraded is that investors worry that other people are going to pay attention and then it actually becomes a self-fulfilling prophecy that you had better sell because everyone else is going to start selling even though you might not agree with what the S&P rating might be.
There's another problem, which requires us to understand what we're expecting of the rating agencies and what they actually do. A lot of investments are mandated by reference to the quality of the assets that are inside the investment as dictated by the credit rating agencies. In a sense, that makes it easier to understand in that if you buy a AAA rated bond fund, you know that all the securities in there are AAA rated, but the problem is that there may be an incentive for some investment managers to go and start using poorer quality assets because if there are some AAA assets that the market prices at a certain level, but there are other AAA assets that the market is saying “We're not sure about this. We think it might get downgraded. We don't really trust the rating.” That would make a security available at a lower price or a better yield, and in that case there's actually a real incentive for some fund managers maybe to go and try and get a better return, a better yield, by buying the worst possible quality debt they can find within a stipulated rating category, and that's really what happened in Europe. When the EuroZone was formed and we started to get a common rating across the entire EuroZone, Greece and Germany fitted into the same investment bracket at that stage. The markets knew that Germany and Greece weren't the same thing even if they believed that Germany was going to back-stop Greece, and so maybe there was 100-150 basis point spread at that point in Greek debt over the German debt, which narrowed because everybody wanted to buy the Greek debt because it was apparently exactly the same risk but it was paying a much higher yield, so there really is a danger that these things create malinvestment by bunching things together and applying inappropriate ratings.
I think the problem is that no one really knows what the credit agencies' role should be and therefore people still apply too much faith to these things. On one hand, we have professional managers who don't really take the ratings particularly seriously and use their own research and their own ideas. On the other hand, we have parts of the market that still apply too much faith to the agencies. People might say that one way round that would be to introduce regulations, so rating agencies are now covered by Dodd Frank, and we have the S&P leak that France was going to be downgraded being investigated by the ECB, so we have all these situations going on, but that concerns us as well because these are meant to be independent bodies that are going to be giving opinions about, say, the US government, and if they're going to be regulated by a US government body, but they're going to be giving negative opinions about the US government, again that's getting into the conflict of interest area as well. Going forward, it's very difficult to see what the role of the credit rating agencies will be.
What we would say is largely to tend to ignore them. Get proper professional analysis of any particular security - don't just rely on the fact it's got a particular label given to it.If the ratings agencies are still doing anything wrong today, they're still being too optimistic about stocks and securities and for too long. Lehman Brothers was AAA rated virtually until the very end. Irish sovereign debt was AAA rated until 2009, which was two years after the crisis began, so there's a real concern that if they are still doing anything wrong, they're actually still being too lax.
03 February 2012 State of the Union In my recent two-part discussion with Banphot on The Money Channel, we discussed our alternative assessment of the state of the American union, turning to the political risks and issues: -
We all saw the annual State of the Union speech on TV for the American people, but we actually read an alternative State of the Union by Nouriel Roubini, the economics professor, who put some thing together that he published in the last few days that for me is a much better description of the State of the Union of the United States at the moment. He described what he thought were seven major problem areas whereby American economic performance is really just papering over the cracks, and what we're seeing is just hiding all the problems that are underneath there, and it's actually a lot of things that we've been saying for some time now.
He was talking about the fact that there's a $15 trillion debt that's just not going away, and what's more, there's a deficit every single year as well, so that debt is just increasing. Like us, he doesn't really believe that American economic performance is picking up, and even though we saw some better numbers coming through for some of the Q3 and provisional Q4 results, but we had Operation Twist in the second half of last year, and that really forced a lot of stimulus, a lot of impetus into the economy. It came with a very large cost as well with all this long-term debt being swapped for short-term debt, so it came at a large cost but that had an impact on the economy, but to us that's not real growth; it's a one time benefit. Unlike QE I think the benefit of operation twist was that it had an impact on the real economy rather than just on financial assets. It's better than QE but it still has the same fundamental problem as QE, which is that the first time you do it, you get quite a big impact, but after that, you always get diminishing returns, so they might do a second Twist, a third Twist. They're talking about QE3. They're talking about buying residential mortgage-backed securities, commercial mortgage-backed securities. They're talking about all these other forms of stimulus that might happen, but the problem with all of them is that even if they do have a positive impact, it's inevitably decreasing.
QE1 had a positive impact on the financial markets. It didn't really have an impact on the economy, but it had an impact on the stock markets, but QE2 was a much more limited impact over a shorter period of time, and we think that QE3 therefore wouldn't be so great, and then QE4, QE5 even less so. Eventually you end up having no real impact. We might get a second and a third Twist, but each time the impact will be smaller and smaller and smaller. We don't really think that these things are in any way a fix, and again we agree with Nouriel Roubini in that the real problem is still there. Roubini describes it as two kinds of deficit problem. One is that there's a stock problem i.e. there's $15 trillion of debt already on the US federal balance sheet, and you have to do something about that because the cost of servicing that debt doesn't go away. The second problem is what's called a flow problem i.e. are you actually paying off that capital every year or are you increasing it. Well America has both problems; it has a huge amount of debt, approximately 100% of GDP, and it's getting worse every single year, and no one really seems to have come up with a solution to that. In America, a lot of the State of the Union was political posturing; it was Obama putting himself in front of the American population as a great advert for a re-election campaign with elections coming up at the end of the year.
We've really got a choice in the States with a Democrat party that believes in raising taxes for the very rich, which we agree with – it needs to happen. Income in the States is so badly distributed that it's all sticking in the top echelons. It's not circulating into the economy. It's stuck on corporate balance sheets, and corporates aren't employing people, so again it's not circulating; it's not having any economic utility. So we see the democrats saying they need to tax that, but they're not prepared to cut the running costs in the economy, so there's no way you can generate enough extra revenue through taxes unless you cut costs as well, otherwise we're still going to be running at an annual deficit. The republicans on the other hand are saying they want to cut costs, but they're not prepared to raise taxes, so we have the worst of both worlds. You need to do both of these things. You need to do something to fix the stock of the debt i.e. how much debt is outstanding, and in reality we think a lot of that has to be written off; a lot of the assets have to be written off; a lot of the debt has to be written down. And you need to fix the flow of the debt as well, so you need to fix the annual deficit.
Just fixing one isn't going to solve the problem. If you somehow cut the debt but you don't stop the deficit problem, then you're just going to end up in the same situation again in a few years time. If you actually do some thing about the deficit, but you're not cutting the actual stock of debt that's outstanding, you've still got this 100% debt to GDP, and that's a real drag on economic activity and economic growth.
I don't see anyone saying that a compromise between Republicans and Democrats is possible, and there are problems with that in that if you increase taxes and if you cut government spending, then you are going to have a fairly ugly situation; you're going to have a depression. You're going to have a very nasty prolonged recession, but unfortunately that's the only way out of the situation America is in with so much debt.
Maybe the favourable response of some of the American population to the State of the Union speech and trying to see some positives in there, we think is a little bit of a wrong response. We think that too much of America is in denial, and they're not really facing up to how bad the situation is and how drastic the measures have to be able to get rid of that stock of $15trillion of debt that has to go away and to face up to the fact that they're running a $1.5 trillion annual deficit. They have to cut their spending and increase taxes. That will almost certainly provoke a very severe recession, going back to the depressionary days of the 1930s, but then that will allow the adjustments to happen. That will allow debt to be written off. That will allow debt to get back to manageable levels, and from that point we can grow again, and that has always been the historic cycle, but this time people are doing everything they can to delay that and kick the problem further down the road.
Eventually you run into the situation where you just can't borrow any more. Greece has a roughly similar debt to GDP ratio as America does right now, and we're all seeing the problems Greece is having in raising money. Obviously, America's got a lot more global credibility, so we shouldn't really compare it to Greece as an economy, but that same problem will happen, but it will just happen at a higher level for America. There will come a point where borrowing money is extremely difficult, and if you can't borrow it externally then the solution is to print it.
Printing money is inflationary as we saw in QE1 and QE2, so if you're not careful you end up in a situation where you have no growth or very low growth, and very high inflation, which means that the growth in real terms is negative, and at that point that's when the whole thing starts to implode. If politicians don't decide to adopt these policies themselves, and we can't think of any politicians who have ever decided to do the right thing and bring on a recession when it's necessary. If politicians don't decide to do that, then the markets will decide that. Now, how much longer America is able to keep things going is a really interesting point because if they keep it going all the way through 2012 then we're into the election cycle, and it may well have an impact on whether Obama manages to get re-elected or not. If it all flares up during this year, we'll see some pretty ugly effects on the market, and that will have a huge impact on Obama's re-election campaign. The two-part discussion is now online at: http://www.dcs-digital.com/moneychannel/program.php?listid=9 & http://www.dcs-digital.com/moneychannel/program.php?listid=9 Click on the January 30th and 31st archive and advance the slider to around 53:30 minutes.
31 January 2012 Cycling Uphill Last Wednesday, myself and AEC Group’s Carey Ramm gave AustCham members a lively debate about the health of the Thai, Australian and global economies. Carey gave a very well-informed view of where the Australian economy is right now, whereas I took more of a look at what’s coming down the track. I used the 4 seasons Kondratieff chart that has been a reference point in presentations by MBMG Group and also MitonOptimal over the years - http://www.youtube.com/watch?v=DsR9z1W4a8I. Interestingly, MitonOptimal’s institutional asset allocation expert, Professor Evan Gilbert, also used the same chart in his Global Weekly Comment the very next day – great minds think alike! 
What I would add is that Asean markets entered into the winter phase in 1997 and took remedial action that has seen them already return to Spring – however the early days of this season will be a particularly cold spring season as chill winds from Western and Japanese winters blow through these markets. Asean will still be the healthiest region to invest but the best opportunities will come when markets are significantly ( 30% or more ) below current levels. These are markets in which patience and stock picking are most definitely virtues.
24 January 2012 It's all Greek to me... How can anyone have any faith at all in the so called ‘technocrats’ to resolve Europe’s problems? After watching CNBC's Michelle Caruso-Cabrera interview Greece's new Prime Minister, Lucas Papademos, my reaction to the unfolding situation with Greece and with the Euro as a whole was stunned disbelief. I told CNBC’s Martin Soong, Lisa Oake and Sri Jegarajah. “If I were Greek, I would be on the streets rioting because I think that's the only appropriate response. There is an unelected prime minister installed by what we thought at the time was the ECB and the core of the european Union, but what we now know was Germany. There is a technocrat with no mandate, installed by Germany, who is part of a mechanism that denied the Greek people the referendum that they had been promised on the Euro, and who stands there and tells the world, ‘The Euro is what everyone in Greece wants.’ But if he looks out of the windows; there are thousands of people on the streets of Athens who don't agree with that. There are a million people in Greece living below the poverty line who are actually starving on a daily basis, and Papademos sits there and says ‘We need this adjustment process, and yes wages are going to fall, but by the end of it we'll be ok.’ This is a multi-year process. For Greece to become competitive is probably going to take five to ten years. The people are not going to go along with it. They wouldn't have gone along with it even if they had elected the people in charge of it. We've been saying this for a period of time, and it's going to be painful in the short term which is why politicians don't want to do it, but the only way out for Greece is to leave the Euro. People wonder exactly how this will happen as there's no provision for this type of scenario in the European constitution, but the EU doesn't have a constitution any more. It was torn up and buried on December 9th by Germany and France ...The EU has no legal mandate. Greece should actually just leave. It should re-introduce the Drachma and Drachmatize the Euro debt, and there are actually two really good play books for this. We were all here in Asia in 1997. We saw what happened. Yes, it was six months of pain, but it was a pretty sharp recovery after that, and South East Asia has done very well. Asean is in the situation today where it doesn't have debt problems. But there's actually an even more current example. There's a European example. Iceland. It devalued its currency, and yet Iceland had one of the strongest growth performances of any economy in the third quarter of last year. Iceland has started to adjust. It's not got anywhere near as far in adjusting yet as it needs to, but it devalued its currency and because of that it's starting to write off debt and assets, and it's actually starting to grow again. Iceland actually grew at 3½ per cent in quarter three, so Iceland seems to be at the start of a path to recovery. What we're seeing now is a situation where everything is politically driven. The dynamic is that Germany is now in charge of the cheque book. That's what happened on December 9th when we got an agreement that everything can be done in bi-partite deals now. If you need to borrow money, you go to Germany, and it's Germany who sets the conditions that will apply. In our office, we have actually stopped referring to Angela Merkel; we now refer to her as Alaric Merkel. Alaric was the king of the Goths, who in the 5th Century marched on Athens, didn't get into a war but surrounded Athens and starved the city into submission, and then from there, in 410, he marched on Rome, surrounded Rome and starved Rome into submission. To me that's what's happening in the Eurozone right now. We've got Germany dangling the cheque book, calling the shots, making all the threats. But how long will everyone else go along with this? So the current offering of 3% on 20 to 30-year bonds is really a bribe. It's an iron fist inside a velvet glove. What are the options if you don't? I think we're getting very very close to the point where private investors are going to look at it and say ‘You know, on a net present value basis, we need to just repudiate that debt.’ So far, they've sort of pushed them along step by step, and they're getting closer and closer to the line in the sand; in fact they're probably re-drawing the line in the sand as we speak, so it's very hard to say the point at which they're going to turn around and say ‘enough's enough’, but we're getting close. There are clear signs. Look at the CDS markets and everything the CDS markets are pricing in. Not only that – there's so much distrust in the Eurozone. We've been saying for some time that the key figures for 2012 are TED and LOIS. As the TED spread shows, no one wants to take the risk of lending dollars. And with LOIS, the Overnight Spread, no one wants to be the one who's lending money to other banks, and that is precisely why there's so much money parked in the ECB every single night. This money's not circulating, which is incredibly bad for the global economy, but it's also a sign that we're getting closer and closer to a terminal event. If you look at the TED spread and LOIS, they've gone from normal levels of around ten basis points, up to around 50 or 60 basis points. Over the last month or so, they've eased off, but we're closer and closer to capitulation. We're getting there, whether it's this week, this month, or six months from now, we're getting there. How far they can kick the can down the road we don't know, but it's getting closer.
23 January 2012 2012 Economic Update The Australian Chamber of Commerce will be holding its 2012 economic update on Wednesday 25th January at The Pacific City Club from 12pm – 2pm. 11:45 Registration opens, buffet lunch opens 12.20 Paul Gambles, Economic Update with a focus on Thailand 12.40 Carey Ramm, Economic Update with a focus on Australia 13.00 Question and Answers 13.30 Session Closes The session title is “Board Room Brief: Australia, Thailand and world economy.” More than ever the imbalances that plague the global economy are causing chain reactions across all continents and all countries. Will Thailand and/or Australia be adversely affected by this? What are the opportunities here? To find out the full answers you’ll need to attend the event – contact us here at MBMG or contact AustCham for full details. Enjoy your day!
5 January 2012 New Year Sentiments and Reflections I hope that all readers and everyone who knows me, knows of me or for whatever reason reads the MBMG Updatehas had a wonderful festive season and is looking forward to all that 2012 can bring. As someone who is always happyto rely on the wisest words of the finest minds at times when I can’t think of anything better to add to what has alreadybeen said, I’d like to welcome the supposedly final year of a particular Mayan calendar cycle (of apparently no apocalyptic significance) with the following views from the shoulders of giants of poetry and philosophy (as opposed to the economic giants whose thoughts I usually borrow): “No one ever regarded the first of January with indifference.It is that from which all date their time, and count upon what is left. It is the nativity of our common Adam.”– Charles Lamb “Ring out the old, ring in the new, Ring, happy bells, across the snow: The year is going, let him go; Ring out the false, ring in the true.” – Alfred Lord Tennyson “It is better to spend money like there's no tomorrow than to spend tonight like there's no money.” P J O’ Rourke “Every New Year is the direct descendant, isn't it, of a long line of proven criminals? “ – Ogden Nash “Surely, it is much easier to respect a man who has always had respect, than to respect a man who we know was last year no better than ourselves, and will be no better next year.” – Samuel Johnson And finally a timely message about how to approach life from George Gordon, Lord Byron, who grew up in the same neck of the woods as I did, albeit 150 years earlier! “Here's a sigh to those who love me,
And a smile to those who hate:
And, whatever sky's above me,
Here's a heart for every fate.” Enjoy your day and your year, have a very happy, healthy, successful and wonderful 2012!
14 December 2011 D-Markation Many MBMG Update readers have recently requested a guide to the EuroZone problem and to the recent manoeuvrings. Here goes: Post 1945 Europe had to rebuild after the devastation of two world wars (in which Europe was the primary battleground) that straddled the Great Depression. Capital Wealthy America funded the recovery of Europe and Japan plus the emergence of newly independent countries in Asia and Africa. The universal mood focused on desperately avoiding further wars at all costs. Allied to the distribution of the prosperity dividend this helped bring about a collaborative Federal Europe. At the core of this federation was Germany, with France attached at the hip to its erstwhile adversary. This symbiosis reflected French deeply embedded suspicions and German war guilt. In both countries the ravages of war dominated the thinking of successive generations. Ironically Germany’s engine of growth, which drove much of the post-war prosperity, dated back to the 19th century harnessing of phenomenal natural and human resources in a powerful and energetic young country and fuelled the over-exuberant economic development and ambitions that ultimately caused World War I. The EU grew out of a primarily Franco-German trade and tariff organization for the steel industry that expanded to include the whole manufacturing sector in the post-war era. Harmony and homogeneity were initially and subsequently far from universal – military regimes prevailed at various times in Spain, Portugal and Greece whilst the Iron Curtain cut a line between central and Eastern Europe that provided the starkest aftermath of WW II long after Western Europe had rebuilt, with Germany itself once again divided and a small corridor providing the only access to the western sector of Berlin. The same urge that eventually unified Germany also drove forward the creation of a federal bloc that ultimately became the largest economic entity on the planet, despite a bureaucratic administrative system that famously interfered in every aspect of life. Pythagoras’ theorem 24 words | | Lord’s Prayer 66 words | | Archimedes’ Principle 67 words | | Ten commandments 179 words | | Gettysburg address 286 words | | US constitution 7,818 words | | EU rules on cabbage sales 26,911 words |
To serve its relative prosperity this Franco-German alliance sought the continuing evolution of the fragile Federation, which remained divided by national borders, languages and currencies. A single currency was conceived twenty years ago and introduced a decade ago as a way of keeping alike the twin dream of a perpetually fast growing federation bounded by homogeneous fiscal, monetary, political and social standards. This is where the wheels started to come off. In fact, there had been clear warnings when the likes of the UK had shown themselves unable to operate within the structures of the Exchange Rate Mechanism (ERM) that had preceded the currency itself. Stark national and regional differences continued in many ways to grow ever wider. Giving previously unimagined access to cheap and easy capital to those EU members whose economies featured a structural lack of competitiveness merely facilitated a transfer of wealth to the more productive core and a transfer of debt to the less competitive periphery. Borrowing was suddenly so cheap and so easy for countries that had previously experienced difficulties raising capital because the myth was propagated that lending to all EuroZone members was the same: When the bonds of the GIPSI countries (Greece, Ireland, Spain, Portugal and Italy) were each rated as being similar to German or French bonds, institutional buyers such as banks and pension funds bought the higher yielding but apparently equivalent risk GIPSI bonds in preference to lower yielding Teutonic ones. This caused the market price differential (the spread) between them to narrow to the point that it virtually disappeared altogether, further embellishing the myth that leverage had created uniform prosperity across the EuroZone, whereas for the periphery the leverage had really only begat a series of bubbles. Like all bubbles, these fed in a virtuous cycle: spiraling asset prices fuelled high growth rates. However like all leveraged bubbles, the debt levels eventually started to impact on growth and asset values when slowdown set in. The process of deleveraging caused these bubble economies to slow even further. This coincided with the bursting of America’s bubble, further showing European growth, further exacerbating the debt burden and suddenly leaving Ireland, Greece and Portugal struggling to service their existing debts in an environment where capital became much more difficult to access. Shackled by a currency whose strength was far more to do with Germany’s positive current account than the budget deficits of the smaller, weaker economies, it was impossible for these economies to grow their way out of trouble. The heart of the federation’s economic system, The European Central Bank (ECB) began providing short-term solutions to immediate cash flow deficiencies in 2008 whilst failing to address the structural imbalances. Despite astonishing endeavours by the likes of Ireland to cut spending, the shortfalls have persisted strangling these economies into the recessions that persist today. Less imbalanced larger economies, such as Spain and Italy, took a little longer to reach the same point. Having now reached that point, the crisis is of such a scale that the entire EuroZone is in recession, the Euro banking system appears grid-locked by mistrust and on the back of a liquidity crisis where the ECB seems to be the primary source of bank funding and the domino ripple of sovereign defaults still appears imminent, despite the agreement that each country can now work around the EU’s own founding treaties and constitution to do whatever bilateral deals are necessary to secure short and medium term funding requirements. Ultimately capital is still available from the ECB via the core, from America (whose own financial system might not be able to withstand Euro defaults) or possibly from Asia, where neither Japan nor China want to see Europe slow down any further. However, neither big bazookas nor tiny pea-shooters of short-term liquidity will fix structural insolvency and imbalances. It will merely delay the inevitable. Beyond short term remedies, there are 2 structural solutions: 1. Countries revert to appropriate national currency policies. ASEAN 1997 is the playbook for this – Europe 2011 faces the added headache of a world that, except Asia, may well already be in recession (and Asia may not be so far behind). GIPSIs can however choose to debts in Drachma, Lira, Peseta, Escudo and Punt allowing for a much quicker healing after a period of initial extreme volatility. 2. The core countries, primarily Germany, can point enough Euros to plug the Euro 5 trillion holes in Europe’s financial system, investing this as permanent capital in assets that will depreciate sharply in value, along with a much weaker currency. This might work. However to create a sustainable solution, it requires a homogeneous EuroZone to be created. To create equivalence across the EuroZone may well be possible especially after the monetization of the German balance sheet by printing an unprecedented amount of currency to swap back some of the core’s ill-gotten gains from the Euro experiment back to the periphery.  ( Click on 9th December and advance the slide to 50 minutes ) But to my mind it’s far likelier to result in equivalence being achieved by reducing the competitiveness and standards of Germany down to the levels of Greece than by improving the standards and competitiveness of the GIPSIs in line with the core. To that end the recent agreements amount to little more than further kicking the can down the road with the added caveat that in recent weeks the EU has supplanted democratic processes in Greece and Italy (in the words of Eric Rosenkranz “Germany’s just chosen a new Prime Minister….for Greece”) and also abrogated its own constitution. This “democratic deficit” to use Nouriel Roubini’s description, may well be a long-lasting problem, well after the warm glow of the short term fix has worn off.
8 December 2011 DELTA MALES AND GREEK ALPHA BETS A trenchant recent observation by MBMG’s affiliated portfolio manager Scott Campbell of Miton Optimal followed on from UBS-gate, where a trader’s mistakes threatened to undermine one of Europe’s biggest banks: ‘We have written in the past that not all Exchange Traded Funds (ETFs) are created equal and due diligence is just as important as with hedge funds or other collective investment vehicles. Well UBS shareholders discovered some of these risks when 31 year old trader Kweku Adoboli lost US$2.4 bn of the banks money. He worked for Delta One and as one city analyst noted, most CEOs of investment banks could not explain what their Delta One team are actually doing! Well the ETF connection is that the not all ETFs are ETF’s. In fact, most are ETN’s which stands for Exchange Traded Notes which are not Funds at all. These are promissory notes from an investment bank giving specific performance of an index or asset or commodity to investors. The Delta One team is responsible for trading the banks’ money to ensure that they can meet this promissory note. Any excess profit (or loss) generated from managing the risk (or creating it) in a cost efficient manner, is kept by the bank. JP Morgan predicted last year that Delta One would be a prime future source of revenue for global investment banks. “What were they smoking?” When investing in an ETF you are buying an underlying basket of assets in a fund that happens to be listed. When you buy an ETN you are buying the promise of an index return by an investment bank. As many found in 2008 with the ETN’s backed by AIG, who nearly went bust, these promises can have very different volatility profiles. Given all the other eerie 2008 correlations going on, ensure you know your F’s from your N’s, as not all is equal. Source: MitonOptimal.com Global Weekly Comment – Week 39 – 30 Sep 2011
6 December 2011 Congratulaions to our affiliated portfolio managers MitonOptimal, the specialist global multi asset management company with a presence in Guernsey, South Africa and Asia who recently announce the launch of its South African institutional asset consulting business. MitonOptimal has an impressive 15 year track record of global multi asset management in very adverse conditions.
Part of this expansion sees the appointment of Professor Evan Gilbert as a director and Head of Institutional Asset Consulting from 1 September. Prof Gilbert joins from Cadiz Asset Management and was formerly at UCT and the University of Stellenbosch. He completed his Ph.D at the University of Cambridge in England. He has a wealth of experience in asset allocation research, trustee training and has written many academic papers on portfolio management and related subjects.
"I am very excited about joining Scott, Roeloff, Joanne, Cherie-Lee and the rest of the team at MitonOptimal. They are an asset allocation specialist and have a partnership culture with a real desire to produce investment results in all aspects of their portfolio management. I strongly believe that the value proposition of active asset allocation and implemented consulting, combined with multi management, can only continue to gain immense traction in the local market" added Prof Gilbert.
Scott Campbell, Managing Director and fund manager at MitonOptimal added "since we founded this business we have believed that the value proposition in portfolio management is global diversification and the ability to add asset allocation alpha by tactical decision making and timeous implementation. The team led by Prof Gilbert and ourselves has the pedigree and enthusiasm to create a new force in the South African Institutional industry. Asset Allocation is shown by academic research to attribute 90% of variance in portfolio returns and our experience to date with institutional schemes is that they do not diversify this most important decision. The real risk faced by trustees is not moving to multi manager, but not having any diversification of consultant. Overemphasis has been given to actuarial static asset allocation and manager search which is the remaining 10% of risk attribution. The US implemented asset consulting market has grown to US$200bn since 2004 and the local industry is also changing quickly. Balanced multi asset managers are the best placed to deliver forward focused performance in the future.
"Scott was recently in Bangkok to celebrate MBMG’s 15th anniversary celebrations at which he showed his audience by announcing that his almost decade long love affair with gold is coming to an end. “There’s still upside but maybe another 10% or 20% or so, perhaps a bit more. But really that’s just nickels in front of bulldozers when gold has already been an 8 – bagger since we first bought in at around $250 per ounce”. All good things come to an end that will include gold’s bull run and then gold could be expected to cyclically languish for the next 30-40 years at as much as 75% below today’s levels. |
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