Investment Environment August 2012

04.10.12

Current economic and political circumstances would indicate that the world is in a real mess! This is highlighted by the debt burden of the developed world which is at levels previously associated with the world wars in the first half of the last century, as shown in the graph (see downloadable pdf).

This would explain the flight to safety that investors have embarked on as demonstrated by the US Ten Year Treasury Bond providing interest rates returns at the lowest level since the beginning of the last century. Furthermore, at current yields (the purchase price of a bond) the forecast is this investment will provide a negative real return for the ten years to maturity (see the graph on the downloadable pdf). The clich├ęs bandied around are “You invest for a return of your money” rather than a return on your money! However, holding conservative assets that provide no return or negative real returns might be unwise as the world will recover.

 

 

However, as the last quarter progressed, there was marginally more optimistic thinking, some of which relates to the following:

• Central banks actions have become key in reducing debt and they have become large players in each of their local bond markets, as demonstrated by the ECB purchasing European peripheral sovereign bonds. This supports the European banks which in turn allows them to commence lending which is economically stimulative.
• The statement from Mario Draghi in London (26 July 2012) “The ECB is ready to do whatever it takes to preserve the Euro…… and believe me it will be enough.” This has limited the EUR/USD downside based on the ECB’s commitment and improved risk appetite, but more importantly limited the potential contagion effect in Europe from peripheral countries like Greece.
• The global economic outlook while confusing with mixed US data and recent disappointments from China, will be counteracted by monetary easing as the US proposes QE3. While this might lead to USD weakness it is good for commodities and economically positive. This assists equities compared to the demand for cash and safe haven sovereign bonds.

Based on these points and the probability that economically we have seen the bottom, it is likely that risk assets and in particular equities will lead the recovery, as they always do! To coin another phrase, “Equities are climbing a wall of worry!”

We believe that the remainder of 2012 will provide opportunities to establish equity positions commensurate with the risk of the relevant portfolio.
 

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