NFB FINANCIAL UPDATE Volume50 June 2010
FROM THE CEO’s DESK
A
much confronted with debt repayment into the next decade and the UK settling into a shared
become the preferred currency for global trade. It was common cause that the US dollar was going to pot. Thankfully, we
parliament, where do we go in terms of investment? Given that worldwide earnings are depressed we could see a positive trend, which in
chose not to react to this implied pressure, and just a few weeks later the precarious nature of Greek and other geographies (not only the so-called PIGS) debt certainly became a focus. This problem will not go away simply because the euro-zone closes ranks and bails Greece out. It is one thing to provide a bail out, it is quite something else to expect these traditionally less fiscally disciplined folk, firstly, to change their ways and, secondly, to buckle down to extremely prescriptive and rather unappealing measures introduced to reverse the negative trends in their economies, which precipitated these conditions in the first place. One of the more worrisome outcomes of the current economic malaise is the re-appearance of nationalistic trends where, already in Europe, talk is heard of a second tier currency for the dislocated economies. Imagine euro 1 and euro 2! Nationalistic tendencies go way beyond currencies and include trade pacts being
turn might return confidence to markets and the next thing that happens is asset prices adjust upwards. My concern is that this has already happened, with questionable “earnings increases” having been reported. Companies have not earned more, they have simply spent less (retrenching, less marketing, no IT replacement, cutting packages and frills) and this has translated into better bottom line numbers. The problem, if I am correct, is the knock-on effect of this when they need to grow. They then have to scramble around hiring people, buying plant, technology and advertising, to get back into the game! This is not all bad, because their lethargy in building people, stock, capacity and ad spend will benefit others when they waken to the resurgent economy and demand, propelling share prices of those companies upward. I guess the trick is then to identify the beneficiaries, invest in them and wait. We are doing just that and, most importantly,
unilaterally amended to support politically attractive protectionist policies. To the shellshocked residents and voters in Greece for
as previously noted, we are also looking into the developing giants in the East and other geographies to add to performance.
example, and the other Club Med states, the idea of a “let's go it alone” escapist approach is probably appealing. The idea of taking the
Interest rates look set to remain lower for longer and until inflation raises its inevitable and ugly head governments will be urging their central banks to
medicine is unappealing and is easily blamed on others. Closing ranks can be expected as a proposed strategy from right wing politicians and
hold off on increasing the cost of money. The upshot of this article is that sticking to the basics is appropriate. Our asset management team is
will be accepted by people eager to resume “life as usual”. The hung parliament in Westminster is a further
actively adjusting portfolios, finessing exposure to equity, property and the other asset classes. The only real issue is that whilst we as a house have
concern. Already pummeled by the economic woes of the last few years, and with its status as a financial centre placing it amongst the worst hit
erred on the conservative during the economic meltdown, we have had little reward, as the cash into which we retreated is paying almost nothing!
economic zones in the recent meltdown, London is reeling. But, watch this space. The currency, independent of the euro, and capable of both
To the World Cup, that is now upon us. Remember, none of us in 1995 vaguely thought that a bunch of South Africans could get to the
strengthening and weakening allows Britain to roll with the blows. It will come back and the NFB team is watching it closely, intent on catching the lows
semi-finals never mind win the darn thing. GO Bafana Bafana, GO!
that sterling trawls. The Brits are a resourceful bunch and we believe they will come back fighting. So, with Europe a basket case, the US very
Mike Estment, CFP® CEO, NFB Financial Services Group
few months ago we were continually being asked when the euro was to
IN THIS ISSUE From The Ceo’s Desk Europe's Debt – How the Mighty Have Fallen Opportunities Abroad: Suppressing the Feelings of Contempt
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financial services group
EUROPE'S DEBT HOW THE MIGHTY HAVE FALLEN The severe economic distress currently being experienced by Europe has knock-on effects for SA. By Grant Magid, Private Wealth Manager - NFB Gauteng.
O
ver recent weeks the hotly debated global topic has been sovereign debt. Sovereign debt is a debt instrument that is guaranteed by an underlying government. The government owes both ongoing interest at a predetermined rate and repayment of capital at the end of the term. We are not going to discuss pricing mechanisms, primary or secondary markets, but will rather focus on the current European sovereign debt crisis and what this means. Since 2008 we have seen global equity markets plummet amidst the US-led banking crisis only to see the rampant equity bull return in 2009, which almost wiped out the memory of 2008. In an effort to keep the global financial system alive, the US led by example by introducing US$3 trillion worth of liquidity into the system. While we have no doubt that the intention of the initial funding was to ensure the stabilization of the financial system as we know it, that very stimulus has lead to where we are now.
We would like to give you a very brief background to the euro and the concept behind it. The euro was introduced in January 1999 and the idea was to try and have a unified currency for the euro-zone. Even though the euro has been the second most widely-held international reserve currency after the U.S. dollar, the transition to the euro was difficult for different reasons: = The United Kingdom did not want to only have the euro, but wanted to keep the sterling pound as well = Each member state wanted the best conversion rate for their
currency as at 1 January 1999 = There were, and are, diverse cultures and population dynamics within the euro-zone = Economies of the member countries are vastly different in size and production and = There are different languages.
Where we are today? The reality is that Europe is technically bankrupt. The risk that governments are not able to pay back capital on government debt has lead to the current crisis and the destabilization of euro-zone members. At the forefront of the sovereign risk crunch is Greece, but there are various other member countries that face similar
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problems. PIIGS (Portugal, Ireland, Italy, Greece & Spain) now need financial aid to ensure that their own financial systems do not collapse. The government debt ratings of these countries have
dropped dramatically with Greece's sovereign debt being classified as “junk�. This term is used for debt which has a high probability of default and hence capital may ultimately be unprotected. The graph below illustrates the total debt which these European Union countries have accumulated.
The issue is, these governments and banks owe each other billions of dollars in debt, and owe vast sums of money to Germany, France and Britain. The total value of the debt in circulation is worth around US$2.34 trillion. The holders of this debt are expressed in the Table 1 at the bottom of the page. The sums are in billions of US$. Due to US and Asian pressure to stabilize markets, European policy makers unveiled a proposed bailout package of around US$1 trillion to stop a sovereign debt crisis and the possible contagion amongst other countries. The reality is the new war chest is likely to be used for countries like Spain and Portugal whose deficits are set to reach 9% and 8.5% of gross domestic product respectively. These are both well above the euro regions limit of 3%. This has called for both countries to introduce budget cuts in the near future. The aftermath of this news has caused havoc in global financial markets with the Stoxx Europe 600 Index falling 8.8% in a single trading session. The knock on effect was the US market very briefly fell 1,000 th points on the 6 of May 2010. The scale of the European debt has caused the euro to come under severe pressure much like in 2008 with the US banking crisis. The euro has depreciated significantly against the greenback. This weakness has pushed the euro back to the 2005 conversion rates against the dollar. This is shown in the 1 year, 3 year and 5 year charts below.
The 5 year graph reflects that there has been almost no change in the currency rates of the euro against the dollar, due to the very recent depreciation. Once the dust starts to settle the real question is how the recipients of the bailout package plan to repay these loans. The massive inflow of liquidity into these economies may cause inflationary pressures, which will ultimately have an effect on monetary and fiscal policy.
The realities are: =
Should Greece default on their debt the economy would grind to a halt and most likely Portugal, Ireland, Spain and Italy would follow. = The euro needs to be protected and the European Union acknowledges that. = The currency is currently vulnerable and the recent drop in the currency was the biggest since the collapse of Lehman Brothers. = The bailout package should be enough to stabilize markets in the short term, hopefully prevent further panic and limit the fear of contagion to the rest of Europe. = The European Union needs to ensure the stability of their members and ensure the continuation of the global economic environment as we know it today. Europe is currently under severe economic distress. This most recent bailout package will go a long way to calming market nerves, but may introduce longer-term structural issues (repayment programs, lower GDP growth, perhaps even some inflation in the very long term). However, Europe is not alone and currencies are a relative game. Look to diversify amongst currencies and be in touch with your NFB Private Wealth Manager.
Table 1 Italy Italy
Spain
Ireland
Portugal
Greece
Germany
France
Britain
$ 47
$ 46
$ 5.2
$ 0.70
$ 190
$ 511
$
$ 30
$ 28
$ 0.40
$ 238
$ 220
$ 114
$ 22
$ 0.80
$ 184
$
60
$ 188
$ 0.10
$
47
$
45
$
24
$
45
$ 75
$
15
Spain
$ 31
Ireland
$ 18
$ 16
Portugal
$ 6.7
$ 86
$ 5.4
Greece
$ 6.7
$ 1.3
$ 8.5
$ 9.7
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OPPORTUNITIES ABROAD: SUPPRESSING THE FEELINGS OF CONTEMPT Offshore exposure for the South African investor is still a vital part of a well diversified portfolio. Written by Duncan Wilson, Private Wealth Manager - NFB Port Elizabeth.
T
he Rand's strength over the last decade, strong local asset growth and muted returns abroad has left many South Africans disillusioned about going offshore. Despite this, offshore exposure for the South African investor is still a vital part of a well diversified portfolio and the fundamentals make for a strong case presently. With markets having recovered strongly from their lows in March 2009 and by all accounts indicating a somewhat over exuberant recovery, The Investor Psychology Cycle (see below) would suggest that investors are nearing, or have arrived, at the top of this cycle, showing signs of greed and conviction. If history is anything to go by, and it usually is, then the depth and breadth of the financial crises would indicate the very strong possibility that the recovery we have experienced thus far in global markets, is all part of a secular bear market, or a sustained downward movement. Global pension fund managers are showing these signs of greed and conviction, as their balance sheets are heavily laden with equities, in an attempt to recoup the losses they incurred prior to March 2009. Markets around the world are showing signs that they are all fairly well priced, with the South African market showing signs of being overbought. Despite this, local fund managers are all expressing their interest in the opportunities they are finding offshore. With a glaring lack of
makes up for less than 0.5% of the global market space, it seems ignorant not to expose a portion of one's portfolio to offshore opportunities, particularly on the backdrop of a strong Rand. In the nineties, South African investors ploughed money overseas, fuelled by fears domestically and the view that the US was the global stalwart and the US dollar impermeable. However, as Jeremy Gardiner of Investec has noted, over the last decade the US dollar has halved and the US equity markets have basically delivered a zero return. Over the same period, the SA market has returned a convincing 15.8% per annum in US dollars. Two important points lead on from this: 1. No financial asset goes up or down forever. Financial assets all go through periods of over- and undervaluation, and it is the level at which you buy them that is most important. 2. One has to be careful of buying anything after a strong run or an extended period of strong returns, as your potential returns going forward, will be muted. The South African psyche around offshore investment currently, is indicative of the other end of the spectrum of the Investor Psychology Cycle, one of contempt. In our view, based on our local currency strength alone, there lies a definite opportunity in the offshore.
local opportunities and the fact that the South African economy
The Investor Psychology Cycle Greed & Conviction Indifference
Enthusiasm
Dismissal
Confidence
Denial
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Caution
Fear
Doubt & Suspicion
Panic
Contempt
Contempt Source: Prieur du Plessis - Investments, Markets, Money
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