There is real hope now. The Brussels Summit, has taken the bold decision to move away from national banking systems towards a banking union regulated by the ECB with it’s unlimited liquidity and to bypass the sovereigns and recapitalize banks from the central fund ( EFSF and ESM). Off the table is the risk of Eurozone rupture for the time being.
You won't wake up some morning to find banks closed, Ireland out of the Eurozone and Europe balkanised. That is worth celebrating. During a TV interview at Punchestown Races recently ( Interview ). I asked Taoiseach Enda Kenny if he was a "lucky general", something Napoleon sought in his commanders. At first he mistook it as criticism before grasping the notion. Kenny is lucky, he's played the right hand and the breakthrough is real thanks to the combined fear of France Italy and Spain finally mirroring Ireland's two year old diplomatic strategy. That's also worth celebrating.
Europe has finally grasped, from the Greek electorate to the German Bundestag, that there is no going back. Its forward or ruin. But huge tasks and risks remain;
What France Italy & Spain Face
France, Italy and Spain, just like Ireland cannot afford to meet all the liabilities both on and off the national balance sheet, from future tax receipts. That means painful structural reform, shrinking the relative size and cost of the State. In the meantime the excess debt built up from decades of deficit funding will have to come down. That, for many economies, will act as a drag on growth for the next twenty years probably in the order of 1% to 1.5% pa of GDP. It is going to take herculean efforts to resolve these structural problems and, arguably, a new generation of politicians will be needed to do so. Similar problems face the United States which reaches its Congress-imposed borrowing ceiling at the end of the year and Britain which is in hock for over £1 trillion. Both economies however benefit from running their own currencies and have the wit to cut costs and adjust taxes without creating a negative feedback loop
How Ireland can take off
Ireland, once the excess banking debt is finally removed through successful renegotiation of the detail, has the capacity to take off, at the rate of a newly industrialised economy. That's not pie in the sky. With continued consumer debt deleveraging and proper application of the new insolvency regime, consumer confidence can return and spending can recommence especially if the expectation shifts towards higher rather than lower prices next year.
How Pessimists May Be Wrong-Footed
Pessimists, locked into past positions still point to the potential for the perfect storm; Eurozone failure, US recession, Chinese bubble burst and a new regional conflict in the Middle East. They forecast a return to a 1930s style depression. But there is another scenario now supported by the initial steps Eurozone policymakers made last week towards a federal Europe. This is further progress in Europe as skilled diplomacy surmounts differences, further recovery in US consumer spending and housing is helped along by the massive US cheap gas glut, Chinese growth flattens to 7% and war with Iran is sidestepped.
It’s OK to Start Dreaming Again
Put those together and the global economy could hit a genuine purple patch of 4% pa growth for the next decade giving Ireland much cause for optimism. So while you shouldn't put your life jackets away just yet, cautious optimism could be very well rewarded. There are lots of under-priced assets out there. Now is the time to tip toe out back to taking risks again. Watch as property prices stabilise, mergers and takeovers dominate headlines, stock markets strengthen and a new cycle begins. We will still be grappling with the legacy of debt, huge structural reforms and global imbalances but the future is worth betting on. So if you've got the cash but have been putting off splashing out on a new kitchen, extra bedroom or an extension, now is the time to ring the architect! It’s okay to start dreaming again.
Time to Move Back to Growth Funds
Now is the time to begin a careful but phased return to growth funds. We’ve identified well positioned funds across most fund ranges which you can transact usually at zero switching costs. If you’d like some help with yours just drop us an email through the website and we can take things from there for you.
The bottom of the market is impossible to call which is why I suggest a phasing back approach, repositioning no more than one third of monies, currently held in defensive funds, back into growth funds. It has been an extremely challenging time with every asset class under pressure and the stability of the banking system and the Euro in a genuine existential crisis. Stock markets climb on a wall of worry and while there are still many really big problems to resolve, the elevated risk of a banking collapse and Euro rupture has lessened considerably following last weekend’s Summit, to a point where the case can now be made to ease back into unprotected growth funds.
Treat this as phase 1. I’d suggest three tranches of movement back in order to lessen timing risk while benefitting from may prove to be undervalued assets, especially European equities. Later this year or next I hope to follow with suggestions on phase 2 and 3.
Inflation – the next cycle
The current cycle of saving and paying off excess debt is a natural human reaction when it is felt that products and services are likely to be cheaper next year. But that psychology changes when feelings shift to fears that prices could go higher next year. That’s when inflationary pressures mount, the game changes and inflation becomes a self- fulfilling prophesy. When inflation does hit, it can come quickly which has been the experience at the foot of other major inflationary turns in economic history, Germany 1923, the USA in 1946 and again in the early 70’s which started a ten year inflationary spiral with deeply negative real returns on fixed income bonds and cash deposits.
The next long economic cycle, starting in the early 80’s and characterised by downward inflationary pressure due to globalisation, ended with an almighty credit bubble burst. It is safe to say, we are at the end of that low inflation and low interest rate cycle, where money was cheap, leveraging got out of control and sovereign bonds were king. Throughout this period many Western Governments financed their promises by running uninterrupted annual deficits. Fixed Income bond yields are at historical lows, German bunds are negative, interest rates are on the floor, the ECB is set to cut rates again to less than 1% and a stimulus equal 1% of Eurozone GDP is promised.
What to Choose
In this scenario with equity markets, especially Europe trading at very cheap prices, all indicators point to the logic of loading up on global companies with strong balance sheets sitting on pots of cash and enjoying market dominance with muscular brands. It also points to commodities which have heavily peeled off in price in recent months in expectation of lower demand growth from the developing world. Equities and Commodities look like good value and potentially are on the cusp of a long term bull – but nobody can say for certain if a trapdoor event couldn’t reopen and trigger another Lehmann-style rout. It is still fragile ground but that’s when it time to move, not when everyone else is doing so and prices are higher.
Still I urge caution and suggest the beginning of a phased movement back to funds that gives your money exposure to Europe, USA, Asia / Pacific and Commodities, beginning now with a 33% shift back into “risky” funds. Remember if you need a steer on your own funds, whether personal or pension just get in touch here: Contact Eddie.
Eddie Hobbs July 6th.