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Investment Opinion from John Townsend

• Investing While Living in Germany, Yes You Can
• Investment Opinions - January 2012
• Investment Opinions - October 2011
• Ad hoc Investment Update 05 August 2011
• Investment Opinions - July 2011
• Investment Opinions - April 2011

Investing while living in Germany, Yes you can!

Germany has a strong investment culture, with products ranging from the excellent to the downright dubious; so much so that an investment here should be seen as an entrepreneurial exercise with 'investor beware' as a constant and very serious watchword.

It is often useful to use a 'platform' to administer German investments. Investors always retain the ownership of their assets, but the collection of dividends and payments from stocks, bonds and funds is automated and efficient. Above all, the annual costs of using a platform are low.

US citizens can invest in stocks, bonds and funds as long as they do so via a platform that is willing to make the necessary income reports to the IRS. Most German organisations refuse to do this, being wary of the penalties for making an error or omission. There are however enough professional platforms available to US investors residing in Germany to be able to make a considered selection.

Seeking advice on investments

The tradition in Germany has long been to buy financial products from one of the very many banks here. An investor must be aware of the risks involved in using this source of advice and product. The German commercial and savings banking system is an efficient sales machine, lacking the strong controls or serious supervision from central authorities and happily unencumbered by any but the most minimal consumer protection laws.

Those bank employees with direct customer contact are often judged for the furtherance of their careers by their ability to sell their employers' financial products. Banks have mainly their own and a small selection of other products available for sale to customers; in our experience of unwinding unsuitable investments, these products are placed with clients with scant regard paid to their suitability. It should also be remembered that banks can afford better and more expensive attorneys than most of their customers and the enforcement of investors' rights could be a long drawn out and expensive process.

Very often, depending on an individual's credit worthiness, a bank will suggest extending a loan to allow an increase in the investment in that bank's fund products. Unless a desire for risk lies prominently in mind of an investor, such leveraging should be resisted, as any losses are directly for the client's account and a leveraged position loses money at a much faster rate than simply using available funds.

Some investment advisors are biased, whether legally or emotionally, to the products of a single fund company (or KAG). The emotion all too often has a direct correlation with the level of front end fees paid to the agent. This is fine if an investor knows precisely which stocks, bonds or funds they want to invest in, but is less useful when seeking independent advice. Investor and consumer protection legislation is less advanced in Germany than in many other countries; the result is that an investor can receive assurances that stand little or no chance of becoming reality.

Independent advisors undertake their own analyses of an investor's ability and willingness to take risks, as well as using quantitative and qualitative methods to find the most suitable investments. They will provide an investment concept based on matching the clients' needs with suitable investment products and will give this report in writing for the investor to consider. We strongly recommend that if an investment advisor is unwilling to commit their thoughts to paper by providing such a written concept, a potential investor should look elsewhere.

Beware of popular products with names such as Riester, Rürup or Basis-Rente, which are all too often sold as tax saving vehicles, but are in reality long-term pension products, offering no access to invested funds until you reach the age of 60. If a foreign investor leaves Germany, the funds have to be left behind to accumulate until they mature and will then be paid out only as a life-time annuity.

Investment products to consider

There is a risk ladder which offers broad guidance on investment products for investors of different temperaments; the investment markets should only be used by longer term investors and a time horizon of less than 3 years runs the risk of falling between adverse market cycles. There is no good reason to risk capital losses within a short investment time horizon.

From the least risky to the most adventurous:

• Cash savings plan / Bank deposit with a bank covered by the government guarantee scheme
• Guaranteed pension plan or deposit with an insurance company
• Investment or mutual funds - ranging from Risk Category 1 (the least risky) to 5 (potentially a wild ride)
• Closed-ended funds, (Geschlossene Fonds) with a finite maturity date and all too often a distinct entrepreneurial risk*
• Direct investments in Government subsidised long-term projects
• Investment in residential property
• Zertifikate - certificates or instruments using derivatives to reflect movements in indices or markets
• Hedge funds / Private Equity investments

*Recent changes in German law require an investor to receive an up to date prospectus, which sets out the risks and opportunities of the fund; the potential investor should normally be asked to sign a declaration that the prospectus has been received, read and the risks understood. All prospectuses have to be approved by the German authorities (BaFin) as far as the structure of their contents is concerned. This has ABSOLUTELY NO reflection on the viability of the fund or the chances of it meeting any of its financial goals.

Taxation

Successive governments have worked hard to close the loop-holes that their predecessors might have thought a good idea. Sometimes the volte-face can be retroactive, which causes consternation, but normally there is fair warning of impending changes. Many tax laws have not been as carefully drafted as one might have hoped, with the result that the courts rather than the government end up as the final arbiter of what was intended, and tax laws being newly interpreted.

On 01 January 2009, Germany introduced a 25% investment tax which encompasses all capital gains and income from investments entered into after that date. The change was preceded by a fanfare of new products, but in the end came at the same time as the worst economic crisis in living memory, resulting in a muted response from investors whose portfolio values had fallen so far that it would be some time before a capital gain could become a meaningful prospect. All new investments will however be subject to the new tax structure.

There is an annual 801 Euro (1602 Euros for a married couple) tax allowance on income stemming from interest and investments; this can be divided up between institutions, but the tax authorities seriously object to any attempt at exceeding the overall allowance and the punishments can be painful and are well worth avoiding.

There are some, though very few, exceptions to the general dearth of tax sparing schemes. For instance double taxation agreements between Germany and several other countries, resulting in potentially useful tax allowances or an investment in property. It is important that all foreign investors considering an investment in any German investment market should consult a tax specialist before making a decision.

A tax consultant in Germany, ever mindful of their potential professional liability, will not normally give an opinion on the economic viability of a project, but will give a confirmation (or denial if necessary), of the stated tax implications of an investment.

Basic principles of investing in Germany

1. Treat all complex schemes using multiple products with suspicion; they are rarely designed to be in the best interests of the investor.
2. There are no rules governing the promise of abnormally high returns to potential investors; if an investment scheme sounds too good to be true, it probably is.
3. Beware of imprecise claims regarding the returns from an investment. The magic words 'Chance auf', all too often followed by a very high percentage yield, are almost always based on an improbable combination of events; if the goals are indeed ever achieved, it is probably due more to accident than design.
4. Without regard to your own political views, it pays to be financially conservative.
5. Always consult an independent advisor and insist on receiving a copy of all documentation, including a record and risk analysis of your needs and wishes, an up to date prospectus and any application forms. You will need these in case of a dispute.
6. Investors have a two week cooling-off period after the signing of an application form. This is your right, you should be aware of it and use it if you feel even remotely uncomfortable with a suggested investment.
7. Always spread your investment risks, ideally never having more than 10% of your portfolio with any one fund or strategy, irrespective of the product.
8. Guarantees are only as good as the company that issues them.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the Chartered Institute for Securities and Investment in London.

Townsend@insure-invest.de
www.insure-invest.de

John Townsend's Investment Opinions - January 2012

Politics is not the art of the possible. It consists in choosing between the disastrous and the unpalatable. - John Kenneth Galbraith

1. Once the Europeans have reached a coherent agreement on their debt problems, it is likely that equity markets as a whole will take off sharply. At that stage investors not invested in equities will already have missed the upswing. It would therefore be wise to invest in equities now. Equities are in any event presently trading at very low price levels.
2. Corporate borrowers in the US, Germany and the United Kingdom provide high yield bonds with credit risks better than many European and non-European governments. There is little chance in the short term of inflation rising rapidly and the high yield first class corporate bond markets should provide stable returns.
3. Investors still looking to invest in Gold are well advised to consider the gold mining sector. Much physical gold is currently held by speculators, who will in time have to sell but there is constant and steady demand for the metal from jewelry manufacturers in India and the Middle East. The gap between the current high gold prices and gold’s real value will continue to close. Gold mining company shares were hit by the recent general lack of enthusiasm for all equities and are presently very good value for money.
4. Investors should above all avoid holding cash at the bank; they should increase their equity holdings, whether in US Dollars (for the time being), Euros or Pounds Sterling. They should avoid government bonds at all costs and seek the value of higher yielding corporate debt. These suggested sectors are all well served by experienced fund managers.

There can - and must - be no doubt that the world needs a strong European currency. The only serious doubt is the form this currency should take.

The European financial crisis of the last half of 2011 arose from investors’ lack of faith in the European governments’ ability to take any coherent decisions. Greece, the trigger for the crisis, if not the only country to have problems, tried hard to portray itself as a genuine working European economy (which it isn’t); in reality Greece cannot be saved and must in time leave the Eurozone. Italy theoretically has a sound economy, but again the lack of faith investors had in the incompetent previous government’s ability to recognise and deal with its liquidity crisis made supplying the country with more loans largely unaffordable; the new technocrat government could make a difference, but this is not yet certain.

There has been a general easing of economic tension since the beginning of 2012, but that there is still no coherent policy in Europe for managing both debt and growth, especially in the peripheral countries. Economic policy in Europe is being disclosed by a hydra, with each head saying something different. Germany, supported by France, is insisting on economic cutbacks that would probably work in a German context; sadly in the peripheral countries these policies serve only to strangle growth and cause deep recession. On the other hand, the emergency funding is to be almost entirely provided by Germany, so German opinions clearly carry weight. None the less, even if the policy of financial belt-tightening is agreed by the other countries, the policy is unlikely to survive much beyond the French election in 2012. European agreements, especially uncomfortable ones, have a habit of falling apart once the money has been paid.

The German view is at best unwise; it would cause the current situation to be perpetuated until the Eurozone falls apart, as the weaker peripheral nations cannot, with the best will in the world, meet the economic strictures. Perhaps this doesn’t actually matter. It would be logical to divide Europe into two zones; the strong economic powers of the north and the weaker economies of the south, each zone with its own one or more currencies.

Without a far-reaching change in the Eurozone, the weaker peripheral countries will continue to weaken, because they can’t devalue their currencies to become more competitive and their growth will be strangled. The stronger countries will at the same time become even stronger, since their currencies won’t appreciate and their economies can thrive.

History shows that trans-national currency unions have not succeeded, generally for the similar reasons. For instance, the Latin Monetary Union was established in 1865 wherein France, Belgium, Italy and Switzerland agreed to change their national currencies to coins with the same standard level of gold or silver to make these currencies freely interchangeable. The aim was to aid the payment of trade. Spain and Greece joined in 1868 and Romania, Bulgaria, Venezuela (!), Serbia and San Marino joined in 1889.

The union fell apart when two Nations, the Papal State and Greece, debased their currencies, reduced the levels of precious metals and flooded the market with substandard coins, causing first the removal of the silver coins and ultimately the ejection of Greece from the Union.

The Latin Monetary Union collapsed for precisely the same reasons as the Eurozone faces now; then Greece and Italy tried to reduce their national deficits by devaluing their currencies, while other countries tried to maintain the stability of their own; today the weak economies cannot do that. The chances of the single currency surviving in its current form, bearing in mind the great differences in aims and economic policies of the component members, have to be slim indeed.

Banks are refusing to lend money to each other, forcing the ECB to be the supplier of liquidity to European banks; these banks then lend, if they can, to their governments by buying the debt paper.

European banks and therefore by extension Greece and Italy, have too little capital to meet the stringent requirements imposed on them by nervous politicians and must face not only a liquidity crisis, but also a solvency crisis. The solvent banks deposit their surplus funds back with the ECB.

European financial problems are also interconnected. If one government should default on its sovereign debt or enter recession, non-governmental investors such as banks and insurance companies will suffer severely and face large losses. For example, in October 2011 Italian issuers owed French banks some 366 billion Euros. In the event that Italy should become unable to finance itself, the French financial system will face significant pressure, which would necessarily force the French government to support their banks and therefore affect French creditors and indeed their credit rating. France has already been downgraded, largely because it is a member of the European Financial Support Facility and could be called upon to provide financing which it can’t afford.

The financial system is further complicated by the presence of Credit Default Swaps (CDS), which provide an underwriting in the event that a particular bond or financial paper is declared in default. No-one knows the value of CDS in circulation, but they are in total probably many times the actual value of the debts themselves. A CDS can only be triggered if a bond or loan is declared in default.

Many international banks sold CDS’s thinking them a convenient off-balance sheet means of earning fee income without taking on undue risk. They may however have to pay the face value of the Swap contract if a default is declared. Several of the smaller - indeed non-European - banks will not be able to afford this and the crisis would then spill across Europe’s borders.

Politicians in Germany and France have been quick to lay the blame for the financial instability at the doors of hedge funds and other speculators, the term ‘locusts’ has been regularly used. Why not? Such organisations are predominantly Anglo-Saxon and are theoretically not often found in powerful political positions in mainland Europe. In reality it is the banks, including the most prominent members of the European financial fraternity who appear to have used Governmental support to shore up their own balance sheets, damaged in large part by heavy speculative use of derivative instruments.

The new head of the International Monetary Fund, Christine Lagarde, regularly issues new horror scenarios and warnings. Most recently, the IMF announced that a mild recession is to be expected in the Eurozone, indeed a severe recession in Italy and Spain. The resulting financial contagion is likely to affect those countries that have strong trade and financial links Europe. The IMF however also calls on European countries (in this case Germany and France) to rethink the economic cutbacks they are insisting upon because the need for growth so far seems to have been forgotten.

Strangely enough, the horror scenarios of economic weakness do not include Germany, and only a mild recession is forecast for the United Kingdom. The economies of the United States of America and Japan will continue to avoid recession, despite neither country having a credible economic plan.

The US dollar strengthened against the Euro as the European crisis developed. This is a sign of investors looking for a safe haven, almost at any cost; not the strength of the US economy, the trend is likely to be reversed once Europe emerges with a coherent policy. The problem is that there is no clear safe haven for surplus funds; the US Dollar, the Euro, Yen, Swiss Franc and Pounds Sterling are all less than perfect as quality havens and the volatility in exchange rates between them means that investors need to rethink their currency exposures to meet their own individual needs.

The economy of the United States is however showing first signs of a new dawn, with a number of major industrial companies showing respectable profits. Now is a good time to revisit funds specialising in US companies, but it has to be clearly stressed, not banks.

Germany too is leaving the Eurozone behind with strong profitability in companies, aided by a (for Germany) weak Euro. German equities are at historically low price levels, having suffered badly from frightened investors while the Eurozone was facing its worst economic turmoil. Much the same applies for many of the other Northern European markets. Investors would be wise to continue to avoid the equities and debt of southern European states, including France and the banking and finance sectors altogether until the crisis is resolved. (This is unlikely to be soon).

Looking ahead at the next 5 to 10 years, it is clear that domestic consumption in the developing markets will change radically. Emerging countries are already a source of economic growth and this will strengthen in the future. European Economic weakness will probably last 2 - 3 more years, but the developing world is creating demand of its own. Emerging countries will need raw materials, engineered products and above all meat. These will probably always have to be imported.

China has not stopped growing and it is not facing an economic decline; far rather China is reorganizing its economy on a more efficient basis. Chinese financial institutions have so far been lending aggressively especially to the property sector. The Chinese government is trying to curb the worst excesses of this lending, but has little influence over the alternative lending sources from Hong Kong in particular meaning that inflation is hard to control.

The Chinese central bank is a large holder of US Dollar and Euro government debt; it is likely that this position will have to be reduced in 2012, thereby driving the price of this debt down. Investors are again strongly advised to avoid the government bond sectors in ANY currency. Bond yields are lower than the present rate of inflation and holders of these bonds can only lose money.

The next 12 months need to be treated with caution; the economic picture is far from clear and the political will to find a coherent and practical solution in Europe and the USA is not exactly obvious.

 

Past performance is no guarantee of future profitability.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the Chartered Institute for Securities and Investment in London.

Townsend@insure-invest.de
www.insure-invest.de

John Townsend's Investment Opinions - October 2011

We walked to meet each other up to the time of our love and then we have been irresistibly drifting in different directions. And there's no altering that.
— Leo Tolstoy (Anna Karenina)

Greece will default on its debt. Does this matter? Probably not

Some Eurozone countries are heading for a mild recession (or soft patch). Does this matter? Probably not

European governments are unable to agree a coherent policy on recognizing the scale of the problem of national debt and doing anything about it. Does this matter? Very definitely

Greece accounts for only 2% of Europe's economic strength and frankly, despite the pious calls and doomsday prophecies of many European politicians, the departure of Greece from the Eurozone will probably come as a relief to many of the smaller states. These are afraid of having to pay even a small share of the costs of a country whose populace is guaranteed an income far higher than their own. Whether Greece will benefit more from having its own currency which can be depreciated at will is open to debate.

Greece has already been given a 110 billion Euro bailout and, like lending to a wastrel relative, this money was immediately spent. The European Union, European Central Bank and IMF are now paying out additional funds to Greece on a more or less monthly basis, but theoretically only after it has been shown that the previous tranche has been used for the purposes that were set out. In practice the rules are already being eased as Greece has failed to meet the preconditions of lending and the lenders were unwilling to take a hard stand.

European Politicians avoid any mention of Greece leaving the Eurozone in case they cause a sudden massive blow to the system. Let us be clear; Greece needs to and will leave the Eurozone as it is currently constructed.

The humiliating failure of Eurozone governments to reach a decision on how best to face the crisis early in 2010 has caused sentiment in the financial markets to turn against Europe and those countries seen as its main trading partners; this includes the strong economies of the developing world. Europe has been shown to be as ineffectual as the League of Nations which, when faced with crises in Manchuria and Abyssinia in the 1930s were unable to formulate a coherent and believable response, opening the way for the Second World War.

The probable outcome of that European indecision is that Germany will pay the bills that arise, including for the economic restructuring of Greece, because Germany has the only economy that can raise the funds to do so. France still has a AAA rating, but has severe economic problems and cannot afford to bail out its own banks let alone the rest of the Eurozone.

The big question is whether Germany will meet the cost only once or possibly twice; first for the support of Greece by paying for the day to day running costs of the country until it is stabilized and secondly, to support those financial institutions in Europe - including German banks - that invested in Greek and other economically weak government debt such as that of Portugal, Spain, Ireland and Italy as if they were German debts only with higher yields and which now need to be recapitalized as that lower quality paper loses all or part of its value. It is unlikely that the German taxpayer will be happy with this solution, but an alternative outcome could be that a much needed reform of the European banking system, starting with the German banks, will be set in motion.

The European governments have formed the EFSF (the European Financial Stability Facility) which has just received approval from the last of the 17 governments of the Eurozone. The EFSF will be able to lend up to 440 billion Euros to member states of the Euro area which need it. In addition the European commission can make up to 60 billion Euros available and the International Monetary Fund up to 250 billion Euros. The 110 billion Euros already supplied to Greece are not included in this facility.

Good as the theory is, the facility is already facing calls for it to be increased. It will not be able to cope if countries such as Italy or Spain (or both) were to require financial assistance and a total size of 2-3,000 Billion is suggested as being necessary. Pressure is also mounting that the facility be used to recapitalize banks. The financial markets have already lost faith in the EFSF and existing paper is trading at a yield of between 1 to 1.5% over German government bonds.

The joint Eurozone and G20 summit last weekend in Paris brought hope and warnings but no concrete suggestions. The forthcoming European summit meeting in Brussels followed by the G20 meeting in Cannes will also issue warnings that the European sovereign debt crisis is likely to cause recession in some countries in and outside Europe. European ministers will be asked to set out a sensible common policy; but trying to achieve this, in the face of fundamental disagreements between Germany and France and powerlessness on the part of the smaller nations will like trying to herd cats.

On the other hand; if Greek (and Italian, Spanish, Portuguese and Irish) bonds were allowed to trade at prevailing market rates, (in the case of Greece some 35-45% of its face value), then Greece might just be spared a default. Instead the banks and financial institutions would have to take a market loss on their balance sheets. Something some of them could probably not afford to do without government support. Those banks that sold credit default swaps might avoid having to pay out if there were no widespread default.

Interest rates in the US and Europe are effectively already negative; yields on government bonds are at near record lows and inflation is rising. The flight to quality resulting from an equity market crisis has brought investors firmly back to the US Treasury markets and 10 year US Treasury annual yields have now fallen to some 2%. Inflation is rising and is at present 3.7 %. While negative interest rates are a traditional way of reducing overall debt, it means that investing in the 'risk free rate' is a guaranteed money loser.

Politicians in the USA, having suffered the indignity of finger pointing from Europe during the financial crisis of 2008, are now gleefully responding with the same behavior. In a time when the US is heading towards a presidential election, any crisis at home or abroad can be used as a weapon; the truth is not necessarily relevant. The prevailing political picture within Washington shows the opposition to be working hard to ensure that any government policies are blocked, irrespective of the cost to the country. There is therefore little prospect of an economic lead from the US government.

Potentially strong markets such as emerging markets and commodities have been dragged down by political fears. Traditionally an economic downturn in the US has meant a lowering of demand for raw materials. The Chinese central bank has attempted to stifle excessive growth by raising interest rates and the markets have seen this as a sign for concern. All equity markets have therefore fallen and all equally will have room for recovery. In the US the situation remains difficult as there is still a significant economic drive to reduce debt. On the other hand there are an increasing number of very profitable corporations which are presently announcing healthy quarterly profits and which have returns on their corporate debt and equities far in advance of anything that can be achieved from investments in government paper.

Corporate borrowers are presently achieving better terms in the Credit Default Swap Markets than even some mainstream banks or smaller governments. Bearing in mind the urgent need for structural change in the banking markets and the changes for greater efficiency already made in the corporate market, this a sign that new thinking needs to be applied to investing.

Emerging markets are assumed to be suffering because their traditional export markets such as Europe and the USA are experiencing economic weakness. China instead is developing its domestic, especially its consumer, markets and there is sharply growing demand for consumer durables and health care products produced domestically. The demand for raw materials and commodities for industrial production and foodstuffs has not reduced, if anything it is set to increase with stockpiles being formed in the event of shortages. Countries such as Indonesia are growing in economic importance as the wealth per head of population increases. India is now overcoming the problems caused by inefficiency and corruption. Latin and South America is also strengthening led by Brazil.

The price of gold bullion fell sharply during August and September, while the price of gold mining companies fell in line with the declining equity markets over the past year. Much gold bullion is currently being held by specialist gold and hedge fund investors who will probably need to reduce or eliminate their holdings in the near future. There is still strong demand for gold for jewelry and industrial purposes in much of the world and once the speculative bubble has disappeared, the prices will begin to stabilize and rise more gently from the floor levels set then. The time to invest in gold mining equities in funds managed by specialists with a proven track record is coming close.

Many large insurance companies and investment funds are maintaining very high levels of liquidity and have been doing so for several months. Their intention is to start investing when they are sure that prices are moving up again; no-one wants to be first, but that price movement will certainly happen and the investment funds will flow again.

The next big issues will be which sectors, from the many that have suffered unnecessarily from the fall in the investment markets, should be used by investors.

1. Interest rates are negative and inflation will rise, so the longer term low yielding government bond sector, especially in the developed world should be avoided.
2. High yielding corporate bonds, especially from companies with a sound credit rating will provide stable returns despite rising inflation.
3. Equity markets in Europe and the US for top quality companies are at very low levels, with some excellent companies trading at ratios of 8 or 9 times earnings. Logic dictates (admittedly in an illogical market) that prices here will rise.
4. Gold mining shares have fallen in line with the general equity markets and the gap between gold bullion prices and mining company equities has widened.
5. Well managed conservative mixed funds run by managers with a history of successful risk management in their sector have held up well and will continue to form a solid foundation for a risk managed portfolio.
6. The continuing development of infrastructure needs in the emerging markets makes well managed infrastructure funds an interesting sector.
7. Physical assets including equities, which have a measurable value, will provide excellent growth opportunities in the near and medium term future.

 

Past performance is no guarantee of future profitability.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the Chartered Institute for Securities and Investment in London.

Townsend@insure-invest.de
www.insure-invest.de

Ad hoc Investment Update 05 August 2011

The past week has seen violent movements in the investment, especially the equity, markets. We are unlikely to see a quiet summer. The causes are many, but the major influence has been panic caused by a concern that Italy and Spain could try to find room under a European financial rescue umbrella which is not large enough for either, let alone for both countries. Mr Barroso, President of the European Commission, fueled the flames by suggesting an increase in the Financial Eurozone Rescue Fund, something which is highly unlikely to happen. Highlighting the problem however, has made it difficult for the banks of the affected countries to fund themselves in the interbank market and they will now be forced to strengthen their reserves before the end of 2011.

Let's be clear, there is no recession looming, the US Dollar will not collapse nor indeed will the Euro. To compare Italy with Greece is to compare apples with oranges. Neither Italy nor Spain is likely to need the rescue umbrella in the near future or maybe at all. It seems that economic facts have not been able to influence a good story.

Minor market movements have been exaggerated by automatic stop-loss and system trading sales where investments, particularly equities, have been triggered into large scale sales. The only problem is finding a home for the money that is being generated. There has been a half-hearted flight to quality, though with the three main credit-rating agencies threatening to downgrade US debt, attempts have been made to invest additionally in Swiss Franc bonds, Sterling Gilts, Norwegian Kroner Bonds, German government Bunds (Euros) and Gold.

The present panic fails to notice that the emerging markets, especially in South-East Asia have strong and dynamic economies, with increasingly strong and profitable companies. Additionally US Corporations, together with their Northern European competitors have shown very strong growth over the past year. In the current reporting season, 71% of US corporations which have announced their results have surprised the markets with better than expected profitability.

Economists from major global financial institutions agree that any talk of a new recession, whether by itself or the second half of a double dip which started in August 2007, is wildly exaggerated. The current problems are being called a 'soft patch' with much stronger markets being expected in September and October ending with a strong end to 2011.

Elsewhere, Chinese inflation has peaked at 6.4% and is on the way down. The Chinese central bank has raised interest rates for the Renmimbi Yuan 5 times so far this year in order to stifle excess growth. The GDP growth figure for the first half of 2011 still exceeded 9%. Imported raw material prices are normally measured in US$ and a weaker dollar brings with it lower import costs.

Equity values are presently excellent in the US, UK and Germany. Companies have strong cash-rich balance sheets and bank loans are now easier to arrange than before.  Average dividend yields for German companies are presently 4.1%, which is a far better return than the 2.3% yields offered by German government debt. The DAX Price Earnings ratio is presently 9.4% (expected to be 8.8% in 2012). There is every reason to begin to invest in German (and Northern European Equities).

To summarize:

1. Panic in the market has caused unnecessary over-selling which is now offering excellent buying opportunities. As the Panic subsides, brave investors will be able to buy at very attractive levels.
2. The Debt crisis in Europe is exaggerated and politicians have to do more to remove uncertainty and avoid illogical comparisons between Italy and Greece for instance, which are wrong, cause market worry and therefore raise volatility.
3. The US debt agreement and especially the committee which has to agree the cutbacks in the US Economy before the end of 2011 needs to show results. The employment creation figures to be announced today will hopefully confirm the 'soft patch'  conviction as opposed to an expected US recession.
4. Inflation in the OECD countries as well as the major emerging market countries has stabilized at low levels. The realization of this will help remove many concerns from the investment markets.
5. There will be increasing moves to establish an alternative reserve currency to replace the US Dollar. The ECB does not wish to have the strain put on the Euro and the Swiss and Norwegian Central banks don't want their currencies used, so a composite currency similar to the SDR of the 1970s or more recently the ECU will be discussed.

 

Recommendations:

1. Don't sell investments now, especially not Equities
2. For those investors with spare cash, the time to consider purchasing equity funds managed by skillful managers is very close.

 

Past performance is no guarantee of future profitability.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the Chartered Institute for Securities and Investment in London.

Townsend@insure-invest.de
www.insure-invest.de

John Townsend’s Investment Opinions - July 2011

Greater love has no man than this; that he lay down his friends for his own political life. Jeremy Thorpe - British Politician

It would be lunacy for the United States politicians not to agree on a new debt programme and thereby let the country experience a technical default. That doesn’t mean it won’t happen; just that it is (hopefully) unlikely.

European debt is also causing concern; it is bad enough that Greece, Portugal and possibly Ireland will need more fresh money than they can ever repay, but the concern is that Italy and Spain will also be forced - or maybe see the opportunity presented by the first three - to write down the overall value of their own debt. The press calls this contagion; the rating agencies, being wary of renewed criticism after their astonishing lack of success over calculating the quality of sub-prime debt have instantly placed the credit rating for Italy in particular under negative review and are issuing dire warnings over the impact of debt renegotiations.

Ultimately much depends on how much Germany, either as a government directly or by also press-ganging its institutions, is willing to pay to support the Eurozone. It is unlikely that many smaller Eurozone countries will want, or can afford, to take ‘their’ share of the new debt burden, especially if there is little chance of ever getting it back. In the end there can only be a political solution and that can’t be reached quickly. The major elections in France and Spain in 2012 and Germany in 2013 will serve to prevent hard decisions from being taken.

The 17 countries in the Eurozone are constrained by the lack of flexibility of the currency. Reducing the value and therefore the cost of debt repayment by devaluing a country’s currency is nothing new; the US has been doing so for decades. Germany and Northern Europe have the economic strength and success to cause the Euro to be strong. The Southern European countries desperately need their currency to depreciate to allow them to be competitive in the absence of efficient industries and services. Longer term (say over 5 years) there seems little chance of the Eurozone remaining in its present form.

Experts from the ‘Economist Intelligence Unit’ write that the investment markets are presently seeing a ‘soft patch’ rather than a slide towards recession.  The expectation is that oil prices will ease in the second half of 2011 and that economic growth in the developed world will increase in the same period. There are however big downside risks.

Chinese growth is slowing, reflecting the government’s attempt to prevent the economy from overheating; growth is still expected to be between 4 and 5 percent, which in the western world would be seen as healthy. Other developing countries are also experiencing slower growth. The ‘Economist’ suggests this is not only healthy but ultimately desirable, bearing in mind the strong growth shown in 2009 and 2010.

Interest rates in many countries are rising (albeit very slowly) as governments and central banks attempt to stave off inflation: This is itself much lower at present than many experts had recently predicted.

Uncertainty has caught the mood of traders and investors who have reduced their risk exposure. Equities are being sold in order to seek the safety of higher quality government bonds, which in turn are dropping in price as the flood grows stronger. It seems clearly better to take an almost certain small loss in government bonds than risk a larger drop in the value of equities. Overall fear has overcome greed at least in the short term.  There will be little clarification until:

1. The problems in the Eurozone are eased, even temporarily
2. The US politicians stop playing politics with the national debt
3. The US treasury decides whether to have a third round of quantitative easing to bring even more liquidity to the US market.

All of this is however just kicking the proverbial can down the road, it doesn’t help much and simply delays the day when serious decisions have to be taken and carried out. This is unlikely to happen this year and probably not even in 2012. But if the changes are not carried out voluntarily, they will be forced later.

The second half of 2011 will probably be more investor friendly than the first. Economic growth in the stronger OECD countries, especially the US and Japan and the northern Eurozone is likely to pick up. Manufacturing production should also resume normal levels after the component shortages caused by Japan’s disasters are overcome.

Much has been made of the impact of speculators on market movements. Let’s be clear; speculators don’t start trends, they recognize them and follow them, often exaggerating them. Their actions often cause a pendulum effect under which movements are taken to an extreme, only to come back again. This was often seen in the investment markets since 2007 and can be seen clearly in the price of gold in the past year. Fine if one is looking for the wild ride; less so if the investor seeks overall stable growth. Credit rating agencies also don’t cause problems; they recognize them and react accordingly. Depending on prevailing political sentiment, they are damned if they do react but equally damned if they don’t.

Many large and successful companies and institutions in the US and Europe are reporting strong profitability so far in 2011 and have very large cash reserves. As long as investment markets remain volatile, these will remain unused, but it won’t take much positive movement to trigger new investment in inventory and corporate expansion.

Japanese industry is recovering from the earthquake and tsunami and full production is resuming. While the economic results of the second half of 2011, based as it is on reconstruction will probably be very positive, Japanese risk is not really suitable for the non-Japanese private investor.

Investors should be looking at a carefully selected spread of markets in the second half of 2011.

Long term government debt - even from top quality issuers - should presently be avoided, as rising interest rates and inflation will prove costly. There are however some very successful short-term debt managers who are worth seeking out. High yield markets offering higher returns than government bonds can be attractive, always bearing in mind that higher yields normally equate higher credit risks.

Major US corporates are likely to perform well, as are the funds investing in their debt and equity; depending always on the skill of a manager in selecting the best names.  German and northern European corporates, reflecting the strength of their national economies will offer good credit related returns. The equity markets are historically cheap and will benefit from calmer conditions. Overall Eurozone growth for 2011 of an average 2% (1.4% expected in 2012) will be achieved in the second half of the year and that growth will in practice be concentrated in the northern countries.

China, India and the Asian developing Markets will also continue to see growth, albeit on a reduced scale compared with the previous years. Volatility will be high, but the credit worthiness of many countries in the sector is higher than some of the European developed countries and the risk perception is probably greater than the reality.

Latin American countries are suffering from the uncertainty within the US economy. Following a strong, raw material led growth in 2010, there is likely to be a pause for breath.

Eastern Europe will continue with slow growth, led by Russia where high oil and natural gas prices are providing liquidity. This should benefit the Russian cash flow and hopefully the economy too.

There will continue to be demand for raw materials of all kinds, not only energy but also metals and food commodities. Funds specializing in this area will continue to show strength.

Overall, the need for diversification and careful asset allocation remains very strong; Investment portfolios need a stable foundation of funds which are unlikely to drop much in value in order to provide protection for the higher risks - probably specialist equity funds.

The need to identify managers who have a proven ability to manage the risks as well as assets in their strategies while retaining a clear direction is paramount. Equally, the need to select strategies which have a limited correlation with each other and limited bunching of investment targets is strong. Portfolios constructed in this manner will not always avoid short term losses in adverse markets, but will show stable growth when markets reach more normal stability and growth levels.

 

Past performance is no guarantee of future profitability.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the Chartered Institute for Securities and Investment in London.

Townsend@insure-invest.de
www.insure-invest.de

John Townsend's Investment Opinions - April 2011

Sometimes it's hard to catch the wind and bend it to your will. Even though it's hard to know just how the story ends, the road is long and it takes its time, on that you can depend. - Lay Me Down - Crosby and Nash 2004

The tragic crisis in Japan began last month. It was as if three simultaneous 'black swan' events had occurred; an earthquake triggered a Tsunami and together they triggered the collapse of safety systems of a large nuclear power station causing nuclear radiation pollution and economic disruption, not to mention a devastating effect on the Japanese people living in the three affected prefectures.

The immediate economic effect of these disasters outside Japan is hard to judge, though the resulting effect on local industry was devastating. Many small specialist components for the car and consumer electronics industries were produced in the affected region and cannot be quickly replaced by supplies from elsewhere. Manufacturers producing casings for water pumps for specific car and truck engines or indeed the world's only manufacturer of tiny metal flakes for metallic paint were hard hit. Another manufacturer produced coatings for circuit boards, which cannot now be produced in as large numbers as before.

Global industry has found itself unexpectedly vulnerable to the disruption of supply chains from very small companies. This will inevitably call the whole system of 'just in time' parts supply from a single supplier into question.

Unforeseen effects of the crisis are a near hysterical fear of nuclear power, with demands in Germany for the immediate phasing out of nuclear power stations. Remember that Sweden faced the same issues following the Three Mile Island partial nuclear meltdown in 1979, the Chernobyl accident in 1986 and a leak in Sweden's own Forsmark nuclear power plant in 2005. A political decision was taken to phase out Sweden's nuclear power plants, but then with 5 out of 10 nuclear power plants shut down, Sweden's electricity generation capacity dropped by more than one fifth, leaving the country vulnerable to the volatile costs of oil and gas. In the end, Sweden decided to replace existing reactors with new, state of the art ones starting in January 2011. Germany will probably have to do the same, because other than coal, there is no viable substitute.

Fear of radiation, however irrational that may be, has also damaged Japanese trade, with supplies to Japanese restaurants (which probably don't import food from Japan anyway), car imports, food products and technology all now being scanned for radiation. The bureaucratic processes often take a long time and fresh fish for instance, begins to rot and becomes unusable if not checked for radioactive levels quickly.

The profitability and therefore share prices of Japanese companies have suffered, but this does not mean that investors should see a buying opportunity in this area; many other stock markets with much more promise, such as in the US, Germany and Northern Europe lost ground in the post-crisis panic. Japan has had a moribund economy for over 10 years and reconstruction will have to be paid for by the state and large Japanese institutions, leaving little room for profitable investments in infrastructure. Large falls in the European stock markets had little logic and bearing in mind the rising overall price trend should recover in short time.

Inflation, despite previous denials from economists, has returned to worry investors. Portfolios with fixed income bond funds as a foundation should start to lower the duration of their holdings. Duration simply means the weighted average of all the income streams from a bond or portfolio of bonds. A fixed interest rate bond will lose capital value as interest rates rise, especially now where interest rates are near to zero percent. Some experienced fund managers are even using derivatives to achieve negative duration.

In order to compensate for rising interest rates and inflation, investors should, if their risk parameters permit, consider emerging market debt funds. These invest in either US$ or local currencies. Many emerging market issuers in the public market have investment grade credit ratings, but the volatility of this sector is higher than that of the traditional markets and investments in this sector should not exceed a tight preset limit. The higher yield will compensate, to some extent, for the higher credit risk. An alternative to emerging market debt are high-yield corporate bond funds, though they need an exceptional manager with a sound credit analysis team behind them to succeed in this field.

Bill Gross, the founder and main fund manager of PIMCO, one of the largest bond fund houses in the world and now owned by Allianz, has publicly stated that he is no longer prepared to invest in US Government debt for his portfolios. Japanese institutions, whether the post office pension fund or major insurance companies are presently selling US Treasuries in order to raise yen for the post earthquake rebuilding in Japan. The Chinese government is also mulling over the extent to which they are willing to invest in US paper. This will inevitably force up yields (and lower the capital values) of the US treasury markets and is a very good reason for leaving the longer maturity government sector alone for the time being.

Ireland and Portugal have joined Greece under the European community's financial safety umbrella. The worry is that Spain and, perhaps more probably, Italy might need to join them. The rescue fund, as currently envisaged would not be able to cope with this strain and the internal pressures of Europe would mount. Germany could then decide to leave the community taking for instance Holland, Denmark and maybe even the UK with them under a new currency. Beware of those countries that produce olive oil.

To summarize:

1. Panic caused by the crises in Japan affected equity markets in Europe and the US. As long as the panic prevails, there is an opportunity for investing in high quality equity funds with high quality fund managers.
2. Asian emerging markets are likely to be major drivers of economic growth in the next year or two, both in terms of equity and debt investments. But the risks in these investments are higher than in more traditional sectors and care should be taken only to choose experienced fund managers and not to exceed very low portfolio strategy limits.
3. US government and state sector debt is likely to lose value. On the other hand, US companies are showing a strong recovery and make an interesting potential investment.
4. Inflation is rising and will continue to be important for a long time to come. Traditionally the property and equity markets have performed well in these circumstances.
5. Raw materials will face increasing demand as the global economy grows. While volatility in this area is high, a small percentage of these funds should be included in most portfolios.

Past performance is no guarantee of future profitability.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the Chartered Institute for Securities and Investment in London.

Townsend@insure-invest.de
www.insure-invest.de