Euro Survival

I have always been inheritantly wary of large entities such as business conglomerates and in particular the European Currency Union. How can it be possible, even with the best management available, to drive and manoeuvre these unwieldy entities towards a common goal? Especially as in the case of the E.U. this task is being attempted by politicians. So surely the Euro must be doomed to failure. Who in their right mind would contemplate trying to orchestrate the people from the Mediterranean regions to walk in step with the people and their work ethics from the Northern climes?

I mean, have currency unions ever been attempted before and if so were any successful? Well the answer to that is yes and yes. The Latin Monetary Union in the late nineteenth century failed as did the Scandinavian Monetary Union attempted at around the same time. Both struggled on for about sixty years before throwing in the towel and admitting defeat. The German Zollverein was launched in 1834 and although it had its ups and downs until the Weimer Republic was established in 1919 it must be considered a success. Of course the obvious success was that of the United States and the American dollar which even survived the Civil War during its seventy years of becoming established.

So history says that it is possible to achieve a Currency Union, but it is likely to take a long time and it’s not guaranteed to be successful. In today’s world where information passes instantaneously and politicians are subject to tribal self- interest abuse from opposition parties can the Euro succeed? As the Union is formulated today the answer is probably no. However loosening the strings by letting some countries leave and give more financial help to those struggling countries that wish to stay, may help it to succeed. After all there is a huge political will to make the Euro work and the majority of Europeans are still in favour of it so perhaps it will fudge its way to a lasting solution.

If one assumes that the Euro remains in existence then along the way there will be more pyrotechnics with accompanying Bank collapses and country crises. These events will provide great opportunities for investors to buy as the markets rise and fall whilst the Euro struggles to become a stable currency. Certainly watching the stronger German stock market may reveal Fund Managers capable of taking advantage of these fluctuations as German stocks become artificially cheap. This should show in the Saltydog numbers. We will have to wait and see.

A Perfect Storm (revisited)

At the end of April 2012 I wrote an article entitled “The Perfect Storm”. In this article I envisaged the catastrophe lying in wait for the Investment World that would be created by the following three events. Firstly, the slowing down of the Chinese manufacturing miracle would create internal unrest and bloodshed sufficient to unseat many Asean countries` economies. Secondly, the Euro as a currency and Euroland as a market would cease to exist. Finally, that the safety and security of American government Gilts and Bonds would be eroded. Well, a year down the road very little if any of this has taken place. During this period we have seen the world stock markets rise to approach, and in some cases breach, their all time highs and then fall back close to where they started.” Volatility” is still the by-word.

China has seen its rate of manufacturing growth almost halve to an enviable (for the rest of the world) seven percent. During this time the Chinese government has contained any unrest by allowing wage rates to rise and by investing internally into the country`s infrastructure. The Chinese middle classes are fast forming the largest population of tourists as they catch up with travelling the world. Provided that the Chinese government is able to continue in this approach and let internal consumption continue to rise and create the majority of the demand for their manufacturing base, then China could very well not be a problem for the investing world, but in fact a great opportunity.

Today the Euro and Euroland still exist in their original form, but what the next few years will bring is still very much a case of watch this space. There are still huge differences in the strength and viability of the various member state economies. The questions of austerity for some and not for others and high unemployment for some and not for others are open wounds that continue to fester. The politicians for all their bluster continue to kick this can further down the road for somebody else to eventually resolve. The UK politicians are facing demands from the population to hold a referendum as to whether the UK should leave the E.U. Should this referendum take place and the vote be carried then many other E.U. countries may follow suit. That would spell the end of the E.U. as a future world force.

The safety and security of American government gilts and bonds is still a meaningful question, but one that no longer would seem to be an imminent danger. In fact quite the reverse may be the situation. The American economy would now seem to be on a rising curve. Increasing manufacturing at home, falling unemployment, increasing new house starts and the godsend of Shale oil and gas is revolutionising the economy for the better. It has now reached the point that Q.E. will be curtailed in the near future. There is still however the matter of enormous existing debts to be serviced but inflation and the removal of overseas purchases of oil and gas will all contribute to the reduction of these debts. This being the case, then the American dollar strengthens and the country`s bonds and gilts are secure. Now that is quite a turnaround from a year ago.

What will the next year bring for the investing world to consider and act upon? Perhaps the developing world`s emerging middle classes will create such a demand for gold jewellery that the price of mining stocks will rise due to demand without gold having to be considered as a safety valve against the dollar.

Maybe the U.K. will become a rising market if it continues to increase employment in the Private sector whilst reducing the amount of people employed by the State. Perhaps the UK Austerity measures can be made to stick and attention would be focused on the vast amounts of wealth that is wasted on unmonitored projects and institutions. This may in turn revive the desire to be self reliant and less dependent on State handouts. All of this could lead to a rise in the UK stock market and a place for your investments. Now wouldn’t that be nice!

The Whipsaw Effect

In the last few days I’ve done a good deal of soul searching as I have reviewed our speedboat portfolio for the latest newsletter. Go back a couple of months and we were fully invested with stock markets at a long-time high. The portfolio had only been going for 6 months and was showing a return of nearly 25%.

You may well of heard the butterfly effect – a principle of `chaos theory‘, in which one small change could create a massive difference to other events at a later time. The central tenet is often summarised using a famous saying. Its origins and the quoted geographical regions vary, but for the sake of this piece we will say ‘a butterfly flapping its wings in Washington could cause a storm in Tokyo’. Well, on the 22nd May the US Federal Reserve butterfly (common name: Ben Bernanke) fluttered his wings by indicating that its programme of quantitative easing might be reduced. Within a few hours the Nikkei 225 had dropped by over 7%, and the value of our funds fell with it.

Markets continued to fall and within a couple of weeks the FTSE100 had dropped by nearly 12%. We followed our principle of selling when markets fall and were soon 100% in cash. The markets almost immediately recovered over half of the losses, and although we’ve reinvested we missed out on the initial gains.

It’s hard to think of a better example for our critics to use to demonstrate of one of the problems with momentum trading. They talk about the whipsaw effect where markets head in one direction, but then do a quick about turn followed by a movement in the opposite direction. These are the most difficult conditions for the momentum trader who is looking for trends that last for longer than a couple of weeks!

So does this mean our theory is inherently flawed – definitely not. By reverting to cash we protected ourselves from further falls. Although on this occasion they didn’t materialise they could have done. We may operate short term, but we’re playing the long game. If markets drop significantly, and then almost instantly recover, we have to accept that we always won’t time our selling and reinvesting perfectly and will either make a small gain, break even, or make a small loss – on this occasion we lost a few weeks profit. What really matters is the one time when markets start falling and then keep falling – not going safe in 2007 could have cost you 40% of your investment and don’t forget that even when the FTSE100 peaked in March this year it was still lower than it was in December 1999. In the last few years we have seen two other markets corrections, August 2011 and May 2012. On both occasions our ‘Tugboat’ portfolio headed for the safe haven, we minimised our losses and when we reinvested we had made a net gain.

Think of being active as an insurance policy – you may not appreciate paying your premium every year, but at least you can sleep at night, and when it really matters you’re safe.

The Enema Within

Normally one confronts an enema with a certain amount of fear and trepidation accompanied by an overwhelming desire to stay close to the porcelain. Almost certainly you will be under taking this action because of a deeper under lying medical problem. This is a “clear-out” with a purpose and you have confidence that at the end of this effrontery the medical profession is competent to improve your health and well being. Therefore you put up with it and wait for better times.

I view the financial “Austerity Measures” at present being inflicted on the country in much the same light. They are necessary to clear- out the bad practices and the monstrous growth in debt and credit that has become the norm. So really I should be prepared to grin and bear it until the skies over Dover become clear again. But wait a minute this treatment is not being administered by a Churchillian figure or the medical profession. Rather it is being delivered by inexperienced politicians, few of whom have had a job in the real world and they in turn are relying on Bankers, FTSE 100 Industrialists, the Legal profession and Local Authority Bigwigs to deliver these savings and changes. These are the same people that by and large would appear to have one aspiration and that is to milk the system, the tax-payer and the shareholders for their own benefit. To add insult to injury many of these people have already fulfilled the “Peter Principle” and have been promoted to their level of incompetence.

The enema is now being administered to the population and the pain is being inflicted but it is not being accompanied by the clear out and the financial correction we have been promised. I certainly do not have an answer to this problem which would seem to me to require a clear-out of these same people that are dealing out the medicine and perhaps replace them with a benevolent Dictator whilst the changes are completed. Would we be allowed to suspend democracy for a few years is the question? Probably not.