Investment Overview June 2012

‘The End Game’

Following over two years of ‘indecision’ ‘political wrangling’ and ‘market turmoil’ I can see a Greek departure from the Euro as early as Quarter Three of the this year. This is a position I have indicated on a number of occasions over the last few months and, far from it being a ‘Happy Outcome’, I do believe, if it happens, it will be the right one.

Currently we have the EU and Greece playing a game of ‘Financial Chicken’ with both sides playing ‘hard ball’ in their efforts to win the game. The EU are fighting to continue the current mandated position and the Greeks are battling to have the current ‘austerity measures’, prescribed as part of the bail-out packages, ‘cut’ to allow the country to regain some sort of fiscal control. The results of the election in Greece on the 6th May showed that the electorate believed that Austerity was not working and they wanted to renegotiate the Mandate laid down for the Bail-out. However, it has become very obvious over the last few weeks that the rest of Europe are saying that if Greece stay in the Euro then the current Mandate for the Bail-out remains. As stated on a number of occasions by German Chancellor Angela Merkel, for the Greeks to remain in the Euro all current conditions will continue unchanged so clearly the aims of the Greek People and the rest of Eurozone are incompatible and something is going to have to give. Therefore, I believe the elections in Greece on the 17th June are no longer a referendum for Greece to stay or leave the Euro, but a determination as to whether Greece will have an orderly or a disorderly exit from the Euro-Zone.

The current position shows that the Eurozone exposure to Greek debt is approximately 300 billion Euros of which approximately 1/3 is owned by Banking Institutions. This is despite the restricting of debt for the private sector that was a precondition of the second bailout. In itself this is very manageable albeit creating further discord between the other Eurozone nations notably France and Germany. What will be needed is for the ECB (and other Central banks around the world) to pump liquidity into the banking system to cover both the losses that will occur through the Greek exit and to limit the effect of ‘Contagion’ across other South European states. Also we need to see a set of fiscal policies in Europe that promote growth opportunities for all states to ensure that recessionary pressures do not drag on into 2013 and stifle the programme of measures agreed by all member states. This is where Political differences will be at their most ‘strained’ and without positive agreement we will see the same situation arising next year with a bigger and more dangerous situation looming in areas like Spain and Italy. Already, we are seeing a net outflow of monies from Spanish banks at the same levels as Greek banks and without any signal that the Euro is safe Spain could well be next country seeking a bail out. It is with this in mind that I see the final hurdle that needs to be cleared, the ratification of the new European Stability Mechanism (ESM). It is quite obvious that markets will not be convinced that the 250 billion euros presently in the EFSF is anywhere near enough to support any form of bail-out for Spain. The areas that I am looking out for to ensure that markets will not ‘implode’ between now and a Greek exit are:

1)  Another tranche of LTRO’S (Long Term Refinancing Operations) from the ECB

2)  The implementation of the new ESM with conformation that it has the correct amount of ‘firepower’

3)  Some form of Eurozone Deposit Insurance Scheme to convince holders of bank accounts in areas under pressure of ‘net outflows’ that their money is safe. This is something that the Italian Prime Minister Mr Monti is promoting and I feel will be an easy set of policies that could be brought in by all governments quite quickly and at a cost that is far cheaper than trying to support failing banks.

4)  See some ‘concrete’ policies to stimulate growth in all European countries. The role of Eurobonds put forward by the French and Italians (and now supported by the ECB) should form a big part of this strategy.

If these strategies are put in place before the Greek exit from the Euro then, as equity markets have already priced in a Greek exit, further major turmoil on global markets will be averted.

However if the current lack of proactive action continues then we could see some major falls in equity markets as contagion rips through the other areas of the Eurozone. Countries like Ireland and Portugal may see that it is better for them to exit the Euro rather than to continue with measures that will only add further pain to their respective economies and with no ‘light at the end of the tunnel’.

With continued economic pressure being felt in China and now signs of a slowdown in the US Recovery we know market conditions will continue to be very ‘tricky’ for clients. My own thoughts are that 2012, like 2011, will be a year where global growth is flirting between staying just out of recession and moving into a ‘double dip recession’. However the further we get through the year and with the measures shown above being applied then more confidence would prevail and we should finish the year with positive global growth. Areas like Europe and the UK will continue to struggle to add growth prospects to their economies and will remain in recession throughout the year. However, in the case of the UK, it will be a very mild contraction and we should see signs of moving back to positive growth early in 2013. If the policy makers in Europe can get some agreement on a growth strategy then, like the UK, we should see a move back to growth sometime during 2013 however it will be the middle to end of that year before we see them actually moving out of recession. China have already started to look at a loosening of their monetary fiscal plans and with the aid of a more settled European position they should achieve their recently revised growth targets. At the start of May these were revised down to 7.5% the lowest level of Chinese GDP for 8 years. Like China I do not think the US will slip from the path of a solid, if not inspiring, set of Growth patterns during 2012 and of all the westernised areas should achieve it’s 2012 GDP Target. My concern for the US will be 2013 when whoever is in power will have to move quickly to put some sensible policies in place to reduce what is becoming a major Fiscal Issue, the control of the US Debt position.

In terms of how this reflects on the management of the portfolios I will continue to keep the defensive position across all areas of risk moving the risk-based assets to the lowest agreed levels. For those clients that have moved to the ‘Defensive Portfolio’ that was introduced again in early May I would be looking for them to continue in that position for at least another two to three months.

Ian Jackson

Investment Manager