● The euro set about terrifying the markets again this week. The Germans are saying they don’t want another bail-out for Greece unless private bondholders take some of the pain. The European Central Bank isn’t having it.
Meanwhile, the Greek people are getting fed up with austerity and the government is close to collapse. And you’ve got Ireland and Portugal watching from the wings. If any deals are cut for Greece, they’ll want a piece of it too.
David Stevenson wrote all about it in Money Morning yesterday: What happens when Greece finally goes bust? Suffice to say it’s all getting a lot messier than investors had expected.
The basic problem with the markets is that investors have become used to being pandered to. If stocks fall in the US, the Federal Reserve gets on the case right away. So they assume the same will happen in the eurozone.
But in the eurozone, national politics are in conflict with federal politics. The Germany / ECB battle just sums that up. Germany doesn’t see why its taxpayers should bail out Greece. The ECB sees them all as Europeans, and so they should act for the ‘greater good’, to avoid the potential for a Lehmans-style collapse.
Who’ll win? We don’t know yet. But we suspect that in the process of finding out, the euro is going to fall a lot further. Our trading expert, John C Burford, has been writing a lot about the euro / dollar exchange rate this week.
As I’ve said before, John’s emails are thoroughly recommended: even if you have no intention of taking up spread betting, his views on managing risk will be useful to ‘buy and hold’ investors too. Sign up for his free email here, if you haven’t already.
● But there’s more to this than just a weak euro story. This is also about the dollar. US inflation came in higher than expected this week. And the jobless figures were a little less bad than expected. That makes it harder for the Fed to justify extra money printing, which is good for the dollar.
On the other hand, factory production was far worse than expected. That makes investors scared about the pace of global recovery. When investors get scared, they tend to run for the dollar.
And when the dollar goes up, most other things go down. That’s the main reason I’m betting against the Aussie dollar – it’s the currency most strongly linked to the commodities bull market. One of our readers, Alex, gave me some useful tips on my trading following last week’s roundup email – thanks for those Alex. If you didn’t catch his comments, you can read them, and throw in any comments of your own, right here: MoneyWeek Roundup: Why I’m shorting the Aussie dollar.
● So how far could the markets fall? Tim Price hasn’t been pulling his punches recently. I suspect subscribers to his Price Report newsletter have been reading it from behind the sofa.
In his latest edition, Tim published a ‘chart of doom’ comparing the current path of the S&P 500 with both the 1929 crash and Japan’s long years in the doldrums. So far, we’ve avoided the falls seen in both of those cases.
But Tim argues that the credit and property bubbles seen in the US were just as significant this time around as back then. And with quantitative easing coming to an end this month, investors are starting to get the wobbles again.
With several very respectable commentators, including CLSA’s Russell Napier, arguing that this bear market won’t bottom out until the S&P 500 hits 400 (it’s over 1,200 right now), another major correction is certainly not out of the question.
How do you protect yourself? Tim’s solution is asset allocation. Make sure that you are “sufficiently diversified across multiple asset classes so you can sleep soundly at night… and where you do decide to hold equity investments, choose them with real care”.
Find out more about Tim’s approach here.
• On the subject of picking stocks carefully – there are few things more irritating for an investor than being suckered into a stock by a promising story, just before it issues a profit warning. It’s tempting to stick with such stocks in the hope that things get better. But as Bengt Saelensminde pointed out in his Right Side email this week, these things tend to be long and drawn out.
“What I’ve found over the years is that profit warnings tend to fit a pattern. Spotting these bombshells early could save you a fortune, believe me.”
Profit warnings tend to come in three phases, says Bengt. The first warning “probably won’t even look like one. In fact, to the uninitiated, the phrasing of the news release will probably look like a jolly good little story.
“But there’ll be a sneaky little sentence tucked away somewhere – a phrase laying the foundation for the second profit warning further down the road.
“I’m talking about a small suggestion that a cost is going up, or a particular market is ‘tough’ or ‘challenging’. It may be a technical issue that’s causing some difficulties and delays. ‘Not to worry’ is the message – ‘we’re on top of things. Look at all this other good news!
“The point is that, in the release, there’ll often be more good news than bad… That’s why you need to read company announcements at source and not via newspapers.”
This is the critical warning to watch out for. If you spot it, you can probably still get out before things go pear-shaped. Otherwise, you’re on to the second phase, where the problems come out in the open.
And if the company’s suppliers and customers react badly to that, you might even get the third phase of profit warnings.
“This is where you’ve really got to watch out. The last sort of business you want to be invested in, is one that’s caught in a vicious circle. That is a downward spiral where various stakeholders start to distrust the business and defect.”
To find out more about how to avoid these sorts of stocks, sign up for Bengt’s Right Side email – it’s free.
● Banking reform has been in the news a lot recently. One thing’s for sure, they could certainly do with it. Our own banks are bad enough. But for real obscene ‘rub the taxpayers’ noses in it’ greed, you can’t beat the US.
My colleague Merryn asks a simple question in one of her latest blog posts: “Is $43m too much to pay the CEO of a bank the stock price of which has fallen 80%?”
Not hard to guess the answer to that one. Merryn relates the frankly outrageous story of the pay packet the CEO of US giant Citibank is entitled to.
Worse still than the sheer amount being paid, is that, as CLSA banking analyst Mike Mayo points out, “the bar for incentive compensation is abnormally low”. And it encourages risk taking too, because the CEO “gets to take two-thirds of his stash in early 2013, and the rest in 2014 – ie he could be long gone… by the time any problems show up”.
You can vent your feelings about this miserable state of affairs here: Is $43m too much to pay the CEO of a bank the stock price of which has fallen 80%?
● As for our own banks, my colleague Tim Bennett has put together a topical video this week discussing what all this ‘ring-fencing’ business is about, and why it matters.
You could spend hours reading all the talking heads going on about what is frankly a rather dry topic and emerge none the wiser. Or you could spend ten minutes watching Tim talk you through the important bits, then go and enjoy the rest of your weekend. I’d humbly suggest it’s a no-brainer – watch his video here.
To hear about other bits and pieces on the internet that have amused us or made us think, sign up for our Twitter feeds – we’ve listed them below.
Have a great weekend!
• MoneyWeek
• Merryn Somerset Webb
• John Stepek
• Tim Bennett
• Ruth Jackson
• James McKeigue
• David Stevenson