● She did it. On Thursday, German chancellor Angela Merkel persuaded her coalition government to back the latest plan to save the eurozone. German politicians agreed to expand the European Financial Stability Facility (EFSF) – also known as the great big bail-out fund – to €440bn.
If just four more members of her coalition had voted against her, she’d have had to rely on the opposition. And that would have weakened the authority of the eurozone’s most important politician. But instead victory belonged to a beaming Merkel and global stock markets bounced on the news.
So can we finally forget about the region’s worries and wade back into the stock market? Not at all.
As MoneyWeek editor John Stepek noted in Tuesday’s Money Morning. Approval “is just the beginning”. Because even €440bn isn’t enough. Europe needs to make the bail-out fund still bigger. And getting that past the German government will be much tougher.
Because while there are various ideas about how to ‘lever up’ the fund, they basically all point to Germany acting as guarantor for most of the rest of the European Union.
“The Europeans have run out of ‘sneaky’ solutions to the problem. They’re still trying to find them, but unless the Germans turn around and agree to shouldering the debt burdens of most of the rest of Europe, then it’s not going to happen.
“So a lot more arguing and making and breaking of plans lies ahead for the eurozone. And the longer it takes them to hammer out a deal, the more likely it becomes that events will overtake them.
“In short, if markets are rising today because of ‘hopes’ for the eurozone, you can almost certainly expect them to start falling again in the near future. Because those hopes are going to be raised, then dashed, then raised and dashed again several times between now and a Greek default.”
So what does that mean for your portfolio? John recommends large defensive stocks, which can hold their own in any economic situation. He also reckons you should hang on to gold as portfolio insurance.
● Of course, the market turmoil has also thrown up some potential bargains. On Monday my colleague David Stevenson gave his top tip. David’s a contrarian by nature, so he’s been trawling the least loved sectors in the market, and alighted on a particularly ugly one – insurers.
It’s been a terrible year for the sector. A slew of natural disasters resulted in the “costliest six-month period in the market’s history”. Then, because of the economic slowdown, they’ve had trouble passing price hikes on to their customers. And their investment arms have struggled to make money amid weak markets.
So why on earth would you want to buy in now? Because, says David, there are signs that the cycle could be turning. “The chief financial officers of North American insurers reckon we could be seeing the insurance cycle bottoming out. In a survey by risk management consultants Towers Watson, 74% said they believe that standard property premiums are at the bottom or turning upward.”
This matters. “The time to buy into insurers is when the premiums ‘cycle’ is nearing an upturn. If you wait until the market is obviously hardening again, you’ll have missed the chance to get in cheaply – share prices will already have gone up”.
Moreover, while insurers have been hit hard they are still in “pretty good financial nick” says David. “Their balance sheets are stuffed with cash and low-risk assets. So much so, that some stocks are now trading on discounts to their net asset value (NAV). In other words, their assets alone are worth more than their market caps. That means the sector could see more takeover bids, as big value investors move to cash in on the great value on offer.”
Convinced? Read the rest of the piece and get David’s best bet in the sector here.
● And what about gold? Like all commodities, gold can be pretty volatile. And the recent slump from more than $1,900 an ounce to nearer $1,530 has been among the worst ever. But don’t panic, says Dominic Frisby in Thursday’s Money Morning.
One reason for the sell off is that the “Chicago Mercantile Exchange (CME) – the world’s largest commodity exchange – upped the amount of margin it required to buy a gold future (in other words, you had to put more money down to invest). There have been three rises since July and in total margins have risen by $5,400 – nearly 90%”.
The CME does this to fulfill its “remit to calm markets where there is excess speculation. If it ups the amount of margin required, those with too much leverage will have to close their positions.”
Dominic admits the short-term effect is “ugly” but says in the longer term, it won’t end the gold bull market.
The other reason that gold has fallen, says Dominic, is losses elsewhere. “Whether it’s home traders or large funds, people will want to lock in some profit where they have it. Gold and silver are where they will have had it, so that’s where the selling will have come in. I know from experience this is what happens. The psychology is that you’d rather take a profit than a loss. And it’s a relief to take a profit in a falling market.”
But these fluctuations are temporary, says Dominic. “The fundamentals for gold haven’t changed.” Even if we do face a 2008-style meltdown, gold will outperform other investments. Back then “it was the last liquid asset class to capitulate in this carnage. And just as then, I expect, should such a scenario occur, that it will be the first to rise out of it all.”
● Of course, you shouldn’t have your whole portfolio in gold, any more than you should have your whole portfolio in wine, Japanese stocks, or buy-to-let property. My colleague Merryn Somerset Webb interviewed Anthony Bolton the other week, and he reckoned 10% was a sensible figure. Depending on your individual circumstances and taste, we’d say that’s about right.
Ultimately, gold is insurance against monetary disaster. As Merryn has pointed out before, as disaster gets closer, insurance gets more expensive, hence the rise in gold over the last ten years. We suspect it will get more expensive still before the current crisis is played out.
● Merryn also interviewed ex-chancellor Alistair Darling for this week’s issue of MoneyWeek. She asked him about what he might have done differently if he could have been the one running the country over the past ten years.
One interesting point that came up was Bank of England governor Mervyn King’s claim that if he’d had to take house prices into account in 2004/05, he’d have been forced to hike interest rates to choke the boom. The business lobby would have been up in arms. But, asks Merryn, isn’t it the job of governments to take tough decisions? Darling wasn’t convinced.
Yet this is pretty much the nub of this whole crisis – whether you’re talking about the eurozone fracturing, the US fighting over spending cuts, or the cries for a ‘Plan B’ over here. No one is willing to take the tough decisions early on, and as a result, we end up with the worst of all worlds.
Maybe we’re just spoiled. A quote from the president of Estonia, in this week’s MoneyWeek, caught my eye. His country has just been through a brutal bout of austerity. We’re talking wages seeing double-digit falls and GDP tanking. Yet the economy is now recovering and the social fabric is intact. The Estonian president’s take on it? “After [Stalin’s] mass deportations, [austerity] didn’t seem that bad. I guess it’s harder if you’ve been living the good life of bunga bunga parties”.
● Of course you don’t just have to look abroad for examples of how economies have dealt with downturn. The past also provides some pretty good examples of what we’re facing now, says Brian Durrant in this week’s issue of The Fleet Street Letter. The emergence of stagflation, sterling vulnerability, a weakened US economy and an energy crisis caused stock markets to crash in the 1970s.
● If you’re just starting out as an investor, or you know someone who is, I advise you to look at my colleague Tim Bennett’s video tutorials. Tim covers a range of subjects, and I think you’ll find they’re a painless introduction to many of the most important financial topics. You can see his full back catalogue here. And do please leave your feedback and ideas for future videos in the comments below – Tim can’t answer every query but he does pay close attention to feedback.
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
• James McKeigue
• David Stevenson
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Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Please seek independent financial advice if necessary.