● The stock market is booming. The FTSE 100 is up 12% this month, while American and European indexes have also posted massive gains. The main reason for the optimism is Europe. All month, hopes have been building that Europe’s leaders would ‘solve’ the eurozone crisis. On Thursday they announced their plan and the markets loved it. Then America chimed in with stronger-than expected GDP figures. So is everything going to be ok?
Not at all, says John Stepek. The real question is: “how long will this particular sticking plaster last before the next panic?”
At first glance, the crisis summit seems to have achieved its three main aims. It has persuaded private-sector holders of Greek debt to take a 50% ‘haircut’. It is forcing Europe’s banks to raise another €106billion of capital. And it is going to increase the firepower of the bailout fund – the European Financial Stability Fund (EFSF) – to €1 trillion, from €440 billion.
“The trouble is, we knew most of this before the big summit. And the details have yet to be hammered out. In other words, this is a statement of intent, not a done deal”, says John.
But the biggest sticking point is that the European Central Bank (ECB) isn’t involved in any of this.
“The reason that Britain, the US and arguably Japan haven’t gone bust yet is because they have central banks that are able to print money to buy their own bonds.” That’s allowed them to at least delay the day of reckoning.
But “Europe is not at that point yet”, John continues. “And until Germany gives the ECB the go-ahead to print Europe’s way out, we’re going to be returning to these summits over and over again. Because fundamentally, there still isn’t enough money to go round to deal with all these debts.”
It’s hard to know if Germany will ever accept money-printing by the ECB. But with plenty more crisis summits and market disappointments to come, you should stay invested in defensive stocks.
● Defensives are a long time MoneyWeek favourite, but why are we so keen? One reason is that “they don’t need economic growth to make their profits”, says David Stevenson. Another benefit is that “several defensives offer inflation-matching yields”.
One of David’s favourite defensive sectors is healthcare. “Regardless of how weak the global economy is, people around the world will need to spend money on healthcare… That’s why global ‘big pharma’ firms have been able to generate ever-increasing streams of profits and cash flows”, says David.
Yet despite its track record of consistently making money, the sector has fallen out of favour with investors. The main reason has been the so-called ‘patent cliff’.
“Many former blockbuster drugs either have lost, or will soon lose, their patent protection. That means these medicines can then be copied by ‘generic’ rivals and sold on the cheap. In turn, there’ll be less profit to be made from these products.”
Indeed, analysts reckon that between 2011 and 2016, $255bn-worth of annual sales of the world’s top-selling drugs will go off patent. To give that some context, this year the global industry will turn over around $880billion.
Scary stuff, but David thinks it’s actually an opportunity for investors.
“The patent cliff might be steep. But it’s also an extremely obvious problem – you can see it coming from miles away. As a result, by now it has been fully ‘discounted’, ie it’s well and truly baked into the share prices of major drug makers.”
While investors have shunned big pharma’, it has carried on making money. Which “means the sector now contains both cheap stocks and some well-above-average dividend yields”.
Moreover, there are signs that big pharma’s move to develop new product lines and exploit growth in emerging markets is paying off. To find out David’s top tip in the sector read the full article here: The best British big pharma stock to buy now.
● Given the market turmoil so far this year, it’s little wonder most investors are just looking for somewhere safe to park their money. But not all ‘safe havens’ are as safe as they seem, says David.
Take Canada, for example. “The country’s economy has bounced back rapidly from its recession low. What’s more, it’s managed to do so without going spending-crazy. This year’s government budget deficit (the shortfall of tax revenues against state spending) will only be about 3% of GDP.”
Unemployment is just 7%, compared to 8.1% in Britain and 9.1% in the US. Meanwhile, its GDP is now 2% higher than the pre-recession peak – whereas Britain and America have yet to recover fully.
But David doesn’t think Canada can keep it up. Not in the short term at least. “The trouble is, for all its resilience, Canada is a major global commodity producer. So it’s unlikely to be immune to another big economic dip.” With China’s economy looking likely to slow down, commodity demand could dry up.
And Canada has another problem, says David. “The public sector might be in reasonable shape. But its consumers are heavily indebted.
“The ratio of credit market debt (mortgages, consumer credit and loans) to disposable incomes is around 150%. That’s higher than in the US. And Canadian incomes are growing much more slowly than this debt. So there’s little scope for consumers to spend more to offset the adverse effects of weak commodity prices on the economy.”
Fortunately for indebted Canadians, interest rates are no longer rising. That means their debts won’t get harder to service. “But that’s a negative for Canada’s currency, known as the Loonie. Holders of the Loonie will receive lower returns than they might have expected when interest rates were climbing.”
Add in the fact that historically the Loonie falls when commodity prices dip, and there could be a moneymaking opportunity here for traders.
● You can short-sell the Loonie against the US dollar using spread betting. For more information on this check out our spread betting page. And if you want some top trading tips, sign up for John C Burford’s free MoneyWeek Trader email.
● It will come as no surprise to regular readers that one safe haven we still believe in is gold. In Thursday’s The Price Report, Tim Price outlined an interesting way to play precious metals. Tim has found a Latin American gold and silver miner with an amazingly low cost base. This firm’s efficient operations and rich deposits mean it can get the stuff out of the ground cheaper than most of its rivals. Moreover, “it’s a ‘soup to nuts’ or full service operation that embraces all stages of the mining value chain, from exploration and development through to mining”. It wouldn’t be fair on Tim’s subscribers to give away the tip, but if you’re interested, you can find out more about Tim’s newsletter here.
● Back in the UK, there are fears that Britain’s economy is following the grim example set by Japan, where equities and property fell from their 1989 peak and never really recovered. We’re not going down quite the same path, blogs Merryn Somerset Webb, but UK house prices still have a lot more to fall.
So far, adjusting for inflation, UK house prices have dropped by about 25-30%. “That’s a lot. But it still isn’t enough. On numbers from Capital Economics, prices still need to fall by another 20% or so to “restore the historical link between prices and average earnings.””
The drop may be a slow process, with inflation steadily bringing down real prices. Or it could be more dramatic.
“With household income unpleasantly squeezed by high inflation and very low wage rises (combined to create a fall in real wages) and as unemployment edges up”, we could see a sharp fall in house prices. “That’s particularly given the case now that there are hints that borrowers won’t be living with ultra-low mortgage rates forever, regardless of what happens to the base rate.”
As usual, houses prove a controversial topic among our readers. Critic Al Rick notes that while “the UK’s woes may be 20 years behind those of Japan… they are not far behind those of other countries, such as Ireland and the US, which have sustained very considerable house price downgrades”.
Yet, not everyone is so bearish on the housing market. Alex thinks that house prices are fairly valued and don’t have further to fall. “The fact is that at £160k the average house is not actually very expensive by today’s standards because the average couple earns around £50k combined.”
If you haven’t read the blog yet you can do so here: Why house prices aren’t finished falling yet.
● This week marked the 25 anniversary of the City’s Big Bang. It changed the way London worked as a financial centre forever. It also laid some of the seeds of the current crisis. For a summary of why, try MoneyWeek deputy editor, Tim Bennett’s free video tutorial. Tim used to work in the City and has the knack of breaking down complex financial topics into easily digestible chunks. His latest tutorial “What was the Big Bang?” is available to view now.
● And finally – a story. 70 years ago, a British man made a startling financial discovery whilst gathering what he called ‘inside information’ on Hitler’s Third Reich and Mussolini’s fascist regime. It’s an entertaining read and could even change the way you invest so read on 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
• James McKeigue
• David Stevenson
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