An old saw has it that one "sells when the violins are playing and buys when
the cannons are firing".
Going strictly by this maxim, now may well be the best time to buy risky
assets, what with North and South Korea are exchanging gunfire of the real kind
and investor expectations with respect to Ireland's bailout signify an
altogether different type of cannon fire. At the very least, it cannot be said
that anyone purchasing risky assets today is doing so with blinkered
expectations of a steady, smooth ride up in coming months and years.
That in turn implies that there is little risk of a sharp clawback in trading
levels - say 20% - from here over the long term. Bigger
movements are par for the course for now, but it doesn't look to me that a
sharp sell off from here is likely for longer-term investors.
Given the extremely sharp moves that would likely result from here, it stands
to reason that some significant value creation opportunities would become
available particularly in areas such as value assets, with high dividend or
coupon return and potential capital gains and revenue growth.
Let me clarify at this point: any strategy being discussed in this article
should be considered extremely speculative and risky with a high degree of
knowledge implied for the specific investment choices in question. Investors
who do not have the ability to secure and process such security-specific
knowledge are well advised to stay away from risky assets if they aren't able
to execute "short" positions as described in
the Short List (Asia Times Online, July 3, 2010). Don't try this at
home, kids.
What could go wrong?
The first thing that anyone with even a moderately bullish assessment - and
admittedly this is new ground for me, given what readers have been exposed to
from me for the past few years - has to consider is really what could go wrong
from here. Assessing that is key to what is being discussed here simply because
the specific catalyst to creating value is panic of the sort that I envisage in
coming weeks and months.
In other words, how could things possibly get worse?
1. Europe cracks up: this has been a long time coming and after the current
bunch of failed rescues in Greece and more recently in Ireland the writing's
very much on the wall. Take in Portugal and eventually Spain (11% of European
GDP) and there is simply no way that the euro can continue to hold together
(see (F)Ire and
Ice, Asia Times Online, November 19, 2010). The question though is -
why is that important? It is certainly not unexpected and while an eventual
unraveling of the euro will cause significant economic volatility it will
probably end up unleashing the true economic potential of a number of sectors
across Europe while destroying uneconomic industries and pushing certain
governments (eg Greece) to a deserved debt default. In the short-term though, a
collapse of a European sovereign rescue (eg Ireland) would cause a significant
downturn for risk assets as the US Dollar rises in value and global growth
expectations are pushed down. This would therefore mark a buying signal.
2. US banks blow up: given recent speculation with respect to the mortgage woes
(see The
Wizards of ABS, Asia Times Online, October 29, 2010) there is a
realistic probability that one or more US banks would be declared technically
insolvent with inevitable nationalization to follow. With the securitization
market shut, new lending from banks will be shut and thereby force through a
significant de-leveraging of both individuals and governments. This would roil
the financial system globally much as what happened after the collapse of
Lehman Brothers and the bailout of AIG in September 2008; but in turn present
some interesting opportunities for investors to acquire longer-term value
creating assets
3. Inflation is the third angle of the global strategy for creating value. Its
manifestation from QE2 (see
The Incorrigibles Asia Times Online, October 16, 2010) into emerging
markets like China with expensive currencies would promote the political forces
required for a significant currency adjustment. What the US and Europe cannot
achieve with their meandering growth, namely a negotiated currency adjustment,
would instead be created by the destruction of the purchasing power of the US
dollar and the euro that would unleash massive commodity inflation itself
feeding political instability in these countries. A sudden currency adjustment
would necessarily produce a massive asset price downturn in China across both
the stock and property markets - in turn laying the ground for patient
investors to scoop up longer term value and growth oriented assets in the
country.
4. Political economics is the other emerging factor. There is nothing
accidental about the changes of government and the gut-wrenching electoral
reversals being witnessed by established political parties in the US and Europe
- as I wrote in
Debt and Democracy, Asia Times Online, November 11, 2010 - economic
upheavals frequently lead to political weaknesses. Ireland has already been
plunged into political chaos after the government agreed to a rescue package
and the Green party pulled out of the ruling coalition. That is almost nothing
- Weimar inflation famously created the Nazis while abject poverty is driving
the crazy tactics being unleashed by North Korea against its richer neighbor in
the South.
The war in Iraq will intensify simply because oil prices go up further; for the
same reason Iran will find itself in the cross-hairs for some time to come.
None of this is positive for asset valuations - as stock market movements on
Tuesday (November 23) showed after the gun battles in Korea, there is much
downside risk in these events.
5. There are other points of weakness - be it the fate of Japan or the expected
sharp outflows of capital from Asia and Latin America as investors in Europe
and the US bring back funds required to repair their domestic balance sheets
and pay higher taxes entailed from the current spate of sovereign and bank
rescues; and emerging markets impose capital controls to stem inflows further.
All of those are linked to the three factors quoted above, but are also likely
to cause separate points of volatility for the markets.
Under these conditions, what are the things to look for:
a. Basic - no fancy consumable items, just focus on consumer staples and basic
goods such as primary goods, textiles.
b. Utilities - an area where profitability will decline initially due to macro
factors, even as fundamentals are reasserted over the longer-term.
c. Rental assets - capital shortage boosts rents and makes it easier for those
with capital to improve their real yields with the added benefit of inflation
protection.
d. Demographics - allow demographics, ie markets with young and growing
populations, to dictate your secular investment choices when you consider
investments post any sharp market corrections.
e. Gold - a rising value of the US dollar (driven by falling risk asset prices)
would necessarily push down the price of gold. However in a world where
confidence in the financial system is set to decline "permanently", and the
role of reserve currencies that are mismanaged becomes rather questionable,
gold retains its long term advantages for anyone who cares to preserve
purchasing power.
So in conclusion, I can see a light at the tunnel. Trouble is, it could be from
an oncoming train.
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