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17 April 2012

April 24, 2012

IMF report on the global economy (World Economic Outlook) was out Tuesday 17th of April.

In a nutshell it raises 2012 and 2013 Euro zone forecasts, with some growth expected in the latter (+0.9%) following a milder than expected contraction of -0.3% in the former.

If we consider that Germany, the largest economy in the region IS growing, it confirms a deeper recession for the rest of 2012 concerning Greece, Portugal, Spain and Italy. It obviously doesn’t bode well for any further Euro crisis not to happen « as long as, says the report, the underlying issues are not resolved”. I don’t know that the EU has taken any action to resolve its paralysis through further federalisation of taxes, labour rules or public spending, to be able to act in unison like the US, as it would need to. Therefore, the lack of confidence in the Euro will keep on dragging on its recovery…No sense being Bull the Euro then.

Either reduce or hedge against the USD. Lucky the Swiss National Bank supports Swiss exporters with their biggest trading partner. EUR/CHF will remain as boring as it gets since September 2011.

Given low level of short-term interest rate differentials, hedging is cheap if we want to remain exposed to European assets. Do we? Not to financials in the Euro zone, as its bank financing requirements to replenish their capital buffers (Core.  Tier 1 ratio at 9.00%) are estimated at 23 percent of the zone’s GDP…unless one believes that bank shares have been so badly battered that it could be an opportunity. That is the “what goes down goes up” type of thinking. Well, after 23 years following the markets on a daily basis, this is truer on the downside than on the upside. Often what goes down stays long down. Banks are deleveraging, economic growth will be hit, and so will the banks. Unless we let them speculate, as they are provided cheap public funding to survive anyway…that is what the IMF proposes. Keep on giving to the begging banks, so that they can put too much money at too much risk. So I suggest we don’t let them and we don’t invest in bank shares.

Deleveraging of banks will strangle companies that have borrowed too much. Yet there are plenty of good companies out there, full of cash in their war chests, ready to either chase cheap targets or invest in growing ideas or markets. We then look for balance sheet value in world equities, with deep pockets even better. We actually also look for value in corporate bonds and we base our choice on that company on which you wouldn’t mind selling a put option on its net assets. Can the company pay back its debt if we sell off its net assets? We buy bonds of those, maturing in 4-5 years, where the yield curve is the steepest.

Back to equities, we want to be careful with the use of  “growing markets”…emerging comes to mind but signs of slowing down appear in BRIC’s an MIST’s alike, notwithstanding inflation, friend of the looming crisis in the Middle East; Israel attacks Iran. Hezbollah and Hamas fight back. Israel retaliates. The Arab world is in fire, at a moment where it is getting more prone to Islamist leanings. Oil price goes up. Inflation is confirmed. Central banks start raising rates. The dream of a growing world economy collapses. So we leave emerging markets on the side for the moment. There will be a time to return. We keep some gold aside, in case this latter scenario goes live.

Talking about growth, equity markets have done extremely well since the beginning of the year. They have actually outperformed all forecasts. This means appetite for risk should be lower now than it was at the beginning of the year. If we believe that risk appetite drives investment in shares, we reduce equity exposure at large; build up some fixed income, including cash.

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