Hi!,
A yet another tumultuous week in global financial markets, with the focus shifting from Greece to Italy, and markets questioning the viability of Italy's debt burden. Europe, being the largest economic bloc in the world, matters (much to the chagrin of us non-Europeans!) and therefore ii is important to map out the alternative scenarios in which the current crisis could evolve, and adjust the probabilities appropriately as we go along (as pointed out in last week's newsletter, based on Nobel Laureate Professor Kahneman's work, trying to predict outcomes of financial markets provides no better odds than the game of rolling dice!). With this objective in mind I summarise below the key points from two important articles which appeared this week in the FT – Martin Wolf's Wednesday column and a note written by Gavyn Davies (ex-chief economist of Goldman & Sachs and former economic advisor to the UK government):
-As pointed out by Nouriel Roubini in a recent paper, the real issue in Europe is the financing of the balance of payments deficits in the periphery - i.e. the "flow" of debt. While, reducing the outstanding amount of debt is important (the "stock"), it is the reduction of the external deficits which can restore competitiveness and economic growth.
-Roubini outlines four possible options for resolving the crisis: 1) aggressive monetary easing and stimulatory policies in the core combined with austerity and reform in the periphery, 2) deflation and structural reform in the periphery to bring down wages, 3) permanent financing of the periphery by the core, and, 4) widespread debt restructuring and partial break-up of the Euro.
-The first option would work without much disruption, the second is likely to take too long to work and therefore evolve into the fourth, the third would ultimately work for the periphery but risk insolvency in the core, and the fourth could ultimately work but be extremely disruptive in the interim.
-These options have serious obstacles: the first option would work but is unacceptable in Germany, the second option is acceptable in Germany but (ultimately) unacceptable in the periphery, the third is unacceptable in Germany, while the fourth is (currently) unacceptable to everyone.
-The current situation involves a mix of the second and third options – austerity in the periphery with reluctant financing by the ECB. This could eventually morph into the first option if continuous financing of external deficits results in inflation.
-The external deficits of the periphery (totalling $ 183 billion) are essentially being financed by Germany (which has a matching external surplus of $182 billon), via the balance sheet of the ECB. Prior to 2008, this was done by the private sector (mainly by banks buying government bonds ) but is now being undertaken by the public sector.
-In the long term the only viable solutions are the first and fourth options – either there is adjustment by all countries or the Euro breaks up. An orderly exit by the weaker nations is likely to have serious global contagion effects and therefore leaves only the first option – financing of the periphery, adjustments in both the core and periphery, resulting in growth and therefore an easing of the crisis.
Clear and insightful pieces, something which is sorely lacking in the current debate on the Eurozone crisis. The only two viable options – monetary easing and widespread adjustments versus the break-up of the Euro, provide a stark choice for core Europe – and in particular Germany. For all the public angst in Germany about bailing-out the peripheral governments, it has been quietly (and indirectly) vendor financing the purchase of its goods and services to the tune of $182 billion a year! As Gavyn Davies points out - its current plan of forcing the peripheral nations to undergo austerity to balance budgets and introduce structural reforms (i.e. labour market flexibility and privatisation) while providing short term financing via the ECB – is unlikely to work (based on historical precedent) as it forces n unacceptably major contraction of economic activity leading to devaluations by debtor nations. Unfortunately, this realisation is likely to take some time (another year perhaps?), thereby prolonging the uncertainty in markets!
So how does one invest in these markets – as I have suggested in previous newsletters – keep a well diversified portfolio comprising EM stocks and local currency debt markets, multinational high quality stocks, global energy and natural resources, developed world high grade and EM credit bonds, US Treasuries and mortgages (primarily as an insurance policy!), gold and cash. The markets are likely to trade in wide ranges for the foreseeable future, but the risks of a 2008 style meltdown are remote as policy makers have repeatedly shown their ability to act (if absolutely required!), so increasing exposure in the aftermath of steep downdrafts ,while lightening up a bit subsequent to euphoric surges would be an appropriate strategy. Yes, this would require discipline and a strong stomach for volatility – but it seems that is what our policy makers around the world have hoisted on us!
http://blogs.ft.com/gavyndavies/2011/11/06/the-eurozone-decouples-from-the-world/#axzz1dHvEXqGW
http://www.ft.com/intl/cms/s/0/1299d48c-0a01-11e1-85ca-00144feabdc0.html#axzz1dSZMQPxR
The attractiveness of Asian Stock Markets:
As I have noted several times in past newsletters, Asian stock markets currently offer extremely attractive entry levels. Some interesting observations made by Mark Galasiewski (the editor of the Asia Elliot Wave publication):
-6 of the 8 Asian markets covered by him have yet to exceed their historical highs (in real terms) achieved in the late 80s and early 90s– the exceptions are the the Hang Seng Index which is only 22% higher than its 1997 high, and the Sensex Index which is only 6% higher than its 1992 (yes that is correct!) high.
-True bull markets exhibit gains on a real, as well as nominal basis – and Asian markets have yet demonstrate that over the last two decades! This despite their economies growing (in real terms) at 6-8%.
-The Hang Seng Index P/E, which recently fell to 7, is at a level which has historically marked major bottoms in 1974, 1982, 1998 and 2008. The P/E value of the Shanghai Index is also close to historical lows.
An Ayurvedic Home Remedy (Dr. Vasant Lad):
According to Ayurveda, allergies are a doshic reaction to a specific allergen, such as pollen, dust, chemicals or a strong smell. Depending on the particular dosha (body's mental and physiological constitution)which is aggravated, allergies can be classified as vata dosha (air) type, pitta (fire) type or khapa (water) type. In my previous two new letters I have covered characteristics and treatments of vata and pitta allergies and I present below the same for khapa allergies:
Khapa-type allergies are often experienced during the spring season, when plants and trees shed their pollen into the atmosphere. When the pollen are inhaled, they irritate the delicate mucous membrane leading to hay fever, colds, congestion, cough sinus infection and even asthma.
-Take 1/4 tsp of the herbal formula sitopaladi (4 parts), yashti madhu (4 parts), abrak bhasma ( 1/8 part) with honey 3 times a day.
-Kapha type allergies result when excess khapa builds in the stomach and lungs. One method to deal with this is a purgation therapy (virechana) – take 1 tsp of flaxseed oil 2 to 3 times a day for 2 – 3 days. Tripahala powder (a combination of three fruits/herbs which balance all the three doshas) can also be taken at night in a cup of hot water.
-Vomiting (vamana) therapy can also be very effective (if you have the stomach for it!). Drink a few cups of licorice tea and follow it with a pint of water with a tsp of salt mixed in it. Drink enough to fill your stomach and then rub the back of the tongue and vomit it out!
Quote for the week:
Regards,
Aditya
Regards
Biharilal Deora, CFA, ACA
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