Long Incompetence

Correction! Yesterday’s Markets and Money had an error. The article, “Does Greece 2011 = Austria 1931?” should have been attributed to Sound Money. Sound Investments editor Greg Canavan. Greg’s by-line was mistakenly omitted. You can read the article on Greek default here.

–Did you miss it yesterday? In his YouTube update, Slipstream Trader Murray Dawes said this:

If we go back down under that 10-day moving average again, which comes in around 1170, and back under yesterday’s low was 1163, that will create a nice pivot point…There’s just so many things out there that may bring this market undone…If this short-term uptrend is negated quickly, maybe even tonight…we could definitely see the move down to the bottom of the structure at 1100.

Murray was looking at the price action on the S&P 500 as leading indicator for Aussie stocks. The S&P 500 closed down 2.07% at 1155. That’s just below Murray’s Point of Control at 1155. Watch the full market update here.

— So how about that rumour-fuelled rally that kicked off the week with so much false hope? Blame Timmy Geithner.

— Obviously he is a little nostalgic for the pre-credit-crisis days. That’s when SPVs (special purpose investment vehicles) were all the rage. Banks like Bear Stearns would set these vehicles up with a sliver of equity, then borrow wads of short-term money to invest in longer-dated assets, like mortgages.

— And just like that, you had a highly leveraged ‘investment’ vehicle. That is, until the providers of the short-term cash realised they were funding dodgy mortgages. So the providers began withdrawing their funds, which forced Bear Stearns to liquidate its mortgage portfolio. And that kicked off the great US housing market crash.

— But Timmy Geithner still thinks SPVs are kinda cool. Actually, he thinks they can solve the European debt crisis. He reckons Europe should put the money from its European financial stability fund (EFSF) into an SPV and leverage it up by, oh, around eight times.

— That would give the fund the ‘firepower’ it needs to halt contagion. The SPV would be able to issue AAA rated bonds and use the proceeds to buy lesser quality bonds. It’s a way of putting more of the risk back onto taxpayers without really telling them about it. Which is why the market got all excited…for two days.

— When CNBC broke the news on Monday (and attributed it to ‘top European officials’, implicating the European Investment Bank (EIB)), it ignited a rally worldwide and sent the Aussie market soaring.

— Then the EIB quickly denied it had any knowledge of the plan. Germany said it was stupid. Unlike Timmy G, the Germans remember how the last lot of SPVs ended up (in tears). Financial alchemy only allows a problem to be postponed, not solved. And it usually makes the problem worse.

— The market wants this problem solved. But the bankers just want it delayed and pushed onto someone else.

— The latest rumour driving the market is that some Euro states are pushing private creditors (i.e. European banks) to take a larger haircut on any ‘orderly’ Greek default. Back in July, they agreed to a haircut of around 20 per cent. This is way below what is needed, but they’re not prepared to go any further.

— If it weren’t so critical to everyone’s wealth, this power struggle going on in Europe between the politicians and the bankers would be highly entertaining.

— Here you have two groups of power-hungry people that have co-existed quite happily for some time. Pollies have the overt power, bankers the covert. The common bond for them in many ways is debt. Governments create debt and bankers channel funds to the government, clipping the ticket along the way.

— But having gorged on debt for so long, one government is now about to explode. The mutual dependency the two once enjoyed is under threat. It will be quite entertaining to see them turn on each other.

— Except that it destroys your wealth in the meantime. This was one of the themes of our Sound Money. Sound Investments report published last night. Lies, deceit and ineptitude by the ruling class are damaging sentiment, which is damaging your wealth.

— The situation is best summed up in the following quote:

‘Nothing doth more hurt in a state than that cunning men pass for wise.’

— Francis Bacon

— And let’s face it – there are foxes all over the place when it comes to international finance.

— But how does it affect your wealth?

— Sentiment can easily wipe 20-30 per cent off the value of your portfolio. In a bull market, when times are good, a company might trade on a price earnings multiple of around 15 times. But when following a financial crisis that multiple on earnings will go down, say to 10 times. And when the people and institutions that were largely responsible for the crisis put their hand up and proffer solutions, that multiple might shrink even more, say to eight times.

— So in this case a company with $1 of earnings will trade at $15 in the good times. In a low-growth post-crisis environment the market will only pay $10 for the same company. And when a bunch of bozos gets together to try and ‘fix’ things, the market freaks out and marks the price down again, to $8.

— In our hypothetical example here, the company, miraculously, has maintained its one dollar of earnings. The change in price is purely sentiment driven. In reality though, a low-growth environment means earnings would probably fall. Now, put a lower multiple on lower earnings and you have a definition of a bear market – which is what you are seeing equity markets in now.

— The depth and severity of any bear market depends on many things. But the constant bumbling around of the central planners of the world are doing you no favours. And if they lead us into credit crisis part two – which looks increasingly likely – another chunk of wealth will come out of your portfolio.

— You need a hedge. Perhaps one of the investment banks can design a product that enables you to go ‘long’ on political incompetence?

— Oh that’s right, there is such a thing. It’s called gold.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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1 Comment on "Long Incompetence"

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Richo (the 2nd)

I liked the balanced permanent portfolio approach that was articled earlier this week. Gold may have a place in a portfolio but if gold goes back below $400 you wouldn’t want all your eggs in one basket

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