Not a big following it seems on the HHV forum but I pulled this summary out of the last FR, I thought was a good assessment of the state of the global economy...
Outlook
The world economy and markets are in a highly vulnerable position and we are cautious - cash and
gold comprise 10% of fund assets.
Many international stockmarkets have enjoyed strong performance in 2009 as a result of the successful
rescue of the global banking system and huge stimulus applied to prevent economic slowdown. The
price for this action has been an increase in the net public debt of most of the large OECD economies
to dangerous levels. Australia, South Korea and New Zealand are honourable exceptions with
relatively low net public debt to GDP levels.
What worries us is that interest rates are low and any increase in rates combined with a double dip
recession (implying lower tax revenues and higher spending) could put some key countries into a
situation where debt service takes up a much higher portion of government spending.
This can lead to a death spiral where lenders demand higher interest rates to balance the increased
risk of lending to a poor credit and the pressures escalate until the country is forced to declare
bankruptcy (as has repeatedly occurred in Argentina) or governments are forced to cut spending
aggressively and raise taxes (as happened in Canada and Sweden in the 1990s).
This is the process that Greece and the other PIIGS (Portugal, Italy, Ireland, Greece and Spain) are
currently going through and which is putting the Euro at risk and transmitting fiscal pressure to the
relatively stronger economies of Germany, Scandinavia and France. The United Kingdom is teetering
on the brink of joining this group of weak states in which case they would sport the non-euphonious
acronym PIIGSUK.
But it is not only Europe that is in trouble. Japan pays an average interest rate of 1.35% on its net
public debt - and its debt to GDP ratio in 2009 was 192%. Its debt is low cost because it is funded by
unsophisticated domestic savers. However, Mrs Watanabes appetite for saving appears to be
slowing and Japan may have to turn to international lenders which would make it vulnerable to an
increase in its cost of funds to a more normal level of 5% to 6%. This would take its debt service to
government revenue from its current level of 9.4% towards a catastrophic 50%.
The United States, the central player in the world economy (and political structure) is also in a
dangerous position with net public debt estimated at 84% of GDP. This figure is forecast to rise
substantially as the government racks up huge fiscal deficits (around 10% this year) and its political
system is caught in deadlock between Republicans who will not countenance tax increases and
Democrats who will fight hard to avoid spending reductions. The United States does have the
financial capacity to reduce its debt burden - it has no Federal retail tax and with the cost of petrol at
about 30% of the European level a substantial increase in petrol excise is possible. But there is much
political fighting to be done before the situation improves.
Australia is a safe haven in this unstable world as a result of 27 years of good government and its
exposure to the growing Chinese economy. However, most of its larger stocks now look fully priced.
That said the small and mid-cap companies we tend to specialise in seem to still offer excellent growth
prospects, but are being valued at levels below where they were before the GFC. We currently have
30.4% of our fund assets in Australia and New Zealand.
For most of Asia things look brighter, however several of the data points from China are starting to
look concerning, especially inflation and increasing bank loan losses following the government
mandated surge in lending last year. Chinese markets have done less well than most of Asia in recent
times but very little seems cheap enough to compensate for very high corporate governance and
regulatory risks.
In India, growth is picking up, without many of the artificial drivers used in China, but inflation is
also a concern, mainly due the weak monsoon, which is pushing up food prices. Share prices in India
have already done well, and bargains seem rare, other than the Indian banks we already hold, and
some small cap names.
While inflation is picking up generally in Asia, Japan is still plagued with deflation as the two decade
long process of deleveraging following the burst of the late 1980s bubble economy continues. The
outlook in Japan is further clouded by decreasing investor confidence in the policies of the newly
elected Democratic Party. On the other hand the longstanding poor performance of the Japanese
markets is increasingly throwing up opportunities to invest in well managed companies with good
businesses and dirt cheap prices.
The biggest concern however is probably the state of world bond markets. Driven by a desire for
apparent low risk assets, bond yields in most of the developed world are still not far off the multidecade
lows they reached last year. However they are starting to show disturbing signs of weakness
as investors focus on the high government debt burdens and intractable fiscal deficits in much of the
OECD. In a world where rising inflation and low growth seem a very plausible combination, bond
markets could experience a rout, which would certainly be adverse for share market valuations.
Our response to this environment will be to maintain fairly high liquidity and be vigilant in selling
shares that can no longer be justified in the portfolios on valuation grounds. In the meantime any
corrections will almost certainly throw up some exciting individual share opportunities to refresh our
portfolios. We remain convinced that investing in undervalued stocks is the best long term investment
strategy and believe that our portfolios are stocked with cheap stocks which will deliver satisfactory
relative and absolute performance over the medium term.
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- a good global summary report
a good global summary report
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