Just about everything bad is happening at once. In the US, a governmental structure designed to constrain the exercise of arbitrary executive power has combined with ideological polarization and too-abundant veto opportunities to prevent any intelligent fiscal management. Following the failure of the Super Committee to reach any agreement, we can expect no improvement until after the presidential election.
Crisis to Come?
The Euro Zone faces painfully expensive options to restructure a stupidly designed monetary union. Even more urgently, it must contend with the immediate need to recapitalize banks whose sovereign debt holdings, if marked to market, would reduce their capital levels by perhaps 50%. Absent recapitalization, there would be a crippling withdrawal of credit to European businesses. Indeed, this unraveling is already taking place, as banks struggle with just their Greek exposure. And the absence of direct, democratic control of Euro Zone policy(one of the monetary union’s key structural flaws)means that it will be difficult if not impossible to convince taxpayers of the need to pay up without a major crisis. We expect such a crisis to occur within the next few months.
The emerging-market nations that nowadays drive world economic growth are trying to cope with the inflationary and bubble aftermath of a combination of too-enthusiastic stimulus programs introduced in 2008 and too-abundant capital inflows from troubled developed nations. Leaders in the capitalist West have taken to admiring the macro-economic management skills of the Communist Party of China. However, there is mounting evidence of a meltdown in speculative real estate that is ensnaring local governments, banks and the very large informal lending network that is a core part of the Chinese financial system. Other emerging market countries have been juggling monetary policies, first raising rates to tame inflation and now switching to lowering them as growth has unexpectedly slowed.
And in the midst of this mess, yields on assets deemed “safe” are at historically low levels, encouraging people who should know better to reach for yield by taking risks.
Light on the Horizon
No one can predict the month-to-month progression of events. There can, however, be thoughtful predictions of long-term investment opportunities. The US appears to be on the edge of a new growth period powered by abundant supplies of natural gas, gas liquids and oil based on innovative drilling technology. Some effective neutralization of the foreclosuredriven fall in home prices can stabilize household net worth and allow general demand to pick up. Emerging market growth will resume after the bubble and inflation problems are worked out. And, even in the Euro Zone, the northern economies are highly productive, with substantial household net worth and excellent growth prospects due to export opportunities in the emerging world.
The investor’s problem is to survive the next two to three years of politically driven crisis. Some may believe that they can play the ups and downs of the crisis – after all, on November 22, the Greek two-year note was priced to deliver an annual yield of 127%. You only need to collect two coupons. Others might wish to adopt a barbell strategy. Money that will be required in the next three years or so should be invested in really safe and boring ways, entailing zero or even negative real yields. The remaining, truly long-term investment money should be placed in those long-term opportunities that will shine in 2014 and beyond.
The opinions expressed above are solely those of Contango Capital Advisors and do not necessarily reflect the views of Zions Bancorporation, its affiliates or its management.
IMPORTANT NOTE: Wealth management services are offered through Contango Capital Advisors, Inc. (Contango), a registered investment adviser and a nonbank subsidiary of Zions Bancorporation. Investments are not insured by the FDIC or any federal or state governmental agency, are not deposits or other obligations of, or guaranteed by, Zions Bancorporation or its affiliates, and may be subject to investment risks, including the possible loss of principal value of the amount invested. Some representatives of Contango are also registered representatives of Zions Direct, which is a member of FINRA/SIPC and a nonbank subsidiary of Zions Bank. Employees of Contango are shared employees of Western National Trust Company (WNTC), a subsidiary of Zions Bank and an affiliate of Contango.