consolidation

From A Dog To A Darling: 5 Ways To Profit From Japan That Most Have Missed

From a dog to a darling, Japanese stocks have finally found favour. After returning 52% for investors last year, there are still 5 reasons this market has further to go, with opportunities most have missed. There is the potential for a catch up within the stock market, mispricing, earning growth, restructuring and increased buying. Sectors to benefit from reflation and growing domestic demand within a still unloved part of the market may profit.

[Click image below or this LINK to watch this as a TV Clip]Screen Shot 2014-01-10 at 14.33.03

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Europe – why unity is the only way to survive…

As investors price into the markets only two options for Europe, politicians feel the pressure to avoid a break-up of the monetary union as we know and instead embark on the second scenario, full scale fiscal unity. European countries must share their budgets to share their burdens; fully unite or expect exits; go hard or go home. A Banking Union would form part of this strategy but would it be blinkered to significant risks? Nevertheless, caution can cloud ones vision and maintaining holdings in good quality companies, rather than raising cash levels is preferable. Progress is moving in the right direction and when confidence returns, so could market momentum. 

Click here to watch this being fiercely debated in a short clip on CNBC

A European Banking Union – an essential but flawed strategy  

Ever since the fall of Lehman Brothers and the start of the ‘credit crisis’, a call for greater control over the banks has been hotly debated. Challenged with rising regulatory costs and lower trading volumes margins are being squeezed. Balance sheets are predicted to shrink by at least €1.5tn by the end of next year, even before taking account of an effect of a possible Greek exit.

A proposal that has won support in France is for a European Banking Union. This would involve a single regulator to oversee banks across Europe. Furthermore, it includes an EU-wide deposit guarantee scheme to protect savers in the event of a bank collapse. The European Central Bank has been hailed as the most appropriate candidate as supervisor, explicitly focusing the oversight to the euro area as opposed to the full European Union. This allays one of the UK’s concerns but reservations remain.

A mockery of the original mandate?

Firstly, it may make a mockery of the ECB’s original mandate. Originally tasked with the challenge of controlling inflation, critics maintain this new role would conflict and weaken their ability to do so.  Any move to print money (increasing the amount in circulation, reducing its value meaning more is required to make purchases), could increase inflation instead of maintain price level stability.

A ‘blinkered’ approach?

Secondly, focusing on only part of the problem is not a full solution. A supervisory body overseeing the banks will focus on the largest financial institutions but miss the risks stored up lower down the food chain. The most recent ‘crisis’ was kicked off by Bankia, Spain’s largest savings bank, suffering solvency issues. However, it was formed from 7 already troubled smaller banks and therefore the risks they posed would have gone unnoticed. Oversight is certainly warranted, but is the horse wearing blinkers?

Fiscal unity first

Finally, this is not a first step. Before such a move is considered, fiscal consolidation is required. To provide backing to support banks, greater control over national budgets is needed. Being so heavily affected by the economy in which they are located, unity must start from the top down. A ‘two speed’ Europe with pockets of growth versus widespread recession; a need for interest rate increases opposing desperation for further easing; and budget surpluses contrasting deficits highlighting the instability. European countries must share their budgets to share their burdens, fully unite or expect exits, go hard or go home.

But beware of de-risking

Caution can cloud ones vision and currently cash is not king. As prices rise faster than cash can appreciate in most savings accounts, the value of money is being eroded. Boosting cash levels is not prudent. Instead, maintaining a holding in good quality companies, with confidence they will grow in value over the long run, makes more sense. Progress is moving in the right direction and when confidence returns, so could market momentum.

The EU ‘Rescue Fund’ – Part of The Problem Not The Solution

There is still much to be decided before EU leaders can claim to have provided a comprehensive and credible plan to end the sovereign debt crisis. The rescue fund itself has met with significant obstacles, with demand in doubt and delays to capital raising leading to question marks over its ability to borrow on behalf of those that can’t. Instead of improving sentiment, it may cause it to deteriorate. Details, commitment, growth, structural reforms and greater consolidation of governance, fiscal policy and politics are needed. This has become a global issue.

Deutsche Bank, Germany’s biggest bank, and Credit Agricole, the largest retail banking group in France, rallied more than 19% over the last week in October after certain ‘positive’ news was announced at EU Summit. Measures included the leveraging of the rescue fund to €1tn, a voluntary default of Greek debt and bank recapitalisation. However, this may involve a dangerous derivative structure with insurance coverage not guaranteed and demands not going far enough.

Delays could hit sentiment, deadline looming

The European Financial Stability Fund (a.k.a. the ‘rescue fund’) was created to borrow on behalf of those countries that found themselves unable to borrow (read Greece, Ireland, Portugal etc). However, Wednesday’s attempt to raise capital met a substantial obstacle – limited demand, leaving the fund itself unable to borrow. The €3bn 10-year bond offering had to be postponed, in the hope conditions would improve but a ‘red flag’ has been raised. If this fund is already having issues, at its current size with a lending capacity of €440bn, how will it manage with demands up to €1tn? Inadequate demand could cause sentiment to deteriorate, worsening the very situation it was meant to improve.

Demand from the East now in doubt

Plans to leverage the current fund to enable this €1tn of firepower seem to be heavily reliant on demand from the likes of China and Japan. This makes their apparent lack of interest in this recent bond offering most worrying. Investors have maintained the situation is too opaque and the risk/reward potential too skewed to the downside.

Dangerous derivative structure

The ‘Special Purpose Investment Vehicle’ which would allow this leveraging to occur has been likened to a CDO – collateralised debt obligation and the instrument that was at the heart of the subprime crisis, by insuring investors against loss. The bonds act as collateral so investors effectively buy junk sovereign debt with a certain level of guarantee from the fund.

The Greek ‘haircut’ has highlighted some of the risks. The ‘writedown’ of debt was structured as ‘voluntary’. It was agreed that private bond holders should offer to write off half of the amount Greece owed them versus a formal, official, enforced default. The latter would be classified as a credit event and trigger any insurers to pay up. However, the former doesn’t. Therefore investors who insured against losses paid a premium for cover but won’t get paid out to offset the losses suffered. The risk of a debt ‘default’ may not always be mitigated.

 Doesn’t cover all that is needed

More details are needed to understand how bailout facilities will be implemented and hopes for the first signs of commitment from the IMF, China and Japan were dashed at the G20 Meeting last Thursday and Friday. Moreover, the recapitalisation of the banks, which was set at €140bn will need to be increased dramatically. The IMF already put the level at €200bn, with analysts advising a number nearer €275bn.

Finally, the fund does not compensate for what the EU really needs: growth, structural reforms and greater consolidation of governance, fiscal policy and politics. The EU’s jobless figures are the highest they’ve been since the launch of the euro. Draghi may have put the focus back on growth by cutting interest rates, in a move that surprised the markets, from 1.5% to 1.25% but admitted growth forecasts are likely to be downgraded so the EU economy will remain fragile for some time. Accounting for approximately 24% of global GDP and with lower demand hitting export-oriented Asian countries, as for example Taiwan expands at its slowest rate for 2 years.

This is a global issue.