“Our favourite holding period is forever” – Warren Buffet
Don’t celebrate too soon. The agreed write-down of more than 70% of the net present value of Greek government debt in private hands does not mean that the crisis is over. Greece’s long-term debt burden remains high, at a projected 120% of GDP in 2020 – essentially because of ongoing public sector holdings, the size of the ongoing deficit and the shrinkage of the economy – and Portugal is still in difficulties. Low bund, Treasury and gilt yields testify to widespread ongoing investor risk aversion.
It does mean, however, that the immediate risk of a messy, anarchic default – and with it the possibility of near-term secession or expulsion from the single currency – has faded, and the likelihood of the “muddle through” scenario prevailing has risen.
If disaster is indeed avoided, the history books will show that the role played by the ECB was decisive. Since the first large scale LTRO in December, euro area interbank spreads have fallen in a straight line, from more than 100bp to around 55bp as we write, a level last seen back in early August. They have continued to fall through the last week, suggesting perhaps that the weakness in equity markets was more likely a reflection of profit-taking rather than any renewed tension in the banking system.
Meanwhile, the economic data have taken a more mixed tone than in December/January, but continue to show more resilience than feared last autumn, particularly in the US (today’s labour market and import data being a case in point). Globally, in 2012 as a whole we expect to see a modest US acceleration muting the impact of euro area recession and a slowdown in emerging markets, and helping to keep corporate earnings and profitability at higher levels than those priced-in to stocks (even after their post-October rally).
This leaves us inclined to view any short-term setback in developed stocks as an opportunity to add to long-term positions. We realise that we’ve been arguing this now for the best part of two and a half years, but that’s because the big picture as we’ve seen it has not altered during that time. A combination of a recovery in profitability, accompanied by low interest rates (and unaccompanied by euro area banking collapse…) leaves stocks looking inexpensive to us – both relative to their relevant historic trends and, as we note inside, in absolute terms too.
We would not bet the ranch on this view. Those valuations might not count for much if there were to be a sudden sharp slide in forward-looking economic indicators, a marked change in US consumer behaviour, a dramatic further escalation of tension in the Gulf and/or or a resumed surge in euro area banking tension – any of these could change our minds about stocks’ tactical attractions. And we continue to advocate holding above-normal positions in developed equities (and, more recently, high yield credit) ideally in the context of a carefully-diversified portfolio that holds another seven asset classes. But we think the muddle through scenario is still not fully priced in – and we can imagine positive variations on it as well as disappointments.
Kevin Gardiner, Head of Investment Strategy EMEA
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