Time to swim against the tide and dip into Europe again

For investors as well as journalists, where the funds are actually flowing tells a tale, even if it is more often than not a contrarian one. Investing in the places no-one else wants to go is psychologically hard but frequently profitable.

The fund flow data so far this year confirm a marked shift in investor sentiment. A net $16bn (£10bn) – inflows minus outflows – has returned to the world's stock markets, reversing about 9pc of last year's outflows, according to Citi figures.

More interesting is where the money is heading. It has been pouring into emerging markets and out of developed markets, with the exodus from the mature markets accelerating in the past couple of weeks. In total, emerging markets have attracted $24bn, offsetting about half of last year's redemptions, while developed markets have seen $8bn taken off the table. In particular, investors have been least interested in European and Japanese equities as their appetite for the developing regions of the world has returned.

It is probably not too surprising that these are the two markets to have been left out in the cold. Japan has been a disappointment while making the case for Europe has been mission impossible since the Greek crisis flared up two years ago. It is a statement of the blindingly obvious that Europe continues to face some pretty intractable problems. But investment is less about spotting where things are going right or wrong than about noticing where the perception of those trends is at odds with the reality. However bad things are, investors can profit if the market thinks they are worse than they turn out to be.

That is the gist of the argument for investing in Europe today, or as Credit Suisse put it this week: "Europe – lots of problems but raise to benchmark". It is the first time the bank has been anything but negative on the region in two years.

Here are some of the problems for investors in Europe. First, growth is anaemic and, with wages in the peripheral countries needing to fall by as much as 13pc to restore the periphery's competitiveness, it is likely to continue to stagnate. Second, the process of paying down debts has barely begun – another reason to expect weak growth. Third, several governments outside the core look insolvent. Fourth, the euro remains grossly overvalued, which in turn crimps growth.

Against this backdrop, it is unsurprising that investors have shunned the region. Even less surprising when you consider the inability of the eurozone's political leaders to convey any sense that they either understand the scale of the challenge or can find a solution. So why might Europe, nevertheless, be worth a look now? First, because the risk of a disorderly break-up of the eurozone now looks lower than a few months ago. ECB President Mario Draghi's injection of long-term liquidity for the region's banks has made a Lehman-type credit crunch possible rather than probable.

Second, because manufacturing new orders are picking up and earnings forecast revisions are second only to those in the emerging markets and better than in the US, UK and Japan. When European earnings revisions have turned before, the region's shares have tended to outperform over the next three to six months.

Third, because European companies have a significant exposure to the faster-growing markets in the rest of the world. Many of the large, multi-national businesses that dominate most European investment funds are tied to the fortunes of the global economy and not just the eurozone area. Just over half of continental European earnings come from outside the region.

Finally, and most importantly, valuations are attractive on a historical basis. Dividend yields, in particular, are in many cases approaching 5pc, which is around 50pc higher than the average in Europe in recent decades and more than twice the yield on German government bonds. Compared to the rest of the world, the valuation of European shares has not been this attractive for around 16 years.

If successful investing was about following the herd and doing what felt easiest, we would all be good at it. Unfortunately, the rewards accrue to those who swim against the tide and invest when it feels most uncomfortable. Perhaps this is just such a moment in Europe. "Don't follow the money," as Deep Throat didn't say.

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Spain in race against time to avert bail-out

Yields on three-month Spanish notes jumped to 5.11pc at a sale on Tuesday, higher than rates paid by Greece last week.

Mr Rajoy's team is scrambling to find ways to shorten the paralysing hiatus until mid-December when the new government is finally able to take charge under Spanish law.

"We have to go beyond strictly legal requirements because the markets are not going to wait," said Miguel Arias Canete head of the Partido Popular's top body.

Close advisers to Mr Rajoy said the party will have to flesh out exactly how it plans to pull the country out of its downward spiral, and perhaps reach an accord with the outgoing socialist to start implementing emergency measures. The country may need €30bn (£26bn) in fresh cuts to reach its 4.4pc deficit target next year.

HSBC said the country is in a race against time to avoid becoming the fourth EMU country to need a bail-out. "The question now is whether the new government is able to reassure markets that it can deliver quickly enough to beat back the market bears and avoid turning to the (EU-IMF) troika," said the bank's strategist Madhur Jha.

HSBC called for "more clarity" on bank policy, labour reforms and budget austerity. "Markets are clearly worried about the Spanish banking sector – bank restructuring and the provisioning of real estate loans on banks balance sheets," he said.

The bank said the double whammy of surging borrowing costs and a slide back into recession together risk inflicting serious damage to Spain's debt-dynamics, pushing public debt above 86pc of GDP over the next three years.

"Spain cannot face this crisis by itself. The sovereign crisis is a eurozone problem and needs a eurozone-wide solution. The last few weeks have shown that the window of opportunity is rapidly closing for Spain and other peripheral countries unless some very concrete decisions are taken at the eurozone level to negate all talk of a euro break-up. With governments dragging their feet, the bulk of support over the next few months will have to come from the ECB."

"What Spain needs is a policy mix similar to that seen in the UK, with the government having a strong medium-term austerity plan in place while the central bank provides the backstop, stimulating the economy through its ultra-easy monetary policy," said the bank.

There is no sign yet that Germany is willing to drop its vehement opposition to any such action by the ECB.

Bundesbank chief Jens Weidmann repeated on Tuesday that the ECB has no legal mandate to act as a lender of last resort, and compared money printing to the deadly temptation of drinking sea water.

"Whoever believes that the current crisis can be overcome by giving up crucial principles of stability orientation, pushing current legislation aside, is wrong," he said.

A growing chorus of critics in Paris, Brussels, Rome and Madrid say Germany is cherry-picking EU law to justify its hardline stance, ignoring the ECB's duty to safeguard "economic cohesion" and the survival of monetary union under Article 3 of the Lisbon Treaty.

Comments this week by Austria's central bank governor Ewald Nowotny point to a varied spectrum of opinion within the ECB. When asked if the bank might resort to printing money to shore up bond markets, he replied "in this simple form, of course not."

Citigroup's Jürgen Michels said the careful wording is the latest sign that "the debate is shifting within the ECB's Governing Council towards a more pro-active stance given the systemic nature of the crisis."

The ECB majority can overrule the German-led bloc of hawks – and has already done so in buying around €120bn of Spanish and Italian bonds - but mass purchases or quantitative easing would risk a high-stakes political showdown with the eurozone's hegemonic power.

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Tom Stevenson: Four average investors can protect themselves against the loss of company reputation

"A significant risk for investors, is that companies like BSkyB are not always in control of their own risk" Photo: Reuters

With the news of the world complete editorial staff, investors in the satellite television channel has become innocent victims of a spectacular piece of the mismanagement of crisis - by another company.

They should not have taken to the free, however. Sometimes events come out of the blue but not these. It is act decisively, accept responsibility or in fact one of the things that someone with a life in the newspapers would have understood a minimum five years since the telephone hacking scandal response outbreak, five years during which News International has failed to take control of the story.

As Warren Buffett, it can take to build a reputation for 20 years and only five minutes to ruin it. Reputation risk is one of the greatest threats a company faces and, therefore, one of the most important things for an investor to assess. The problem, however, is that, while it is easy with hindsight to see what damage was done to a reputation, it is much more difficult to measure the extent to which a company is or is not in control of his public image.

There are at least three risks that should take account of the investor. Firstly is the measurement in which customers vote with their feet at the first breath of irregularity. Finally, Rupert Murdoch acted because it has the (correct) judgment that revenues would evaporate - because readers boycott paper and advertisers do not want to be associated with such a tarnished mark.

Arthur Andersen was found to its cost, for a professional, business services, the perception of integrity is the greatest asset of the firm. The accounting firm has grown from four great to annihilation in a blink of eye in 2002 because customers walked. Unfortunately, it is not a mere correlation. At the same time Enron was leaving Andersen history, Shell was shaken by the revelation that it had overestimated its reserves of oil. Today, few would associate Shell with this episode.

Another key for investors risk is that the companies (such as BSkyB) are not always in control of their own risk. Last year, BP has found that when oil ran aground on the beaches, indifferent America if the fault lay with the British company or Transocean, its subcontractor of drilling. BP has paid the price. In the same way Walmart may not have used illegal immigrants as cleaners, or even known about it, but that did not prevent further the Distributor for the forfeiture of its supplier by the Government.

A third risk is political. The Gulf of the Mexico a lot of water and he has recovered from the Deepwater spill with surprising ease. But the political capital to win a reflex ban offshore drilling in America was too tempting for politicians. This meant that the rest of the industry investors spilled BP disaster. This type of collateral damage is common. A striking example of the recent has been the stagnation in all areas of the price of the shares of Chinese companies listed on the U.S. list after a handful of allegations of fraud for large projects such as those launched against Sino Forest, a Chinese lumber company. After all, it is never a rotten Apple is?

Only can do you to protect yourself from this kind of impact reputation? Four things. Firstly and obviously, ensure that you are diverse. A fall 50pc price is a disaster if it is the only one you own. But if the stock is one of the 50 in a portfolio, the damage could hardly be noticed. Second, make sure that you invest in companies which have set the roof while the Sun was shining again. Ten years ago, Coca Cola face banned across Europe after an outbreak of poisoning cases. Less than a year, it is the largest beverage sales in the area again with good will and trust, that he had accumulated over the years. Thirdly, talk to suppliers and customers of the company. The rumours that I wrote about last week can provide an alert vital reputation risks to come.

Finally, walk towards the blow-ups as soon as it is deemed that it is safe to do so. BP has been a great investment for anyone brave enough to look through the crisis.

tomrstevenson@fil.com

Tom Stevenson is a Director of Fidelity International investment. The views expressed are his own.

Twitter: @ tomstevenson63

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Mooring ASX with Singapore "against national interests", says Treasurer Wayne Swan the Australia

Magnus Bocker, chief executive officer of the exchange of Singapore, left, speaks as Robert Elstone, chief executive officer of ASX, listening to merge Sydney, Australia Press Conference on Monday, October 25, 2010. Photo: Bloomberg

Securities Exchange (ASX) Australian says Treasurer Wayne Swan was "disposed to the view... that the merger proposed the ASX and SGX should be rejected as contrary to the national interest."

The ASX and Singapore Exchange Limited has announced plans in October last to create one of the most diverse large countries and financial commercial hubs.

However, the proposal struck hedges in Australia, where concerns about foreign ownership and the record of democracy and the rights of Singapore have been raised.

Mr. Swan said on Tuesday that he had "serious concerns" about the proposal and the intention to accept the unanimous opinion of the foreign investment Review Board that the takeover would not be in the national interest.

"It is important to note I did not take final decision, and it would not be appropriate for me to make further comments to the public on an application that is still under consideration," he said in a statement.

The exchange of Singapore said he was informed of the notice of the Australian Government and had asked to provide comments to foreign investment Commission Australia to review the decision.

In a statement, he said Asia remains the engine of growth in the coming decades and a gateway to the region the SGX was "well positioned to take advantage of opportunities in the dynamic economies of Asia dynamic."

Attitude of the Australia could push on the Singapore Stock Exchange to consider merger with other regional exchanges in a climate of global consolidation among exchanges.

The ASX, which has already supported the merger of Singapore would be in the national interest because it would increase the size and diversity of options for investors and reduce the costs of the companies listed on the stock exchange, said that he too maintained "the current belief" in its need to be involved in exchange for consolidation.

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Traders bet £ 2. 7bn against before banks of the report of the CVI

Part-nationalised Lloyds and Royal Bank of Scotland have fewer shares available to borrow, but there is still a short position that could be as much as ?47m on ?13m on RBS and Lloyds.

The equivalent of 1. the market value of Barclays £ 36 5.3 68pc is "on loan, mainly to cover short positions, in accordance with the data Explorer." The market value of the HSBC £ 118. 5bn, 1. 17pc or. 38bn £ 1 is ready while the figure is 1. 68pc or £ 40 m at Standard Chartered.

Partly nationalized Lloyds and Royal Bank of Scotland have fewer shares available to borrow, but there is still a short position that could be as much as 47 million pounds on the Lloyds and 13 m £ on RBS.

Barclays is more at risk of developing recommendations for the CVI, according to analysts and investors. On a note of 25 possible outcomes, designed by Goldman Sachs, Barclays is to be worst affected by the proposals of the Sir John Vickers ranging from capital requirements higher than the more radical division of sale retail and investment banking services.

Lloyds is then followed by RBS, HSBC and Standard Chartered, according to Goldman.

Separately, Morgan Stanley found that 58pc of investors believe that the shares of Barclays will be the hardest hit of all the banks of the United Kingdom.

Evolution believes an "increase in the funding of the costs seems inevitable" with its analysts saying: "for example, Barclays Capital was around £ billion of debt wholesale - if BarCap financing costs would increase by saying 100 basis for this raisonl points'impact could be £ billion after tax""they have added."

Lloyds Banking Group stands to lose the most if the ICB is trying to reduce the dominance of the big four banks on the retail market. While few expect the commission to require the cancellation of the merger of the HBOS-Lloyds, the Group may be forced to sell part of its branches. Morgan Stanley analysts said that the sale of 1,000 branches can cost Lloyds as 17pc of profits before taxes.

Deutsche Bank, said: "we expect a bold document with disposals and other remaining on the table." Morgan Stanley said he expected the report "most severe and demanding that the final result."

The ICB should offer a degree of "elsewhere" - a change in structure to limit the responsibilities of the British Government for the losses overseas.

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Gold is the final refuge against universal currency debasement

The US and Britain are debasing coinage to alleviate the pain of debt-busts, and to revive their export industries: China is debasing to off-load its manufacturing overcapacity on to the rest of the world, though it has a trade surplus with the US of $20bn (£12.6bn) a month.

Premier Wen Jiabao confesses that China’s ability to maintain social order depends on a suppressed currency. A 20pc revaluation would be unbearable. “I can’t imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs,” he said.

Plead he might, but tempers in Washington are rising. Congress will vote next week on the Currency Reform for Fair Trade Act, intended to make it much harder for the Commerce Department to avoid imposing “remedial tariffs” on Chinese goods deemed to be receiving “benefit” from an unduly weak currency.

Japan has intervened to stop the strong yen tipping the country into a deflation death spiral, though it too has a trade surplus. There is suspicion in Tokyo that Beijing’s record purchase of Japanese debt in June, July, and August was not entirely friendly, intended to secure yuan-yen advantage and perhaps to damage Japan’s industry at a time of escalating strategic tensions in the Pacific region.

Brazil dived into the markets on Friday to weaken the real. The Swiss have been doing it for months, accumulating reserves equal to 40pc of GDP in a forlorn attempt to stem capital flight from Euroland. Like the Chinese and Japanese, they too are battling to stop the rest of the world taking away their structural surplus.

The exception is Germany, which protects its surplus ($179bn, or 5.2pc of GDP) by means of an undervalued exchange rate within EMU. The global game of pass the unemployment parcel has to end somewhere. It ends in Greece, Portugal, Spain, Ireland, parts of Eastern Europe, and will end in France and Italy too, at least until their democracies object.

It is no mystery why so many states around the world are trying to steal a march on others by debasement, or to stop debasers stealing a march on them. The three pillars of global demand at the height of the credit bubble in 2007 were – by deficits – the US ($793bn), Spain ($126bn), UK ($87bn). These have shrunk to $431bn, $75bn, and $33bn respectively as we sinners tighten our belts in the aftermath of debt bubbles.. The Brazils and Indias of the world are replacing some of this half trillion lost juice, but not all.

East Asia’s surplus states seem structurally incapable of compensating for austerity in the West, whether because of the Confucian saving ethic, or the habits of mercantilist practice, or in China’s case by the lack of a welfare net. Their export models rely on the willingness of Anglo-PIGS to bankrupt themselves.

So we have an early 1930s world where surplus states are hoarding money, instead of recycling it. A solution of sorts in the Great Depression was for each deficit country to devalue, breaking out of the trap (then enforced by the Gold Standard). This turned the deflation tables on the surplus powers – France and the US from 1929-1931 – forcing them to reflate as well (the US in 1933) or collapse (France in 1936). Contrary to myth, beggar-thy-neighbour policy was the global cure.

A variant of this may now occur. If China continues to hold down its currency, the country will import excess US liquidity, overheat, and lose wage competitiveness. This is the default cure if all else fails, and I believe it is well under way.

The latest Fed minutes are remarkable. They add a new doctrine, that a fresh monetary blitz – or QE2 – will be used to stop inflation falling much below 1.5pc. Surely the Fed has not become so reckless that it really aims to use emergency measures to create inflation, rather preventing deflation? This must be a cover-story. Ben Bernanke’s real purpose – as he aired in his November 2002 speech on deflation – is to weaken the dollar.

If so, he has succeeded. The Swiss franc smashed through parity last week as investors digested the message. But the swissie is an over-rated refuge. The franc cannot go much further without destabilizing Switzerland itself.

Gold has no such limits. It hit $1300 an ounce last week, still well shy of the $2,200-2,400 range reached in the late Medieval era of the 14th and 15th Centuries.

This is not to say that gold has any particular "intrinsic value"’. It is subject to supply and demand like everything else. It crashed after the gold discoveries of Spain’s Conquistadores in the New World, and slid further after finds in Australia and South Africa. It ultimately lost 90pc of its value – hitting rock-bottom a decade ago when central banks succumbed to fiat hubris and began to sell their bullion. Gold hit a millennium-low on the day that Gordon Brown auctioned the first tranche of Britain’s gold. It has risen five-fold since then.

We have a new world order where China and India are buying gold on every dip, where the West faces an ageing crisis, and where the sovereign states of the US, Japan, and most of Western Europe have public debt trajectories near or beyond the point of no return.

The managers of all four reserve currencies are playing fast and loose: the Fed is clipping the dollar; the Bank of England is clipping sterling; the European Central Bank is buying the bonds of EMU debtors to stave off insolvency, something it vowed never to do just months ago; and the Bank of Japan has just carried out two trillion yen of “unsterilized” intervention.

Of course, gold can go higher.

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