Business Times

Investing in times of discontent

What a bizarre world? Italian prosecutors raid the offices of a credit rating agency. The most incompetent executive administration since the creation of the Union in America tells the world how we should all now ignore credit ratings as the faith of governments is what they say it will be. Disenfranchised youth send shocking messages in Norway and Britain.

The British PM eloquently tells us why human rights need to be completely ignored when faced with the chaos they now face in London. Human rights vigilantes meanwhile are gleefully cheering the carpet bombing of civilians in Libya and want more in Syria. What are investors to make of the confluence of these events?

Earning the fruits of a forecast is usually a time of celebration in the investment industry. Scenes of violent disenfranchisement from Norway and London are not for merriment. At the request of the Investment Advisory Group, Sri Lanka’s only independent personal finance advisory firm, I looked at the impact of the unfolding global uncertainties for investors.

My worries on social stability in Europe, highlighted in two previous columns, stem from a historical and political analysis. Europe is the continent that delivered us the worst blood baths of the last century (both World Wars and the tragic break-up of former Yugoslavia). In a twisted self-delusional “supposed” righteousness since the crimes committed during WWII, most Europeans identified with an extreme redistributionist’s left-wing agenda. This has since been dubbed as “liberal white guilt” by sociologists. The problem with extremism is that it blinds itself to real problems. Misguided notions of liberalism opened the doors for hundreds of immigrants on humanitarian grounds, who in reality contained the most dangerous war criminals from around the world. In so doing they planted seeds of discontent amongst struggling middle classes of their own.

Sustainability is crucial in investment analysis. Back in 2009, I attached the highest risk of xenophobia induced social unrest to the Scandinavian region, followed by Europe and Canada. Australia and the US had the lowest risk (although not zero). Of these, Canada is the only domino yet to fall; delayed by the strong rally in commodity prices that is slightly alleviating the unemployment problem.

Social unrest has only added to pessimism surrounding older “Western” economies in general. Given the importance of social cohesion in liberal democracies, investors should brace themselves for populist, redistributionist policies that will do structural damages to these economies in the long-run. The first of these is competitive devaluations as policymakers fight to keep employment within their countries. This will be challenging given the attraction of capital spending for corporate at zero interest rates well in to 2013.

Investment implications
Investors must understand that the “rules of the game” will be changed by governments globally. The hectoring about how the “developed” world has a higher standard of behaviour than your garden variety “kalu kada karaya” is pure piffle. As both President Obama and Prime Minister Cameron has said in no uncertain terms, “we will bend and break every rule in the book as long as it serves us”. The biggest risk to investing is a grave policy mistake based on the line above being doled out by every major government.

Cash and fixed income investors are the most at risk in the current environment. Savers are being punished to save profligate borrowers. With real life inflation running over 10%, all currencies currently yield negative returns for savers. Short duration rupee deposits and Australian dollar for NRFC holders take the lead here. The faith of the elevated $A depends on the extent of the current risk aversion and more importantly the continued price stability of commodities. Terms of trade are set to contract by mid next year with the $A set to reverse downwards. I have elevated medium term fair value to 0.86 (AUD/USD cross) with fatter tail risks at 1.30.

The $US will remain the flight to safety asset during any periods of volatility during the next two years. With a global savings glut and the need for safety, the yields will continue to compress with demand overwhelming supply. This has been evident in the last six weeks with yields plummeting from 3.5% for 10-year bonds to less than 2.5%.

I continue to be bearish on the broader domestic equity market from a thematic perspective. The lack of exposure to the only growing consumption market of the world – Developing Asia and Latin America, set the asset class for prospective disappointment. The relative attraction of developed market equity is the technical reason for bearishness. Amidst the current sell-off “Developed market” equities are undervalued by 15-20% when compared to domestic equities and currency tailwinds should pick up further returns.

Real assets are best placed for these uncertain times. Residential property in Colombo remains overvalued, although rental yields are now more attractive than a year ago. Tourist arrivals will need to constantly be above one million for rental growth to resume while capital appreciation will remain subdued until there is a reverse migration of non residents, and a slow down in movement of citizens to the Northern Province. The capital growth in Jaffna and Hambantota are unsustainable and will be due for a correction, especially on a negative growth surprise. Diaspora interest in Jaffna will not be sustained beyond a threshold of $US 200,000 for a standard house. Fundamentals support growth corridors around the new highways. A global commercial property allocation, with a bias towards Asia points to attractive prospective returns.

Structural shifts in global consumption support the price of farmlands and other growing regions within the country. A continued overexposure is warranted with a decade plus time horizon. Soft commodities should weaken in the short term as supply comes in to the market after a good weather season globally. That said, the price for premium teas, rubber and coconut should hold steady, even inch higher as supply dwindles due to soil erosion. Gold is a bubble and investors should not contemplate buying at these prices. Taking profits from excessive gold holdings and rebalancing towards global equities would allow strong inflation adjusted returns over the medium term.

Investment markets will gyrate along until November 2012. A single party needs to come to power in the US and pass much needed reform through the US congress. While on paper Republicans should win this race, a weak domestic jobs market and continued fall in the standard of living will play in to the redistributionist agenda of the Democratic Party. Such a move will accelerate the decline of the United States across a range of industries. It will also mark a turning point for global asset allocation.

(Kajanga is an Investment Specialist based in Sydney, Australia. You can write to him at

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