Investing Terror Ahead?


Many events… weakness in Wall Street… concerns of another Euro debt crisis… recent US dollar Treasury auctions… shows that there is terror in investing markets.

msci-chart

The MSCI World Stock Market chart from Bloomberg.com reflects the feeling of terror as it has fallen so much in November that it has given up all profits from the year of 2011.

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Yet there is even more potential for terror… the risk of a Euro collapse… the potential dollar disintegration as China and Russia drop the use of the greenback in their inter trade and the rising gloom of another theater of war in the Pacific.

In fact there is enough terror that we could see a stampede… that will create some horrible slide of something.

The question is what? Knowing the answer is the difference between extra profit and ruin.

Major investors are acting as if they believe in inflation. On Oct. 25, 2010 the U.S. Treasury sold $10 billion of five-year TIPS at a negative yield. This was the first time investors were willing to receive negative returns at a Treasury bond auction.

TIPS are inflation protected bonds. The interest rates are inflation adjusted.

November 4, 2010 the U.S. Treasury sold $10 billion more 10-year TIPS bonds at a record low yield of 0.409% after the previous low interest rate of 1.019% was set at a Sept. 2, 2010 auction.

This suggests that investors have confidence the Fed will win the battle against deflation, and create  inflation.  This is likely to cause a falling US dollar.

However if this inflation is going to take time to rise… it is really urgent to get your strategy and timing correct.

Jyske Global Asset Managers (JGAM) decided to keep their portfolios unchanged except for minor adjustments. They are underweight bonds and overweight equities but have increased protection on their leverage (borrowed US dollars) with a stop-loss.  This protection was executed on 12 November causing the loan mix to move from 100% US dollars to 50% US dollar and 50% euro.

This move was made because Jyske had a protective Stop Loss on their dollar loans so that Stop Loss was executed on the 12th of November at 1.3558. The renewed turmoil in the eurozone had spooked investors and there was a lot of volatility in the Foreign Exchange market.

As the EUR/USD cross rate is the most traded currency pair in the market there was extra volatility in this pair.

JGAM still believed in a weaker US dollar but respected their defined stop loss.

However on November 25th JGAM changed their loan mix in our leveraged portfolio back to a 100% US dollar loan.

JGAM believes the market has overreacted to the euro crisis caused by Ireland and the North Korean attack on a South Korean island.  They expect the market will soon again focus on the fiscal and monetary policies in the US. Especially, we view the aggressive US monetary policy to be a long-term weakening force on the USD.

JGAM anticipated the Federal Reserve’s Quantitative Easing on the second quarter of 2010. They believe that much of the liquidity pumped into the system by the Fed will continue seeking more risky assets than almost zero-yielding bonds. Therefore, JGAM expects money flow out of the U.S. – causing downward pressure on the US dollar – and into global equities, corporate bonds, emerging markets and commodities, creating an on-going upward pressure on these asset prices including related currencies.

This means that money will flow away from the euro and dollar into emerging markets.

Jyske sees the potential for a significant negative scenario in a re-emerging euro crisis. Recently, they have seen a weakening of the euro and a widening of yield spreads between the German Bund and peripheral eurozone bonds.

The new RISK

I expect Jyske is now also watching Asia more closely.

I was about to expand my Asian coverage into Taiwan and Thailand based on this… but fate… and Jyske perhaps saved me.  My adviser warned that the two funds I had selected were at 52 week highs.

I had selected those two markets as they are both considered good value markets by Keppler but these high point meant I wanted to investigate further.  So I held back and then needed to visit my mom in Oregon where Merri and I focused on her… not our portfolio.

In the time we were away North Korea revealed more nuclear development and started lobbing shells at South Korea. The US has sent an aircraft carrier that way.

This means I’ll wait and watch Asia a bit.  This also reinforces other investments I recently made in Latin America… mainly in Brazil.

Here are three tips for investing in times of terror.

First, do not leverage heavily.

Second, do not speculate expecting a fast turn.  Look for special values created by the terror. For example if the Taiwanese share market tanks… because of  Korean tensions, it is already a good value market.  It could become a spectacular value.   We’ll see in an upcoming message how in terms of purchasing power parity, Taiwan has not passed Japan in per capita spending power.

Third, diversify and look for inflationary fighters that hold up during deflation.

Examples?

There are three ways that investors are being screwed.

Inflation is ruining the purchasing power of our wealth.

Western banks are keeping the money they have and the cheap money that the government gives them.  They invest it for more and keep the profits.  With this cheap government money they do not need deposits so traditional safe investments (dollar and euro bonds and CDS) don’t earn enough to protect against inflation.

Trading down keeps inflation down statistically… but means that your income and savings really buy much less.

Yet you have to take great care when you enter emerging markets.  For example I am taking the RIC out of BRIC (Brazil, Russia, India and China).

First during a panic stampede because BRIC has been a popular theme, the herds might stampeded there.

BRIC may be a concept that too many investors are talking about now. India however is a poor value market (according to Keppler Asset Management) and has always been volatile.  China is neutral value but borders Korea.

Russia carries a law and order risk.

My Jyske advisor just sent me this note.  Gary I recommend that you keep out of Russia. Very shortly you shall sign a form, when trading in Russia, where you have all risk in regard to the custodian in Russia, if they make any kind of fraud.

I can find ishares investing in Thailand and Taiwan, quoted in the US. These are Index funds but at 52 week highs.

I am a little nervous for the eastern European markets. Poland and the Czech real estate market are still funded in CHF and EURO. There have not been focus on that for a while, but the problem is not solved yet, so be careful with these markets.

Recently I took profits and reduced my position in Turkey.  I transferred the profits into two shares added to my portfolio…   Ishares Latin America  (focused mainly in Brazil) and  Suntec Reit which invests in Singapore real estate.  I wrote about Suntec last month in the article Invest in Turmoil.

The leverage in my portfolio remained 100% in US dollars through this turmoil.

Canadians and non US investors can learn about how to buy these through Jysle Bank Private Bank from Rene Mathys at mathys@jbpb.dk

Professional US investors (portfolios over $1 million) can also buy these shares via JGAM.

US investors with smaller portfolios can invest in managed accounts.

To learn the portfolio mix and leverage of these accounts contact Thomas Fischer at fischer@jgam.com

Gary

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