Growth or Deflation

Maltastar
 

Economic data coming out from the world major economies still indicates that growth is at best anaemic and record low interest rate levels have not helped in stimulating demand and growth.

In particular in the employment sector the data is depressing showing that companies are still cutting their payroll to preserve profitability through cost-cuts and are cautious not to take on new employees before there emerges a clearer pattern of increased demand and investment.

Yet stock markets world-wide have had one of there best quarters since the burst of the tech bubble and the bond market has been a consistent sell-off these last two weeks reversing part of the gains that bonds had gathered since the beginning of the year.

These developments indicate that the market is pricing stock exchange values on the basis of a consistent resurgence in corporate profits which can only come from resumption of healthy macro-economic growth. It also indicates that bond investors are getting wary of the possibility that a bond bubble has been created by the monetary authorities enthusiasm to drive interest rates to record 40 year plus lows, and that once they envisage that interests are unlikely to go down further, in a world where nothing stays static for long, interest rates could be head for an upturn in the medium turn.

However this optimism for growth is not being borne out by factual macro-economic results so far. Unless over the summer we start getting macro-economic data which proves in a more conclusive manner that growth is definitely on its way we could well see the stock markets give up most of their recent gains and bonds recovering in the prospect of further monetary loosening.

But longer term whilst the resumption of growth trends to pre-2000 levels could be a well drawn out affair awaiting growth in demand from developing economies of China and India to fill up unused capacities of western production corporations ( particularly those producing investment assets), the risk of widespread deflation is very minimal. Indeed even from Japan, who has been in deflation for three years, we are now seeing with more regularity evidence of economic green shoots.

Which leads me to conclude that whilst more hiccups along the way cannot be excluded and are indeed probable, adopting a longer term perspective this is a time for bond investors to substantially shorten their maturities and for equity investors to rebuild their positions.

The Local Scene

In line with this reasoning I would find it hard to recommend that retail investors put their money in 20 year government stock for a rate of 5.5%. Professional investors could well do it knowing that they have their eyes on the ball and know when to get out on accumulating more evidence of any risk of a turn in interest rates.

But for retail investors who normally stick to their investments regardless, I would recommend that they go for much shorter maturities even if that means they have to sacrifice the yield.

Which however does not mean that retail investors find my approval if they put their money in a 7 year EUR denominated corporate non-rated bond which was launched on the local market to finance overseas investments by a local group.

At 5.75% this bond was very poorly priced and does not reward the investor for the risk involved. Similar EUR 7 year bond for rated (B+) sovereign borrowers like Brazil, that has suddenly become the darling of emerging economies fixed income bonds investors, yield between 10% and 11% and whilst these are by no means risk-free the investor is at least being fairly paid for the risk involved.

What I cannot understand is how local Regulators are allowing the issue of such non-rated bonds which in the context of an over-liquid and soft market find easy prey in the non-financial sophistication of the local retail investor. What is the use of putting together a fine structure of regulation to control the professional level of investment licence holders if then corporates are allowed to issue non-rated bonds and support them with a high dose of publicity if the retail investor is at least not favoured with a rating classification of the securities on offer? There is no use pretending that retail investors read the Offering Memorandum or seek honest professional advice before they part with their money.

The Portfolio.

Strategy 1 No Risk Lm1002.853
Strategy 2 Medium Risk 996.700 (after Lm40 charges)
Strategy 3 High Risk Lm 980.100 (after Lm20 charges)
Strategy 4 High Risk For Curr 998.63(after Lm40charges)

All prices and rates of exchange are the latest available on Saturday 5^th July.

During the week international equities and bonds both retreated slightly as payroll data of the largest economy show that economic recovery has to be postponed further into the future. On the local front Maltacom where strategy 3 is invested maintained its price at 90c0.

All in all Strategy 1 is still performing best net of charges. This is a simple traditional plain vanilla investment in a term deposit account.

I am effecting a switch in portfolio 4. I am selling 5.835 units UBS (Lux) Technology Fund at USD 118.91 ( originally purchased for USD113.29) producing USD 693.84 convert same into Japanese Yen @118.24 = Yen 82039 and after deducting 2% transaction charge invest Yen 80399 to buy 14.432 units in UBS (LUX) Equity Fund Japan at Yen 5571