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Daniel Zurbrügg
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Daniel Zurbrügg is the Managing Partner of Swiss Infinity Global Investmetns GmbH(http://www.swissinfinity.ch), a Swiss based independent asset management firm. The firm provides clients with independent investment research, asset management and asset protection services. With a global network... More
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Swiss Infinity Global Investments GmbH
  • 2012 – THE TURNING POINT TO BRING REAL CHANGE 0 comments
    Sep 21, 2011 5:08 AM
     
    We believe that the coming months and the next year will be a real turning point for the global economy, global financial markets and world politics. The recent equity market selloff was only the first phase of a longer-term process. Economic growth in the western world is likely to remain weak and possibly remain so for a longer period of time. Asset prices have seen extreme moves in the recent past with gold moving to USD 1’900/ounce, interest rates are virtually zero in a number of western markets and equity valuations have fallen dramatically in the lastdecade. The same can be said about currencies, as illustrated by the extreme weakness of the Euro and the U.S. Dollar inrecent months. We are dealing with economic and political imbalances, also prices of certain financial assets, such as gold and bonds,havegone to extreme levels. We believe the near future will bring some large adjustments in the areas mentioned. These adjustments can take different forms, maybe we will seea real change in U.S.elections next year, maybe a surprise comeback rally of the U.S. Dollar, a severe recession in the western world or even a sharp correction of precious metals? We don’t know yet, but we will try to answer these questions on the following pages.
     
    The month of August was the most volatile month so far this year. The equity market selloff seen in the first half of the month was severe but not unexpected.
    (Major equity markets in 2011)
     
    After a very busy and eventful first half of the year, most investors were hoping for things to get more stable but as we now know, things even got worse last month. Global markets experienced a severe correction with most global equity markets falling between 15% and 25% in early August, since then we have been seeing a recovery which has so far cut the losses of equity markets to around 10 percent or even slightly less. The August correction did not come out of the blue but is the logical consequence of a series of events that happened in the last couple of months. I would like to repeat some of the comments that were made in our Q2 update in April 2011:
     
    Quote: In our Q1 report at the beginning of the year we said that we expect the liquidity driven market environment to weaken and that investors should be prepared to hedge or sell some of their positions…we have implemented active hedges for some of our equity exposures in mid March…the coming weeks will see an intense debate about the U.S. deficit situation…we expect the debt limit to finally be adjusted and moved upwards, but this will hurt the creditability of the U.S. and further weaken the position of the U.S. Dollar…
     
    In the meantime, markets did correct and it was wise to hold less equity exposures or hedge existing positions.The U.S. debt downgrade was not the main cause of this correction, it was just making things worse and was just the spark that started the fire. We too were surprised to see this downgrade come so quickly, although, based on fundamentals, we think this should have happened a long time ago. The fundamental problems that caused this market crisis are the huge debt problems in Europe and the U.S. The fact that there was an intense battle in U.S. politics about raising the debt limit only added fuel to the fire. The last minute deal achieved in the end was too little too late and the worst possible scenario for investor confidence. The whole world was watching the political debate in Washington, this made everybody realize how big the mess really is. In a time when a country is so dependent on foreign capital, it should make sure to build trust and confidence among international investors.The August correction in global equity markets is different from the correction in 2008 when most major equity markets fell by 30-40%. In 2008, the main problem was the global banking system and excess leverage by companies. This time, the main problem is that the sizes of government debt has reached and exceeded critical levels, in some cases the debt burden is as big as GDP and keeps growing. While governments still need to figure out how they can balance their budgets, households in the western world are already in a process of deleveraging, therefore adding to the overall weakness in the economy. This will result in a further rise of unemployment numbers and continued weakness in real estate markets in coming months.
     
    Many western households and governments lived above their means for a long-time.Eventuallydebt problems need to be addressed and adjustmentsto spending and/or income need to be made. A very good example is the crash in real estate prices in the U.S. in the recent past. In reaction to the market crash and the recession in 2001, the Federal Reserve, as well as most major central banks,lowered interest rates significantly and created a lot of liquidity. Banks too, were willing to lend money and give mortgages to people even when their financial standings would clearly be insufficient to qualify for a mortgage. This created an enormous bubble in the housing market that burst at the onset of the 2008 crisis. The correction we have been seeing in recent years is now reversing this excess, leaving millions of households with large debt burdens. Many people even used money from home equity loansto support their consumption spending, a situation that was simply unsustainable. Governmentsaround the world are not doing a better job and also behave in a similar, unsustainable manner. Administrations around the world have a tendency to overpromise (in order to get elected), to overspend (to remain in power) and to under-deliver (often making political compromises with special interest groups). Governments in the western world have extended current and future social benefits to the point where countries eventually have to get in trouble. In the U.S. a lot of baby boomers are starting to retire and there are more than 70 million following in coming years. The situation in many European countries looks even worse. This change in demographics and the fact that social welfare costs are exploding is a recipe for disaster.
     
    So is there a way out of the current misery? Can we solve the enormous economic challenges we have ahead of us? I think that we can make the outcome less painful, but, the economic adjustments have to be made. Governments will try to balance budgets in coming years through significant spending cuts and measures to increase tax revenues, however, this will not be enough in my opinion. In order to carry the heavy debt burden, countries in the west will need higher levels of inflation. This will be like an extra tax on everybody, reducing the net worth of people’s savings and making it harder for people who are already living at the absolute minimum. I don’t think that any western government will go bankrupt in coming years, but there will be a lot more money printing in the future. The Federal Reserve and the European Central Bank can print money forever and this has already started in recent years. The consequences are visible today, with the U.S. Dollar and the Euro falling sharply, a long-term trend that will not be reversed anytime soon, although temporary recovery rallies are always possible.
     
    What should investors do in this challenging environment? First of all, I think everybody needs to realize that the time of “buy & hold” is behind us, at least for the foreseeable future. Western equity markets have not goneanywhere in the last ten years (!!) and interest rates have been falling for most of that time and are now trading at record lows. Keeping a lot of cash longer-term is not wise either since the ongoing currency destruction will likely result in a loss of purchasing power.  Investors also need to compare different assets prices on a relative basis. We strongly believe that global equities are becoming much more interesting now that interest rates have fallen to historically low levels. Compared with fixed-income related investments, stocks are now offering significant value because many companies look much healthier than a few years ago with stronger balance sheets, higher profits and a better market positions. In our view, only a globally diversified portfolio with a good mix between international equities, foreign currency bonds and a reasonable allocation to precious metals has the potential to generate real returns. Investors need to think very carefully about their strategic asset allocation. Also, investors need to be very flexible and review and adjust their tactical asset allocation on a regular basis. When it is hard to find compelling investment opportunities in the west, one needs to start thinking global.
     
    We feel that investors have to get ready for real change in 2012, both politically and economically and, last but not least, in the way investments are being made.
     
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