His vision for starting GWS was to deliver investment strategies and wealth management services typically available at the highest levels of wealth. Today, clients benefit from these sophisticated financial services targeted to meet their unique needs.
Yesterday, the global markets experienced a dynamic sell-off and you should know why. This time it’s Italy.
To explain what’s going on, let’s relate this whole situation to your home loan. Most commonly, mortgage rates are either fixed for a period of time, or adjust based on prevailing interest rates.
Now, the way government bonds work, they are issued in various maturities – from 30-days to 30 years – at auction. In other words, when issued, government bonds pay whatever the public, including institutions and other governments, are willing to pay. This may be a lower rate when similar investments pay low rates, or when other more volatile options like stocks seem too risky. Unlike your home loan, the borrowing isn’t done with one loan at one fixed rate. There is a constantly maturing stream of bonds that must be reissued. So, unless a country has profits (surplus) to just pay off maturing debt, it must refinance when the bonds come due.
The problem that we see in Greece, and now Italy is that confidence in these governments has fallen so much that the world is demanding much higher interest rates because of this uncertainty. This can be financially catastrophic for a country. It’s like a loan shark increasing your daily interest if you fall on hard times. As of yesterday, Greece’s 10-year bonds are yielding 25% annually as most investors don’t believe they will get all of their principal back.
We keep a close eye on these interest rates as there are certain thresholds where the rate is just too high for the country to afford to fund operations. For Greece and Italy, the panic level is in the 7% range. Italian 10-year bonds, which demanded a little over 4% a year ago are now trading with yields hovering around 7%. This jump in yield is a barometer of how the world views Italy’s chances of getting through this tough time. To make matters worse, keep in mind that banks throughout Europe are very much tied to each other with Italian bonds owned by many European banks, who themselves are experiencing tough financial times. As an example, France’s two biggest banks hold over $400 billion of Italian debt.
So how does this affect you and your portfolio? It means that with cuts from European government spending and fear of a European financial crisis, Europe is likely experiencing a recession as I write this. It seems unlikely that the euro-zone economy is growing at a time when there is so much uncertainty.
On the other hand, we believe that the US is in relatively good shape. Anticipating a euro-zone financial crisis, we moved more of our asset allocation to US equities from foreign for most portfolios earlier this year. In fact, we have a greater US vs. Foreign weighting than any time in the last ten years. We also shifted some assets in all but our more aggressive portfolios to more hedged (conservative) strategies this past summer.
Looking ahead there are three things to watch: China’s growth, Japan’s 10-year bond rate and US interest rates.
- Growth solves everything. China’s growth and demand for materials to fuel its growth are major factors in sustaining the global economy. Any sort of slowdown – even temporarily – will have a huge impact on global markets. Since China depends more on Europe than the US to buy its goods, a European recession is of great concern.
- While Greece and Italy (and to a lesser extent so far, the US) are at debt levels that seem unsustainable, Japan is the worst of the bunch. Japan is not in the news because as the US pays 2% to borrow money for 10 years, Japan is currently paying a little less than 1%. A country can handle a lot of debt when there is virtually no cost. If this rate increases – even by 1 – 2% – it could ignite a global financial crisis much greater than Italy and Greece. Greece is not too big to fail; Italy is too big to fail; Japan is too big to save. Even with its enormous debt, Japan can sustain itself for many years as this is a chronic issue not a crisis. We’ll have more on this later in the month.
- All this uncertainty keeps US interest rates low, benefitting US borrowers, but not retirees as retirement income remains at historic lows. It seems that safer yields, in Treasury Bonds and CDs, will remain low for the near-term.
This leaves us with the question we ask when analyzing our investment strategies, which is: What are we willing to put at risk in stocks? At this point, at least for our more conservative portfolios, the answer is “less than before.” We believe that there are other areas where the risk / return relationship is more attractive.