'Hide a good part of your wealth in cash and wait for better times to invest in risk assets,' says Gary Dugan
Source: Private Banking, Emirates NBD , Author: Gary Dugan
Posted: Thu December 1, 2011 5:10 pm

UAE. The Euro zone lurches deeper into crisis taking the world’s financial markets with it. The German government and European Central Bank continue to play hardball with Southern Europe. In these circumstances we can only advise clients to hide a good part of their wealth in cash and wait for better times to invest in risk assets such as equities and commodities.

Cash is your friend. Investors should make sure they have a significant buffer of cash to protect themselves from further downside in markets. A buffer of cash also provides the funds to take advantage of the likely bargains as and when markets reach over-sold levels.

With many asset classes tracking each other very closely it is proving very difficult to achieve gains. In our own portfolios we are holding significant amounts of cash to protect them from further potential downsize in markets.

Equities commodities and many forms of bonds have fallen in value. Emerging countries are still growing but their asset markets are falling. Many assets are falling in fear of the potential fallout from a collapse in the Euro.

The belligerence of some Euro zone politicians beggars belief. The markets ‘hope’ that the German government is just negotiating by blocking any move to transform the ECB into a lender of last resort.

The Germans are thought to be trying to extract concessions from the indebted and troubled Euro zone countries. However the entrenched position of the German government is starting to back fire. No longer is it just the errant Euro zone countries that are seeing their bond yields rise, Germany is also suffering.

Last week the Germans suffered the indignity of seeing one of their bond auctions fail when there were insufficient bids to cover a new auction of bonds. Germany only got bids on 65% of its auction of 10 year bonds. German 10 year bond yields rose 30 basis points on the week to end at 2.27%.

In the next few days the Euro zone ‘leaders’ will try to finalise the operational details of the gearing up of the European Financial Stability Fund. The markets very much doubt that the policy makers will agree on what they will do. In any case even if they all did agree to leverage the fund, after all the prevarication the EFSF may struggle to raise funding in the markets and France would almost certainly be downgraded

Meanwhile Rome burns. Italy is getting closer to being locked out of the global debt markets. In the last week the Italian government has been forced to pay exceptionally high interest rates just to get by. In 2012 the Italian government has €250 billion of refinancing coming due.

At current interest rates the Italian economy would be on a path to ruin. The situation is patently not sustainable. There is market talk that maybe the IMF will step in to provide some help. The ECB on some days have appeared to be the only buyer of Italian debt, they need help.

If financial institutions and governments are planning for a potential break-up of the Euro zone so should every global investor. In the last few weeks we have heard of more banks and governments putting together their plans for how they would cope with the demise a significant fall out of the Euro zone. If a country or a number of countries were to be forced to leave the Euro zone there could be immediate restrictions on the movement of capital in Europe.

If it was anything like the unraveling we saw in Latin America in the past the countries leaving in the Euro zone would be faced with their banking sector going into state control and immediately rationing the withdrawal of capital. Indeed capital controls could be introduced. Exchange rates would move sharply on any newly introduced national currencies. Investors outside of the Euro zone should just make sure that they are not over exposed to region in their liquid and secure investments.

We sense an element of resignation in the markets. The hope was that economic growth elsewhere in the world would make up for downside risk in the Euro zone economy. However many parts of the world are now showing signs of slow down. The US economy has provided some positive surprises in recent months, however more recent data has taken us back to a more somber reality. U.S. Q3 GDP growth was revised down to 2.0% from the 2.5% pace initially reported.

Non-defence capital goods orders excluding aircraft declined 1.8% in October after a 0.9% gain in September. US Policy makers continue to fail to deliver. In the United States the so called super committee failed to agree at their meeting on November 21st hence the economy is now facing a marked tightening of government policy as we enter the New Year.

China is moving to a soft landing or at least we hope, however the flash report of manufacturing confidence suggested that manufacturing was now contracting. The indicator of new orders fell sharply. The indicator of exports actually went up suggesting that it was domestic orders that fell back.

Euro zone economic data continues to point to a recession. Confidence surveys for the manufacturing and service sectors are below 50 suggesting a contraction. The manufacturing survey fell sharply although the indicator for the service sector did improve somewhat.

Euro zone manufacturing orders fell a massive 6.4% month-on-month much weaker than expected and equates to a 5.9% year-on-year fall. The Euro zone economy slump appears to be accelerating.

With such a poor backdrop to markets traded volumes have dried up. The Investment banks are committing less capital to the markets and retail investors are hiding in fear of making further losses.

Trading spreads (the difference between the prices you can buy and sell securities at) have widened. Hence it becomes very expensive to trade the markets. Also less liquidity can mean more volatility. The VIX index of US equity market volatility has remained at stubbornly high levels of 30% plus compared to a more normal level of 15-20%.

In local markets both the DFM and Abu Dhabi exchanges have fallen to year lows and volumes have been petered out to some of the smallest of the year. Local markets will also be unnerved by the developments in Egypt.

Clearly Egypt continues to go through a political transition however when the central banks has to defend the currency by increasing interest rates it takes the risks to a new level.

Note: This is the latest CIO Weekly Economic Review by Gary Dugan, Chief Investment Officer, Private Banking, Emirates NBD.

About Emirates NBD
Emirates NBD (DFM: Emirates NBD) is a leading bank in the region. Emirates NBD have a leading retail banking franchise in the UAE, with 132 branches, 705 ATMs and SDMs. It is a major player in the UAE corporate banking arena, and has a strong Islamic banking, investment banking, private banking, asset management and brokerage operations.

The bank has operations in the UAE, the Kingdom of Saudi Arabia, Qatar, the United Kingdom and Jersey (Channel Islands), and representative offices in India, Iran and Singapore.

For more information about Emirates NBD, please visit www.emiratesnbd.com.

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