Market Comment 14 May 2012

Markets performances were mixed last week, the S&P 500 Index in the US lost 1.1%, mostly on European related fears, but the Eurostoxx 50 Index was essentially unchanged, after five days of volatile movements. More general indicators of global nervousness, the EUR/USD exchange rate, gold and the price of oil all continued to fall. The European bond market also sent a clear negative signal.

The key issue, as we highlighted in our previous letter, was Greece, where the key political parties are struggling to construct a coalition government. If they do not succeed in the next few days, a fresh election will be called, and parties will likely campaign on clearer political platforms: Stay in the euro and continue with austerity, or leave the euro and pursue expansive policies.

The former idea is painful, but the latter will be even more damaging. How did Greece get into this position? Largely through the inability of its leaders, and those of the Euro Area, to reach a quick enough consensus on how much austerity was needed. Many say that austerity is no solution. But the case of Latvia (recently raised back to investment grade by S&P) shows otherwise. Austerity can work, but it takes a sharp and determined effort. In Greece, the process has been slower and so more painful, dragging on for several years. It is little wonder the population is exhausted.

For us as investors, it matters which path Greece follows. Markets are pushing against strong resistance levels, which demonstrates the global concern. New elections would likely see markets breaking down further, even though many assets are very cheap already. On the other hand, if Greece forms a government of stability, then market prices should stabilise and begin to rise.

In such an environment, I look for investments that are less dependent on Greece itself. Gold has sold off dramatically, and is becoming attractive at current levels (remembering that it is a volatile speculative asset class rather than a safe-haven). The dollar too has scope to benefit further too - the US economy is relatively healthy, and the dollar is a safe haven. As markets sell-off, I also like high dividend stocks, and global businesses that offer the chance to benefit from strong Emerging Market dynamics.

Best regards,

James