2nd August 2011: Financial Armageddon?

Tuesday, Jul 19 2011 by
10

Does the date in the title of this thread mean anything to you? If not, it should! It's the date the US hits its debt ceiling:

President Obama's talked of "Armageddon". To Treasury Secretary Tim Geithner - it's "catastrophic". The Fed chairman Ben Bernanke has warned of "calamity". Or, in the words of senior Republican senator Lindsay Graham: "What is calamitous is the path we're on as a nation. We're becoming Greece."

It's a week of breath-holding brinkmanship over America's debt limit - the President's given party leaders just five days to reach an agreement to raise the country's borrowing limit - or risk default when the current $14.3 trillion ceiling runs out on 2 August.

Whilst the political posturing has been proceeding apace, most commentators have been assuming that a last minute deal will be done. Though markets have been soft of late, they are not pricing in the consequence of a failure to agree to raise this ceiling.

This is where I could use the counsel of wiser heads: what would be the consequence of Congress failing to raise the debt ceiling - both in the short-term and looking slightly further ahead?  It's a fundamental assumption of most theories of investing and asset valuation that US treasuries are a "risk free asset" and other debt tends to be priced relative to the "risk free rate". What happens if treasuries turn out not to be risk free? Is there a chance that the US could actually default?

 

Is it time to start piling up those cans of beans, shotguns, and gold bars? I guess the odds of the worst happening are slim and a last minute deal is likely to be done, but ISTM that we ought to consider the improbable case. Even if a deal is done at the very last minute, things would probably get "hairy" in the markets, to say the least, in the final run-up to the deadline. We could easily see a panic sell-off. Time to start thinking the unthinkable...

Thanks for any useful comment!

Mark


Filed Under: Economics, Politics, Debt,

Disclaimer:  

The author may hold shares in this company, all opinions are his own and you should check any statements that appear factual and not rely on them before making an investment decision. The author is NOT a qualified analyst nor authorised to give investment advice. Whilst the author is a director of ShareSoc, all views expressed are entirely his own and not necessarily those of ShareSoc.


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118 Posts on this Thread show/hide all

marben100 6th Aug '11 99 of 118

In reply to tournesol, post #95

Hi tournesol,

Well the one decision that is unquestionably good, is the family holiday one. :0) None of us knows how long we're on this earth for, so "carpe diem" is the name of the game! Let's hope we're all able to continue this banter and debate for many years to come.

 

I thought I'd rebuilt my own pot after 2 previous meltdowns - the tech crash of 2001 and the banking crash of 2008 in which I lost 66% and 50% respectively - so was minded towards a strategy of wealth preservation intermingled with moderate risk taking.

I think your experience illustrates well the core of what timarr bangs on about. Actual behaviour of individuals is very much coloured by their own experience - and markets are nothing more than the sum of the behaviours of a large number of individuals (including fund managers).

My own experience has been rather different to yours. Whether through luck or judgement, I don't know - but all I have to go on is my own experience and my observations over quite a few years now.

 

I avoided the tech boom altogether. When it got going in earnest, in the late 1990s, there just appeared to be so much "hope value" built into the ratings of so many companies that I couldn't bear to invest. Of course, I missed some fabuous gains... but I also missed out on losses.

Most of the painful losses I've suffered have come from pinning too much faith in a single company or sub-sector. That's why I run such a broad portfolio.  The result in 2007/8 is that whilst my SIPP porty was hit hard, it slightly outperformed the market and after a 9% gain in 2007 it lost 27% in 2008. However 2009 and 2010 saw 50% and 42% gains respectively. The net result is that, after this week's turmoil, I'm back to where I was last September - and that was a record high in itself.

So, my experience is that if I continue buying things that I perceive are undervalued, keep an open mind on what fair value is, and spread risk by running a broad portfolio, things tend to come right in the end.

 

Concerning the current situation, I noticed an interesting comment re QE3 in today's FT:

...Even though the downside risks to the economy have got worse, most officials on the rate-setting federal open market committee still expect growth to bounce back later this year, as supply chains disrupted by the tsunami in Japan get back to normal and lower oil prices allow consumers to start spending again...

...Anything that the Fed could do now would take time to feed through to the economy. Until there are signs that the economic slowdown is more permanent, or that inflation is sliding back towards levels where deflation is a danger, there is little appetite on the FOMC for risking higher inflation in the future by trying more asset purchases today...

 

Commentators feel that QE3 is unlikely, in the short term, for the reasons set out in the article. The question is, is the Fed right? I suspect they are and that growth will rebound in the third quarter in the US. If that happens, I suspect the market will rebound too (though the rebound may be fairly short-lived). Of course, if the Euro falls apart in the meantime, then that will change the picture, and the outlook will look grimmer.

Whilst it wouldn't be quite fair to say "we have nothing to fear but fear itself", weak business and consumer confidence is the biggest threat to global growth IMO (but I feel that the UK and the PIIGS are in a different situation). I do not think the UK will experience the rebound that is expected in the US in the next quarter, because of the job cuts underway in the public sector here.

If the Fed isn't right then that probably will trigger QE3 - unleashing a another wave of money on the markets.

So, whilst the mood is all one of gloom and doom, my own view is that the short-term risks are balanced (upside and downside). Longer term, I maintain my stance that whilst the West has a huge mountain to climb and will probably suffer numerous stumbles over the coming years, prospects are set fair for emerging economies. So, most of my investments remain focussed on that thesis (with the notable exception of Halfords (LON:HFD) which I believe is simply discounting too much bad news at present - everything has its price and Halfords is a hugely cash-generative business).

Cheers,

Mark

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marben100 6th Aug '11 100 of 118
1

Must admit I find the title of my thread quite ironic, with the benenfit of hindsight. 2nd August did turn out to be a major turning point in the market, but for more complex reasons than I feared intially! Nevertheless, the extreme US political brinkmanship was undoubtedly a big contributor to loss of confidence in the market.

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Fangorn 6th Aug '11 101 of 118

Hi Tourn,

Enjoy your trip to Kenya, was there in june. Visiting friends in Nairobi, drove down to Mombasa for a weekend stay at a villa backing out on to the ocean. Lots of fun. Am returning next year when I intend to get round to going on one of the safaris....

@DJP.
Have had my eye on Astrazeneca (LON:AZN) for a while - nice chunky yield, higher than Glaxo. Not sure whether to plump for he former over the latter a the mo, or buy both for ISA to tuck away. Do you have a preference out of interest?I've tended to keep a closer watch on Glaxo so AZN has passed under he radar

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marben100 6th Aug '11 102 of 118

In reply to Fangorn, post #101

Hi Fangorn,

FWIW, I prefer Glaxo and have had a fair whack for a little while. I trimmed back on them a little in May, to rebalance my porty as, after a decent rise, they were getting a bit overweight. Though the yield is lower right now, I like their prospects better. Glaxo's earnings are forecast to grow between this year and next, whereas AZN's are forecast to shrink significantly. ISTM that GSK have a strong emerging markets strategy and are diversifying successfully from the pure pharma side, which suffers from a squeeze in western healthcare funding and patent expiries, into FMCG. Sensodyne, Horlicks & Lucozade, for example, are well known GSK brands and India is proving a good market, where "good old British brands" are well recognised. FMCG companies currently tend to trade on higher multiples than pure pharmas and there is potential for splitting the business - where the "sum of the parts" is greater than the whole!

Bit too soon for me to top up, though - have a comfortably sized position now.

Cheers,

Mark

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Fangorn 6th Aug '11 103 of 118

Appreciate your thoughts Mark,

I really need to get some Pharms on board. I used to hold Pfizer and Merck, but we are going back a couple of years. Been meaning to get some Glaxo ( always preferred their diversification away from pure pharma strategy) for a while - but never seem to have got round to it. I tend to procrastinate far too much! If the market continues to be weak however I will definitely be making a modest nibble...:)

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macroeconomix 6th Aug '11 104 of 118

Oh dear.

What with the S&P downgrade, looks like all the stars and planets are aligned for a bloodbath Monday morning. Germany don't want to use the EFSF to bailout Italy.

Looks like the Germans are saying "no" to kicking the Eurozone can further down the road.

[ In German ]
http://www.spiegel.de/wirtschaft/soziales/0,1518,778764,00.html

Trouble is I doubt that the markets will know where to fly to. Very envious of those who cashed up in April/May! I'm pretty much fully invested and will be sitting it out as the bargains appear (real producing assets of stuff that people need - no doubt many shares I own) with the thrown out bathwater.

In hindsight - should have bought more gold/silver than I did - I think the PMs stand a good chance of being the flight to safety currency of choice. Bunds I imagine will be popular too.

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djpreston 7th Aug '11 105 of 118
5

Morning Fangorn/Mark - beer and music festival last night and friends stayed over so didn't hit the sack till 4am and now there's shambling husks all ovver the house whilst 10 kids, 8 and under run amok - seemed like a good time to get out into the garden with a coffee....

AZN or GSK? Difficult one that. We tend to view them as a pair/relative values trade stock so have switched regularly between them. Quite often you'll see one outperform the other by 20% or so and then there's a good switching opp. We've just switched GSK to AZN as GSK has been strong whilst AZN has underperformed. I could easily imagine that AZN could get back to 3100p and outperform GSK in the coming months. Then we'd prob switch back.

On balance the GSK business model looks "better" as Mark has said - geater success thus far on EM penetration, Consumer sales etc. But AZN's rating is v much weaker with better yield and is moving in the right direction (also one of the last real M&A opps in the sector - due to size/scope for savings etc).

One easy solution might be to look at WWH (thing that's the ticker - Worldwide Healthcare IT). I've always quite liked it for an easy broad exposure to the whole health complex. Been a good performer since inception and currently sitting at a historically high NAV discount. The fees they charge aren't onerous, they manage the discount well (look at the fees to see why they are minded to discount management - unlike Blackrock World Mining which is boardering on criminal - huge discount in a top performing trust). Nope, Worldwide Healthcare Trust (LON:WWH) is a great little lockaway for a long term theme imo...

Now, where's the Paracetemol?

Fund Management: European Wealth
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Fangorn 7th Aug '11 106 of 118

I like dedication DJP - crashing at 4am, getting up at 9am, coffee and back on it :)

Agree AZN looks v attractive yield wise relative to Glaxo, probably going to nibble on both this coming week, particularly if there's continued weakness as i expect. Suspect it will be a good time to lock away in the ISA and forget about them....:)

Thanks for the WWH idea. Will have a look once I'm back from Aunty's in Devon....as well as Mattbuoys suggestions..just been clearing out 10years worth of water reeds in the large garden pond...shattered and a tad pongy!

p.s A Barocca works wonders for a hangover I find :)

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marben100 7th Aug '11 107 of 118

In reply to macroeconomix, post #104

Thanks for that article macro. Key points "leaked" from the German govt, mentoned in the article (for non-German speakers).:

  • Italy is too big to rescue
  • It must rescue itself through cost savings and reforms

and...

There is disunity in the ECB about whether or not to purchase Italian bonds right now. FT Alphaville noted on Friday that the next ECB president was expected to be an Italian!

Unless the ECB makes a clear statement today, I guess relevant markets will be highly turbulent tomorrow, as the level of uncertainty will be very high.

I have started a new thread specifically to discuss the future of the euro and consequences.

Cheers,

Mark

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marben100 7th Aug '11 108 of 118

PS Next to that Spiegel article is a rather interesting graphic showing which countries debt German banks are most exposed to. Interestingly, the largest exposure is to the UK (€377.7bn) - being more than double that of the next largest, France, and treble that of Italy.

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emptyend 7th Aug '11 109 of 118
2

In reply to macroeconomix, post #104

In hindsight - should have bought more gold/silver than I did - I think the PMs stand a good chance of being the flight to safety currency of choice. Bunds I imagine will be popular too.

...mmmm...the precious metals are vastly over-rated as a hedge IMO. Granted if there is complete armageddon then the actual metal would be easily negotiable - but I think that many people are invested in derivatives that are some distance removed from the underlying. Accordingly, whilst there are very strong speculative attractions, it is wrong to think of gold, silver etc as a hedge. They produce no income, have limited actual uses and are (at current levels) significantly over-priced IMO.....

...doesn't mean to say they can't go higher -but they are a speculative bet on being able to sell to "greater fools" and they (except in hard physical form under the bed) are not a hedge.

ee

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marben100 7th Aug '11 110 of 118

China's view:

Aug 7, 2011

US downgrade 'sounds alarm bell': China state media

BEIJING - STANDARD & Poor's US debt downgrade was a wake-up call for the world, a commentary in a top Chinese state newspaper said on Sunday, adding that Asian exporters faced special risks.

Citing economist Sun Lijian, the People's Daily said Standard & Poor's on Friday cut to the US' credit rating from the top notch triple-A to AA+ had 'sounded the alarm bell for the dollar-denominated global monetary system'.

The comments carried in the Communist Party mouthpiece follow a stinging attack launched by the official Xinhua news agency on Saturday, which said Beijing had 'every right' to demand Washington safeguard Chinese dollar assets.

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Jimarilo 7th Aug '11 111 of 118
2

Buffett sounded no alarm bells about the downgrade, going so far as to say it wouldn't have much effect on the markets Monday. "If nothing else takes place, meaning, if all other variables hold and there isn't say, a new problem in Europe, it won't make any difference."

http://www.foxbusiness.com/markets/2011/08/05/buffett-to-fbn-sp-downgrade-doesnt-make-sense/

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emptyend 7th Aug '11 112 of 118
9

In reply to Jimarilo, post #111

Buffett sounded no alarm bells about the downgrade, going so far as to say it wouldn't have much effect on the markets Monday. "If nothing else takes place, meaning, if all other variables hold and there isn't say, a new problem in Europe, it won't make any difference."

In other words Buffett is saying exactly what I said on Saturday morning!

There is an enormous amount of complete and utter scaremongering GARBAGE being written about the downgrade, promoted by people (and the press) who haven't the slightest idea what they are talking about..... and those few that DO know what they are talking about seem to be deliberately trying to scare people into thinking that the downgrade is in any way significant.

S&P really had to downgrade the USA after last week's political brinkmanship. It is nonsense to think that the USA could be considered AAA when their politicians had, entirely of their own volition, gone right to the brink of default: it is self-evident that if the political class is willing to do that once, then they may well be willing to do it again - and so confidence in the USA's ability to repay debts in a TIMELY fashion is very clearly impaired [timely repayment is an absolutely key consideration in ratings].

Normally, of course, sovereign countries that issue debt in their own currency would be considered to be AAA (because they can always print more of their own money if required......and it is this element IMO that has so dramatically been shown to be in doubt in the US's case, thanks to the need for legislative approval to raise the ceiling). However, foreign currency debt ratings are a completely different matter - because they don't control the printing presses.......

....and this is potentially an important point, as the ECB, France and Germany consider how to respond to the question of Italian debt - because the Italian debt is in Euro...and the Italians don't control the Euro and therefore cannot print more of it.

If the ECB agrees in effect to underwrite Italian/Spanish debt by buying it in the market (at, say, 6-6.5% yields) and is seen to have the backing to finance those purchases then I think confidence will return very fast......

....yes, US Treasuries will trade a little cheaper than they have - but mainly in the longer maturities (say +15-20bps in the 10 year?), because the short end will be supported by US investors seeking non-bank safety.

In the short to medium term, the US downgrade is a storm in a teacup....but there is no doubt that they (and Italy, Spain etc etc) have to start sorting out their budgets and ensuring that those who can and should pay their taxes actually do so - because that is at the root of much of the uncertainty. Tax avoidance (and simple non-payment) has become endemic in some countries ....and even the UK isn't "clean" in that regard, as we all know some people who fail to report their earnings properly.

Anyway.....I'm away most of the coming week watching the World Badminton Championships* at Wembley (and I've got a ticket spare for tomorrow if anyone wants one...mail me),  so I expect that some shuttle diplomacy will cause normal service to be resumed, the all-clear sounded, and a bit of a rally by the time I get back online - or at least I'm thinking that any cock-ups will be short-lived and any drops will be minor!

*Betting tips:

1) Hidayat of Indonesia to win the Mens Singles (if he can beat Lee Choeng Wei).....c. 20/1

2) Womens singles to be won by Wang of China  ;-))

3) Boe and Mogensen of Denmark to win the Mens Doubles

 

ee

 

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marben100 7th Aug '11 113 of 118
3

News expected today:

 

Emergency talks focused on the debt crises in Europe and the United States are planned Sunday for G7 finance ministers before Asian markets open, while the European Central Bank will consider buying Italian public debt to stem the turmoil...

...Finance ministers and central banks from the United States, Canada, Britain, France, Germany, Italy and Japan may issue a joint statement after the talks, Jiji Press said in Tokyo...

...The Frankfurt-based European Central Bank (ECB) is also scheduled to hold a rare Sunday conference call to discuss a strategy for handling the debt crisis in Europe, where Italy is at risk of default.

ECB sources say officials will discuss whether to buy Italian government bonds to help bring down Italy's borrowing rate...

Mark

PS I have recced your post, ee despite the unforgiveable badminton related puns - enjoy your week. :0)

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macroeconomix 7th Aug '11 114 of 118
3

they are a speculative bet on being able to sell to "greater fools" and they (except in hard physical form under the bed) are not a hedge.

Hopefully not another Gold is a ponzi scheme thread, but just a few points on this. I agree it is not a hedge (although when I say positions in gold, I really mean holding the physical stuff, not artificial ETFs), it is really a play on a trend in lack of faith in Governments and Central banks not to print their way out of their problems.

Gold has been used as money for 5000 years preceding the last 40 years where a paper currency has been the worlds trusted currency of choice. And it is only in the west that there is a prevalent view that gold is a barbarous relic (except maybe Germany where the effects of the 1920s are still in the collective conscious).

For me it is a prediction. A prediction that the currency experiment of the last 40 years (since Nixon closed the gold window) will fail, and that gold will once again be recognised as money.

The Chinese have started all sorts of bilateral trade deals without converting to dollars, are crying out for a new world reserve currency. With the $ on the wane, what are we left with - the Euro?? Also seems pretty flawed to me unless we see discipline not to print from the ECB. The Yuan? Is the West going to trust a communist state? Bitcoins? It really leaves SDRs backed by a basket, and I think a lot of Asians will demand that precious metals form a part of that basket.

[That's my prediction, what I'd prefer is a genuine free market in money, including private money, gold, silver, bitcoins, whatever.]

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emptyend 7th Aug '11 115 of 118
5

For me it is a prediction. A prediction that the currency experiment of the last 40 years (since Nixon closed the gold window) will fail, and that gold will once again be recognised as money.

...mmmm...as predictions go, that one is pretty "out there"!

The question about the most appropriate reserve currency is of course an excellent one - but the stock of gold is far too small to make it useful in that regard. .

I too have little faith in the value of printed paper currencies - but I prefer the hedge of owning (a claim on) other commodities (namely oil...in the ground). IMO far too much of the speculation on gold has been via various sorts of derivatives.......I'd guess that about 99% of all people's claims to "own gold" are actually based on ownership of funds, ETFs, futures etc - and very few own the physical. Its far too much hassle....

....but the point here is a crucial one. If you don't own the physical, then you don't have a hedge against financial collapse, because you will still be exposed to one or more intermediaries staying solvent long enough to uphold their end of the bargain.....and, in the circs that macroeconomix is contemplating, that may well not be good enough!

ee

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Isaac 7th Aug '11 116 of 118

Eur & £ rallying hard against the $ in currency markets just opened.

Why would people sell stocks and go into Bonds/Cash on the US downgrade? Surely Cash is the last place you would want to be?

What is worse owning a depreciating currency or a depreciating stock that perhaps pays a dividend ?

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Isaac 8th Aug '11 117 of 118

I have closed all of my spec positions today on the morning spike. Only keeping long term core positions open like SIA.

I plan to open shorts on the FTSE on any spikes to hedge my Soco position, I see markets dropping til end of Oct with minor bounces.

Sell the rallies is my view.

This is worst then 2008, as governments are going bust rather then banks!

A lot of major supports on charts have been broken - China is heading into a recession! QE3 will only see a small rally IMO.

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AbAngus 27th Aug '11 118 of 118
1

In reply to AbAngus, post #4

I am in the camp that sees the pressure being eased through lots of shocks and aftershocks, some of which may be pretty large.

OK, I have changed my mind. I am actually quite frightened now. I am moving across to the camp that thinks a BIG crisis is coming. To my mind the European politicians have failed to create a method for the gradual release of the pent up debt pressures - and I think it is all about to go bang and take a lot of banks with it.

I just can't see the Cool Northerners and Hot Southerners reaching any manageable solution in the time available. The ECB may have kept the lid on PIIGS bond prices by buying them up but CDS prices and the other indicators of fear are rising. The ECB can't buy up every bond, I think the fuse is lit and the markets will be merciless.

I suppose the Chinese might step in and bankroll us out of trouble; it would be in their interest. I fervently hope so, but I am not counting on it.

Woe! Woe! Armageddon! Even so, I think it will be a deep rumbling sort of explosion, going on for weeks or months rather than instantaneous collapse.

AA (who has to admit that he knows absolutely nuttin')

(As an aside for Marben - who asked about eating badgers - I am told they make a good ham. Perhaps I will live to find out. And there could, of course, be a market for shaving brushes if all the electricity goes off.)

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