Evercore Pan Asset

Some investors are asking, should we sell all our investments? Are we in for another 2008?
 
We do not think so. We have said all year this is likely to prove a difficult and unrewarding year for investment. We have long argued that the Euro crisis will get worse, making many EU based investments unattractive. We have acknowledged that the emerging market world is busy raising interest rates and fighting inflation, creating headwinds for investors whilst this happens. The year so far has seen speedy lurches from markets which favour risk and welcome the decent economic growth which is happening to markets which are worried about the debt reality, only to lurch back again. 
 
Over the last week there has been one of those nasty jolts in the major markets. What are investors worried about? They are worried about the high and rising mountains of government debt. In particular they have looked at Italy, Spain and the USA, and not liked what they see. In each case savers worry that the underlying economies will not grow quickly enough to allow easy payment of all the interest on the loans, and to make rolling over the debts when they mature a routine matter. If a highly borrowed state finds its supporting economy stuck in a rut, tax revenues do not grow quickly enough to make the debt payments easy. 
 
There is, however, a big difference between the US and the Euroland countries. We have always been most worried about the Euro area, because individual heavily indebted countries within it cannot print more money to pay the bills. They cannot devalue their currency themselves, so their economy can work its way back to prosperity by exporting more. The weaker Euroland states are often also the supporters of weak banks. They have created a vicious circle. The weak banks are supported by the state. The state itself is overstretched financially, so it issues more bonds to pay its bills. The banks buy many of these bonds. When the market cuts the price of the government’s bonds, the banks lose money and need more state or other support to keep going. 
 
There have been signs that the weaker banks are not trusted in the banking markets. This in turn cuts the amount of credit and money available, and further depresses weaker Euroland economies. The slower the growth, the more people worry about the prospects for repaying the debts. Bank shares are subject to continuing worries about how much they could lose on their holdings in weaker country bonds. 
 
There are three main ways of resolving this crisis. One is for the weaker countries to leave the Euro and to devalue. This may also entail partially reneging on their state debts owned by foreigners, redenominating it in their new currency. The second is for the countries to remain within the Euro whilst reneging on parts of their debts, to take the overall total down to more realistic amounts. The third is for Euroland to make more rapid progress towards political union, with the richer areas sending more grants and loans to the poorer areas to allow them to pay their way.
 
So far the EU has ruled out dropping countries from the zone. It has worked away on a mixture of schemes to lessen the immediate impact of the debt and to send the problem countries more money. There is not yet in place a stable and convincing answer to the possible future stresses. Until there is, we recommend staying out of all direct Euroland risk. We recommend holding no Euroland state bonds, and no direct holdings in the leading European equity indices and markets. We do accept a little share risk through world indices in limited quantities. Some German and French companies are doing well even in this difficult climate. 
 
We argued throughout the US debt crisis that the US would pay its interest on its bonds come what may, and would therefore maintain a relatively high bond status. We do not recommend holding US state debt, however, as we think the interest rates are low and unattractive. There are figures showing some slowing of the US economy, but we do not expect the US economy to fall into another recession. We expect slower growth from most western countries, as they work their way out from the long shadow of the credit crunch. The US is devaluing its currency to make itself more competitive and to cut the external value of its debt. It can always print more dollars to pay the bills. 
 
 We think China remains the cheapest major share market. It will attract more buyers when it appears that the Chinese authorities have done enough to curb price rises and are switching to a more accommodative policy. The next phase of better world expansion is going to need Chinese leadership. The US and the EU are too enfeebled by the debt crises to be able to boost things much more. The US will be trying to do so, as the President seeks ways to make himself more popular ahead of the 2012 election. The EU is likely to keep stumbling and to have to undertake more cuts, as it seeks to stabilise its very unstable currency. Gold has soared. In these circumstances it is likely some Central banks will buy, speculators will buy, and investors worried about paper currencies will buy. There is also likely to be higher demand for gold jewellery and artefacts as emerging market success spawns many new multimillionaires. There is no logical basis for the current gold price, but there are many people in love with it, and there could be more to come.