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Tactical Update

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The 21st century, global, economic saga continues to provide plenty of nuance.  The past few weeks, we’ve been introduced to a few new characters, Cyprus and Russia.  There is a bit of a rogue element with Russia.  Regardless, the same common themes are present for analysis: leverage, speculation, global capital imbalances and the accompanying political, fiscal, and monetary responses.

Cyprus actively solicited foreign direct investment.  Here, dubious Russian money found a home.  Cypriot banks then levered the deposits and lent a portion of the funds to the Greek government for a subsequent loss of about $2.1bln.  Additionally, they funded their own Club Med real estate bubble, loan losses are still being tallied.

The principle question this time: Should European tax payers bail out Cypriot banks who have been unscrupulously speculating with Russian money?  The answer from the EU falls somewhere between … ”not likely” and “No Way.”  The resulting bailout involves an unprecedented tax (confiscation) of funds of large depositors.  They are calling this a bail-in.  Large depositors are being treated as creditors and given equity in the zombie bank.  For 12 days banks were shuttered, people could only withdraw 100 Euros/day from ATMs.  Lines formed Thursday for the reopening of the banks, people seeking to get their money could withdraw 300 Euros and those looking to leave Cyprus could only take 1000 Euros off the island.  No checks will be cashed and transactions over 5000 Euros will be investigated by authorities.

Markets took the event in relative stride.  This is probably because the entire bailout was only about $20bln, about Bernanke’s weekly QE budget.  The important question is why?  Why set a precedent of taking money from customers of the bank, a practice thought to be taboo?  Doesn’t this raise the probability that people in Portugal, Spain and/or Italy will withdraw their savings, just in case?

Additionally, some are floating the idea of a financial asset tax to help fund future bail outs.  The idea is that a southern European nation may have borrowed too much money and paid this borrowed money to public employees for example.  They claim that the southern European citizen has more saved than his German peer.  So, if Italy (for example) borrowed from Germany and this money sits in the bank accounts or stock portfolios of Italian citizens; why should Germany be expected to bear a heavier burden to bail out a bankrupt Italian government? I tend to agree, on principle.  But, in turn, why shouldn’t an Italian sell her assets, and then withdraw her money from banks and stuff it in her mattress?  Are the stipulations for bailouts becoming politically unpalatable for the debtor nation?  Are the bailouts becoming politically unpalatable and economically infeasible for the creditor nation?  Is the EU moving closer to break up?

Our internal conversation these past 2 weeks has revolved around these precedents, the environment and the implications in the broader story line.  At the risk of sounding extreme, wars in Europe have erupted over many of these same issues.

The European and also Global issues are about imbalances.  There are input cost imbalances, productivity imbalances, currency valuation problems, and a whole host of issues with the cost and access to debt capital.  The level of debt is too high and the resulting balance of payments issues are problematic.  The world does realize the extent of the problem.  Some leaders are actively working toward solutions, individuals are pursuing their own workable equation and markets are forcing the issue in a variety of ways.  The best scenario is a smooth and uneventful unwinding of imbalances.  We don’t want another “Lehman moment.”  Unfortunately, we feel actions and rhetoric of this past week, [the confiscating of deposits and talk of future wealth taxes], raises the probability that Europe may have its own “Lehman moment” at some point in the future.  Events of the past 2 weeks have shone a light on the perilous path of unwinding imbalances.  And, the confiscation of private savings adds a new element of risk.

This week, we made moves in tactical accounts to reduce risk and even ventured back into some fixed income.

Global Opportunities:

  • Sell BHP, YZC
  • Buy ESRX

World Allocation:

  • Sell International Small Cap
  • Buy Domestic Bonds (3.5 year duration)

Tax Free:

  • Extend duration by 10 months

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“Wealth preservation and accumulation through thoughtful investing.”

For information on Alhambra Investment Partners’ money management services and global portfolio approach, Douglas R. Terry, CFA is reachable at: dterry@alhambrapartners.com


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