Archive | July, 2012

Is It Possible to Forecast The Investment Markets?

31 Jul

I think it is unrealistic to try to forecast market trends in the current financial environment – I think it is clear that the potential to both good and bad scenarios are well matched – sentiment still is the driving force – and this will and has led to wild market swings.

In my opinion if there is a definite forecast and prediction given – I would call it a “guess” – unless enough assumptions  are made – but that will make it useless in the “real world” and becomes an academic article rather than a reflection of what could happen.

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What a difference a day can make. Coming on the heels of one of its stronger performances this year, stock markets ended in the red yesterday. The market’s so-called “fear gauge,” or the VIX, spiked sharply but within the current trading range. Markets temporarily paused from their intent focus on potential stimulus, although some weak economic data did surface during the day. Several data surveys plummeted in July indicating a weakening manufacturing environment.

Around the markets
A 2% drop in JPMorgan Chase, on the back of a downgrade from banking counterpart Deutsche Bank. This erased gains stemming from positive news from the likes of Coca-Cola and AT&T. Coke announced today a reorganization of its business around three core units: Coca-Cola Americas, Coca-Cola International, and its bottling division. AT&T announced an extension of its current buyback program that would allow it to purchase back nearly 5% of its shares outstanding.

In other news, shares of Latin America e-commerce site Mercado Libre cratered 7.54% today on no news. The company, with significant exposure to potentially slowing economies like Brazil, finds itself down nearly 14.5% since the beginning of the year. Touted as the eBay of Latin America, the company has an already-proven business model, and despite its pricy valuation of nearly 37 times earnings, its predicted annual growth rate of 28.15% over the next five years makes for a pretty compelling bull thesis.

Conclusion

http://americancenturyblog.com/wp-content/uploads/2012/05/5-31-2012_fig11.gif

“Only mad dogs and Englishmen” would try to predict what the markets will do next. Personally, I believe in asset combining with different correlation to smooth out the returns generated with a bias to dividends, yields and including both collectives, structured products and, where needed, fixed term deposit bonds – to hopefully achieve goals and returns in the short, medium and longer term.

I believe you must follow a defined strategy, assess – review and know when to change the strategy. The art is to measure and own suitable assets based on the potential risk-reward relationship – include assets which behave differently and target specified dates.

You will see from the table above the success and failure of different asset classes from year to year – to make positive returns takes effort, focus and expertise – and then there are no guarantees.

Always review and consider your assumptions, make sure they are realistic and achievable, own assets for the right reason, do not panic buy or sell.

Remember this must be a factual exercise – always try to have full information to make these decisions and learn from your mistakes.

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Emerging Market Debt Warning

30 Jul

Mike Riddell, fixed interest fund manager and heads up the Emerging Market (EM) Debt Fund had to say – he thinks emerging market debt may once again provide a good buying opportunity; however, at current levels, he thinks investors would be wise to look elsewhere. 

Investors will be well aware of the Emerging Market narrative – the asset class will surely outperform because of low debt levels, high growth and strong demographics.

The flaw in this argument in relation to EM debt:-

  • the performance of EM Debt has very little to do with GDP growth rates or demographics
  • it has been driven more by global risk appetite, US Treasury yields and the US dollar
  • instability of the Eurozone

Mike Riddel has highlighted concerns that emerging markets will face further country – and region-specific risks. 

He has sited the potential of an economic rebalancing in China could pose a particularly big risk to the asset class. China has had the biggest credit bubble in the world in the last three years, and rebalancing may result in GDP growth falling to as little as 5 to 6% per annum.

His opinion is, the risks facing EM debt appear to be rising, and while some exchange rates have begun to move, the asset class does not appear to be pricing in these risks.

My Conclusion

I believe that the risk reward ratio does not support holding this asset class and the downside risk dramatically out-weighs the upside potential.

This is not an asset class I currently hold in client’s portfolios, so personally I agree with Mike Riddell’s opinion.

There is no such thing as a bad asset class rather bad valuations – I do not expect this asset class to provide good valuations in the near future. (A price correction could easily reverse my opinion as the valuation and potential of positive returns change an asset class from being out of favour into an asset class which is in favour.)

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Millions Of Pounds Lost In Pension Pots

29 Jul
As an IFA (Independent Financial Adviser) and industry professionsal, I am constantly reminded that the majority of consumers are unaware of the collective value of their pension funds. If this is true, it could potentially result in millions of pounds of unclaimed investments. 
 
Pensions alarm clock

 
 
Friends Life Pension Survey (information available on 23 July 2012 through Friends Life Media Services)
 
Friends Life is the latest of many product providers who have produced a survey detailing that 10% of those who responded had no record of their corporate pensions held with previous employers, and 32% were unsure where was the relevant paperwork.
 
Friends Life confirmed they believed the trend could get even worse in the coming years; their research suggests that there will be more than a seven-fold increase in the number of small pension pots in the system by 2017, with 370,000 worth less than £2,000 created each year. This could equate to an extra £74m in pension savings being lost on an annual basis. 
 
This astounding research shows that people are not paying enough attention to their pensions. Friends Life have suggested that, every year, individuals are losing out on significant savings held within pension funds that they are unaware they have.
 
The survey also indicated that more than 30% of people have pension pots with two or more employers, with a further 5% unsure of how many pots they have. 
 
More than 40% of people responding said they believed they were not paying any charges on their pensions, while a further 26% thought their pension didn’t cost them anything as “their company pays”. 
 
Women were shown to be more apathetic when it comes to pensions and are less likely to know how much their pot is worth, with 72% unaware of the collective value, compared with 64% of men. Also, the study stated women are less likely to keep track of their pension’s documentation, with over 11% having no record of their pensions, compared with 9% of men. 
 
saving up cartoons, saving up cartoon, saving up picture, saving up pictures, saving up image, saving up images, saving up illustration, saving up illustrations   

Conclusion
 
The fear and worry about these pension surveys is, if they are correct we could be facing a whole generation of people who are unprepared for their retirement. 
 
Personally, I believe it is imperative that people are aware of where their money is and what it is doing for them. Too often pensions are deserted and not considered properly before it’s too late.
 
Please make sure you are aware of the pensions you have, the amount you and your employer are paying, what charges there are and how much each pension plan is worth is essential for retirement planning.
 
If you want help, just ask a professional. I am an IFA (Independent Financial Adviser) and would always recommend independent advice. Always make sure that the adice you recieve is independent – sometimes companies will dress-up their advice as wealth management, exclusive or other such terms to hide the fact the the advice is NOT independent – be aware.
 
You should keep up-to-date on your pensions and make sure you track down all investments made via pensions either through previous employers and personal arrangements. I suggest that you maintain a list of all policy details from previous pensions, and keep providers up to date with contact details. 
 
I urge you to think about these factors long before approach retirement – is the quality of your retirement will be linked to your financial security – earlier the planning the better as we would have time to grow the funds and hopefully target any shortfalls

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Will The Earnings Season Lead to Prosperity or Panic?

26 Jul

Looking to the major market indices it isn’t clear what market action to expect over the remainder of the year but could this be another year of two halves? The pattern of the market does look like it’s forming a bearish rising wedge.

Remember, technical analysis is always part art and part science – so you can never be completely certain on outcome based on a market pattern. Using historical analysis – a rising wedge pattern – roughly two-thirds of the time they will break to the downside. (Conversely, one-third of the time they break to the upside.)

Market Timing Indicator for July 23 2012

In accomplishing our goal of capital growth we must do a number of things. We must make returns on our investments, we must protect our investments, and we must limit our losses.  While all three aspects work in tandem with each other, we must bias our allocation towards one specific goal.

Regarding the current portfolio positioning, I’m not so focused on the chance that these wedges will break to the downside – more the impact of each scenario on my client’s portfolios.  Markets are currently heading towards long-term resistance lines that have been around for decades.  If we do break to the downside, although at some point I think we will, there could be a very significant sell off with consequences that no one can predict at this point.  Alternatively, there is the potential to an upside break and if there was I expect it will be quite muted.

The only scenario I believe has a true chance to inflate equity values is a series of positive earnings announcements.  A lot of expectations, earnings numbers, guidance, etc… have been revised downwards over the last couple of quarters, so there is the opportunity for some positive surprises that could lead to some bullish price action.  In absence of such a scenario, I really can’t think of much else that would prompt a run up.

Further, I expect trading in the near future to get very volatile. When reviewing the shape and trend of the last quarter the typical following quarters would show high volatility with little overall change then a correction followed by a recovery phase from over-panic. The question is will this trend repeat this time? 

Screen Shot 2012-07-24 at 20.15.52

Historically, and looking forward as August and September have been very costly for the average investor. 

My focus will be in taking the highest probability client appropriate risk-rated strategy that offer hopefully the best risk to reward scenarios.  There will be times when we miss our opportunities, and times when they’re not timed perfectly.  But, patience pays off in the long run…there goes my crystal ball – still doesn’t work…

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Pension Pots Crippled by Falling Gilt Yields ?

25 Jul
 
It seems that on a regular basis there are articles and information provided suggesting how awful our pension income system is – I am an investment IFA specialising in tax planning. My opinion is different.
 
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My opinion – changes in legislation and regulations have made the arrange more flexible. (This is to an extent never seen before). Yes, Gilt Yields are low and this is a major factor in determining annuity rates and yes, compared to the past the returns achieved are low – but so are the factors creating the environment for higher rates.
 
A key factor is inflation – we recently saw rates hit 3.6% only a few months ago but they have fallen back in more recent times. On a historical basis these rates are very low. Annuity rates were much higher, at a time when inflation was also much higher. So we have been a victim of the success of monetary policy controlling the rate of inflation. The figures around annuities and inflation have moved maybe no quite in tandem but there has been a very strong correlation.
 
There again part of what determines the value of Gilts is inflation, especially level Gilts where inflation (and future expected inflation) is clearly an important factor affecting the pricing i.e. if everything is going up in price and the rate of this increase both known and expected has an effect on the value of assets with known returns.
 
So let’s have a look at the actuals:-
 
Gender Age Escalation Guarantee Purchase Price Expected Annual Payment
Male 55 Level None £100,000 £4,750
Male 60 Level None £100,000 £5,250
Male 65 Level None £100,000 £5,950
Male 70 Level None £100,000 £6,700
Male 75 Level None £100,000 £7,900
Gender Age Escalation Guarantee Purchase Price Expected Annual Payment
Female 55 Level None £100,000 £4,650
Female 60 Level None £100,000 £5,050
Female 65 Level None £100,000 £5,700
Female 70 Level None £100,000 £6,300
Female 75 Level None £100,000 £7,350
 
The above figures were provided through find.co.uk and have been rounded down to provide a guide estimated price rather than actual terms. The basis was a simple level lifetime annuity with no additional benefits.
 

So the question is – in an environment where interest rates offered, say a 5 year fixed rate bond typically pays arround 4.0% AER and the rate of inflation for June 2012, according to the Office of National Statistics, was 2.4% (Consumer Price Index) or 2.8% (Retail Price Index). Are these rates so unrealistic?

For investments, where I advise – my opinion for the future – if I could consistently achieve net returns of 5% per annum plus a bit to neutralise inflation – I would feel job well done.

The concern with pensions are twofold – rates available once at retirement but also the returns achieved during the term getting to your retirement date.

So the investment environment and your success is paramount – effective management is essential and this is where my expertise can help. The current speculation about the Eurozone, amongst other international and national issues, and focus on Spain will have an effect. If you think, circa £29 Billion was wiped off the value of the FTSE 100 yesterday – while Spanish government borrowing costs soared to a new euro-era high of 7.5%. 

As a result, gilt yields have approached all-time lows. This could be disastrous for many pension pots as the vast majority of all pensions and savings are linked, at least in part, to shares. The crisis in Europe is and has driven many investors into gilts (seen as a “safe haven”. The downside effect is this has pushed up the price of gilts, so reducing their effective yield and forcing annuity providers to cut rates to historic lows.
 
This means those on the cusp of retirement are destined to have a permanently lower level of retirement income. Remember, there are choices as to how to draw your retirement income and some of those facilities are flexible and can change. For example there are temporary annuities, income drawdown, and some halfway products available. With pension planning and retirement income – every situation is unique, so I can only comment on options available on a case by case scenario.
 
Issues to be aware of – personally I am uncomfortable as a general with the following – buying an annuity when you do not have a need for the income (I have heard of sales people presenting that you might as well take it – income you could have and why not….beware of sales approaches); moving pensions offshore to circumvent UK legislation (tax planning is all about using the rules as they exist any time you try something else, you run the risk of future legislative changes and the wrath of HMRC).

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How Do We Communicate?

23 Jul

Many people have asked “How Do We Communicate?”

My email address is welshmoneywiz@virginmedia.com & my office number is 029 2020 1241

Let me know if I can help.

Are Equities Mispriced?

23 Jul

Looking at a chart of the VIX index, we have seen a floor to the index generally being around 15 for the last 5 years but with the range 15 – 18 being the sell-trigger or the spark where the index typically sees a rise. VIX is currently at 16.27. Risk pricing in US equities is once again showing a lack of caution.

Is this a trigger to sell?   

To put it another way let’s compare VIX to IG CDX (investment grade CDS index).

Unlike VIX, which is measuring implied volatilities of options, CDX is an indicator of CDS protection premium (spreads) on the bonds of many of the same US companies. I am suggesting that this, in general, compares the risk pricing for equities with that of credit.

The scatter plot below shows VIX vs. IG CDX levels since 2009. Based on this dislocation, equity implied volatility looks relatively cheap.

Summary

The market outlook is not clear and we are sure that market volatility is here to stay.

The issue being the cost of institutional debt, especially debt in the form of Gilts, Treasury Notes and Blue Chip Corporate Bond especially – are expensive

In comparison, on a relative basis, equities seem to be cheap – financial instruments seem expensive – so a suitable market exposure approach may well be to take a classical view and own defensive equities with strong cash flows mixed with some niche markets which are less vulnerable to the current market weaknesses and/or have already seen serious market corrections.

The question is what type of investor are you? Are you investing for months, or years or a fixed point in time in the future?

I would suggest that a combination of strategies is required, combining deposit-based strategies for the short-term, structured products for, the say, 2 – 6 year focus and investment portfolio for the over 5 year investment duration.

I accept and expect every personal circumstance and focus is different.

Good luck investing.

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Don’t Get Caught Out By The Taxation Of Investment Bonds

21 Jul

Earlier this week I met a new client, who is in an awful tax scenario because of how he drew money from two investment bonds – realistically tax should not have been an issue. The problem was caused by their previous financial adviser not understanding the tax rules and making a dire mistake.

I thought I would write an article on this as it is so common for people to suffer a tax bill when no tax could have been payable – the failing being how the bond is taxed and not drawing the proceeds in the most tax efficient manner.

Remember with an investment bond, the policy is made up of mini-policies so you potentially have more flexibility of how you encash.

There are two sets of rules for tax depending on how you withdraw money –  

1. Top Slicing – this is where you draw a proportion of the whole bond equally across all of the mini-policies. The advantage of this is if you draw up to 5% of the original investment, then this is treated as a repayment of capital until such time as you have withdrawn all of your original capital and thereafter assessed to income tax at your marginal rate of tax.

What this means is if you stay within the 5% Rule – you could defer any payment of income tax until another day many years away.

The problem comes if you draw more than this 5%, then the addition is added onto your income to assess the tax liability.  So typically, not the best way to withdraw large amounts of capital from then investment bond.

 

2. Encash whole mini-policies – tax is assessed and payable based on the profit made on each mini-policy.

 

Scenario 1

Client invests £50,000 in an onshore bond and £50,000 in an offshore bond, both invested just under 5 years ago and he has seen a slight drop in value through the investment to £49,000 for each bond.

Client now draws £90,000 – £45,000 from each bond by an equal apportionment across the policies (Top Slicing)

Problem being anything over the 5% Rule, when encashed in this way will be assessed and taxed as income.

Okay, lets say he has an average income of £25,000 per annum

5% Rule for each complete year – 20% of the original – £10,000 on each bond

Onshore and Offshore bonds – to be assessed against income leading to a further expected tax liability of £19,126

 

Scenario 2

Exactly the same as scenario 1 except – now draws £90,000 – £45,000 from each bond by an cashing individual mini-policies

The good news – each investment bond has seen a slight decline in value. Tax is only payable on profits.

Onshore and Offshore bonds – to be assessed against income leading to a further expected tax liability of £Nil 

 

Summary

The point being – if you are withdrawing a fixed regular amount of say up to 5% per annum of the original investment – then Top Slicing can be an effective tool.

If, however you are withdrawing a capital amount there are typically better approaches.

Please be aware that this only touches on the taxation of investment bonds – this is actually a very complicated area but the basics are clear and sound.

CARE NEEDS TO BE TAKEN AND KNOWLEDGE APPLYED

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Investment Tax Wrapper – Investment Bonds v Collective Investments

20 Jul

I always find the argument around the suitability of the investment wrapper paramount. Too often I see new clients – who maybe non-tax payers with an investment bond wrapper rather than collective. If this is personally owned I struggle with why someone has chosen to pay Basic Rate Tax when they most likely could have paid no personal tax – admittedly the tax is paid within the fund but all costs will affect investment performance.

OK lets start by getting a bit of jargon out of the way…when I use the global term Collectives, I am referring to anything along the lines of OEICs, Unit Trusts, Investment Trusts, SIVACs, UCITS I, II, III, etc. I am just trying to use an all-inclusive term.

Choosing the most appropriate investment for an individual will depend upon many factors including :-

  • personal circumstances
  • investment objectives
  • current and future levels of income

What factors to consider?

The summary below compares bonds and collectives from the perspective of taking an income, capital growth and various tax and estate planning options.  Whilst the choice of investment should not be made for taxation reasons alone it will be a critical factor.  Other key factors will include product pricing, charges, investment structure, administration and service, fund choice, asset classes, death benefits and trust options.

Investment Bonds

Collectives
Taking an income Taking an income
• 5% withdrawals can be taken per annum without incurring an immediate tax charge (deferred but not free of tax) and any unused allowance can be carried forward to future years. • Bonds are a useful way of providing an ‘income’ without any impact on an investor’s personal allowance and/or age allowance, (within the 5% allowance).• If withdrawals exceed the 5% allowance (or higher cumulated amount), tax may be payable depending on the tax position of the investor and whether the bond is either onshore or offshore • Because investment bonds are non-income producing assets there is no need for annual tax returns, unless there has been a chargeable event (such as exceeding the 5% annual allowance) resulting in a chargeable gain (realised profit).                             • The income from a collective will be taxable whether taken or reinvested. Non-Equity funds (which hold greater than 60% in cash or fixed interest) have income paid as an interest distribution net of 20% tax (and non-taxpayers can reclaim). Equity funds (which hold less than 60% in cash or fixed interest) have income paid as dividend income with a 10% non-reclaimable tax credit. • Income paid (or reinvested) from a collective will be included in the assessment of an investor’s personal taxation and/or age allowance – although if the collective is held under an ISA wrapper this problem is solved.• Disposal of shares/units to supplement income is a disposal for capital gains tax, although this may be covered by your annual capital Gains Tax Allowance (currently £10,600 in Tax Year 2012/2013). The rate of CGT payable will depend on the allowances and reliefs available to the investor and on their income tax position.• Because collectives produce income they will normally need to be reported each year to HMRC, even if accumulation units or shares are chosen. Capital gains may also need to be reported when a disposal takes place but only if tax is expected to be payable.
Capital growth Capital growth
• When the bond is surrendered (this is a chargeable event) tax is assessed and may be payable depending on the personal income tax position of the bond owner. This is true whether the bond is either onshore or offshore.• Switching funds in an investment bond can take place with no tax implications for the investor. (This is not a disposal for tax purposes while the funds remain under the bond wrapper.)                                              • When shares/units are cashed in, this is a disposal for capital gains tax although this may be covered by your personal Capital Gains Tax (CGT) Allowance. • Losses on disposals can be offset against other capital gains – so can create effective tax planning scenarios.• Taper Relief and Indexation Allowance are no longer available on personal scenarios.• Switching funds within a collective is a disposal for CGT with possible tax and reporting requirements.
   
Tax & Estate Planning Tax & Estate Planning
• Individuals may be able to alter their level of income to reduce or avoid tax on surrender of the bond.Examples – those who have pension income in drawdown can reduce their income received to minimise tax payable; or could use part of the proceeds to help fund a pension, EIS, VCT, etc. so that the tax credit created offsets the tax bill associated with the investment bond encashment. • Gifting the bond (by assigning it nit not for “monies worth”) to a lower or non tax-payer. So an assignment to a spouse or child in further education may not create any liability (depending their personal tax rate) to CGT or income tax. It could reduce or avoid the tax that would otherwise have to be payable by the investor. • Individuals may be able to make a pension contribution to reduce or avoid any further liability to income tax on the surrender of their investment bond.• Gifting the bond to another (i.e. assigning into trust or to an individual) will be a transfer of value for Inheritance Tax and depending the terms of the trust may be covered by an exemption – more commonly though will be treated as a chargeable lifetime transfer.

• Having multiple lives assured can avoid any chargeable event upon death of the bond owner. This is assuming the contract is for encashment on the death of the last life assured. 

• If a chargeable gain arises in a tax year in which the investor is non-UK resident then there will be no further liability to UK income tax.  There may be a tax liability in their country of residence.

• A special relief applies to offshore bonds that reduces the tax liability on chargeable gains for individuals who have been non-UK resident for any period of their investment – Time Apportionment Relief.

• Investment Bonds, depending on the interpretation by local authority, may not be included within the means test for local authority residential care funding – care is needed as this varies from authority to authority, year-to-year, the circumstances surrounding and prior to the investment and many other factors.

 • Individuals may be able to alter their level of income to reduce the tax rate payable on a capital gain e.g. those who have pension income in drawdown may be able to reduce it, by careful selection of funds within the collective to select the desires level of taxable income.• Transferring the collective to another individual or into trust will be a disposal for CGT purposes although this may be covered by your Personal Annual Allowance to CGT, or an exempt transfer between spouses. If into trust, gift holdover relief may also be available depending on the type of trust.• Individuals may be able to make a pension contribution which in turn could reduce the rate at which they pay CGT.• Transferring the collective to another individual or into trust will be a transfer of value for Inheritance Tax purposes, although this may be covered by an exemption.• No CGT is payable on death.

• Investors who are both non UK resident and ordinarily resident will not be liable to UK CGT on disposal of their collective.  However, anti-avoidance legislation means they will need to remain non UK resident and ordinarily resident for five complete tax years for the gain to remain exempt from CGT.

•  Collectives are included within individual’s assessment for local authority residential care funding.
Taxation of Fund  Taxation of Fund
Onshore Bond funds’ internal taxation is extremely complex. In general terms it can be summarised as follows:• Interest and rental income are subject to corporation tax at 20%. Dividends are received with a 10% tax credit which satisfies the fund manager’s liability.• Corporation tax is payable on capital gains at 20%. Indexation allowance is available to reduce the gain.• Investors are given a non-reclaimable 20% tax credit to reflect the fund’s taxation.Offshore Bond funds are typically located in jurisdictions which impose no tax upon investment funds, such as Dublin, the Channel Islands and the Isle of Man. And so:

• Interest, dividends and rental income are tax-free while under the bond wrapper. Some non-reclaimable withholding tax may apply to certain overseas income.

• No corporation tax is payable on capital gains.

• Personal tax position, rates and residence status must be considered carefully as taxation is typically payable at your highest marginal rate when the bond is finally encashed.

 Collectives are only subject to tax within the fund on income received, and so:• Interest and rental income are subject to corporation tax at 20%. Dividends are received with a 10% tax credit which satisfies the fund manager’s liability.• No corporation tax is payable on capital gains within the fund.

 

Summary

There is no black and white answer on this – it is all circumstance specific but an understanding of the differences is essential. My belief is only pay tax when required and lawful – so products with an inbuilt taxation are to be used only when necessary, the lesser tax rate or for a specific reason/purpose.

Investors make money through investments with three key principles – fair costs, minimise taxation and investment performance.

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Some Argue We May Be Heading For a Financial Melt-Down

18 Jul
 
It is concerning that the Bank of England had made contingency plans for its staff to be given bicycles so they could still get around in the event of a full-scale financial meltdown. So are we heading to a financial melt down and market crash?
 

stock market collapse 

This could be good news for investors – this would create a buying opportunity for the prudent investor. It is fair that few economic forecasters expect the economy to go into full-scale meltdown, it appears that if it does, it won’t be long before a new economy establishes itself.
 
A full-scale collapse of the Euro, China grinding to a crunching halt and the US plunging over the fiscal cliff are real possibilities. There are signs from the bond markets, that the financial world is under the fear of negative pressure.
 
stock_market_crash.jpg

Government and Treasury Bonds, in some cases, are paying negative yields – investors in effect are now willing to pay for the privilege of lending money to the likes of Germany, Switzerland, Denmark, Holland, Finland and France, just to get their capital into a perceived safe haven. 

I believe, in the case of the Eurozone, the money flowing into the stronger countries is primarily being driven by fear. How I see this – for investors, say living in the Eurozone countries such as Greece – buying the risk of a small loss on German debt is preferred to the risk of the potentially substantial loss of purchasing power, should the country leave the single currency and bring back the drachma.

The collapse of the Euro would be disastrous for financial markets. 

There are also worries that the crisis in the Eurozone is distracting everyone from the real problem in the US. American Debt is expected to reach the $16.4trn cap before the end of 2012; plus the expiration of current tax cuts and $1.2trn spending reductions could push the US into recession. (The worse case scenario would be a full US default possibly caused by the debt cap.).

economic tsunami

 

The outcome of this is unthinkable – most asset classes would fall significantly in value. Liquidity in capital markets would disappear, corporate bonds and property markets would re-price accordingly and equity markets would suffer a serious decline.

The exception would be expected to be some physical assets but otherwise – value would be irretrievably destroyed, even in asset classes that have traditionally been defined as offering lowest risk.

 
 
 
Gold maybe argued could be one of the exceptions.
 
The troubles of the Eurozone and potential risks of instability are also anticipated to support gold as a possible hedge or insurance against asset devaluation and potential inflation.
 
 
Summary
It is good to review the risk and potential outcome of a total melt down but how large a risk exists? I believe that there is a real and present danger but are not at the point of collapse – we almost saw this scenario at the heights of the global recession lead by banking collapse, massive bail-out programs, etc. etc.
 
Fear is a realistic part of our psyche and is healthy. Maybe some of the past problems have been created or at least exacerbated through the ignoring any potential down-side.
 
Always, I believe, we should only make decisions, including the potential to bad as well as to good – being realistic is key to success and changing our position and asset allocation to reflect what is realistic and potential. Investing is all about what will happen, while taking into consideration what has happened.

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