For investors, the summer of 2011 was tough. The S&P/TSX Composite Index was off 20 per cent, as I write, and the world is hanging by its virtual fingernails onto news from Europe will Greece default on its national bonds, will other countries fall, and will European banks go bust?
The scenario reads like something out of the 1930s. Worse, there seems to be a Mexican standoff in which the Greek voters who demonstrate daily in the streets won t allow their government to but their generous social benefits or raise taxes and in which German voters, tired of bailing out the profligate Greeks, say they won t pay another Euro to bail out anybody. In this social, political and economic mess, the world s investors have been taken for a very unpleasant ride. The prospect of global collapse as banks, which hold each other s deposits and bonds, become insolvent, triggering runs on tellers windows and then depression when the money runs out, has wrecked stock values around the world.
If you held any national bonds except those of Greece, Ireland, Portugal, Spain and Italy, or top grade corporate bonds issued by companies in the U.S., Canada and the U.K. you have done well. Prices of U.S. Treasuries, Government of Canada bonds and British gilts have ascended to the point that their running yields (interest payable divided by price) has hit historic lows. If you want to buy government bonds, it is probably too late. If you are one of the far sighted individuals with senior government debt in your RRSP or safe deposit box, hold on. It is probably too early to sell. For the record, Canadian fixed income mutual funds generated a 3.8 per cent return for the 12-months ended Aug. 31, 2011, which is not bad in a market driven by tragedy.
What comes next is: Will the masters of the European universe allow Greece to disgrace the Euro? To break up the European Union? To destroy banks around the world? No, my guess is not, and here s why. Though German voters are angry that they are asked again and again to bail out profligate Greeks, they have no choice but to do it.
If the Euro fell apart and each of the 17 nations that use it had to reintroduce its own currency, then Germany, in particular, would have the best currency in Europe. The new Mark or whatever they call it would be backed by a nation with a strong trade surplus and a strong national balance sheet. Investors would rush to buy Marks, their price would soar, and Germany, which is heavily dependent on exports, would suffer a recession. German economists know it, the world s monetary authorities know it, and even German voters demonstrating in the streets of Berlin know it. Breaking up the Euro would impose immense costs on the EU as well. It isn t going to happen.
Already, European monetary authorities are coming to the aid of banks that, because of their holdings of Greek and other government bonds, are seen as vulnerable to collapse.
A word of explanation is needed. A bank can be solvent, which means that it has positive net worth, or insolvent, meaning that it owes more to depositors, bondholders and others than it has or can raise. It can be liquid, which means that whatever the state of its books, it has cash and credits to pay out on demand.
Central banks in Europe and the European Financial Stability Facility (EFSF) are rushing to supply liquidity, much as the Fed has done for American banks. The process is one, buy bonds from the banks and in return, give them cash. Nobody is fussy about what bonds are bought and you can be sure that the banks are dumping their worst holdings, all with the consent (or connivance, if you like) of the regulators. The second move is to supply unlimited liquidity to banks, which the European Central Bank the ECB, agreed to do on Oct. 6. The ECB will loan any bank in its region any amount of money to meet depositor withdrawal demands or other needs until January, 2013.
What s next? Global stock markets continue to be challenged by problems tougher to fix than European bank balances. Fears of a slowdown on internal growth in China have driven down Canadian commodity prices including those of copper, potash, and steel. There is growing recognition that the lavish growth rates of stocks in China have been fueled by issuance of new, overpriced shares rather than by organic growth of companies already listed. Market forecasters now debate whether China will have a hard landing with a major recession or a soft landing with a modest decline in stock prices. The jury is out on this one.
In the United States, unemployment of 9.1 per cent, the level reported in September and suspected to be more like 15 per cent when one adds in discouraged workers no longer seeking jobs and other workers with just part-time jobs, is probably 15 per cent. The tragedies of families losing their home to foreclosure, further declines in house prices measured by pending home sales, and the outlook that it will take years to clear the oversupply of houses adds to the grimness of the American outlook.
In this market of gloom and relatively little optimism, stocks look like a long shot. Buy now and wait for many years and you should get a capital gain. On the way, companies that support strong and rising dividends with strong balance sheets are not a bad investment, but not a great one either. After all, a few bad days can wipe out a four per cent to five per cent dividend.
The current economic troubles of Europe, the U.S., and Canada will eventually fade. They always do. For now, being safe is better than being sorry.