Friday, January 13, 2012

Bedlam Asset Management's Global Investment Review Fourth Quarter 2011

These guys make a lot of sense. From our September 28, 2011 post "Don't Sweat it Greece, Sovereign Default is Normal":
Everyone knows* that the sovereign default of England's King Edward III bankrupted Florence's Bardi and Peruzzi banking dynasties in 1345. And everyone knows** that Argentina's default in 1890 brought Baring's bank to the brink of insolvency, staved off by the massive rescue operation organized by the Bank of England.

My question was how common are sovereign defaults?
I found a couple dozen answers in the bookcase and on the 'net but the most interesting came from Bedlam Asset Management.

First a short digression.
The first thing that strikes you is: These people named their firm after the most famous lunatic asylum in the world?
This must be a put on.
Then I read a couple of their market commentaries. They are good. It's not a put on.
I went to their website where the front page says it is for institutional investors only.
No problem.
I click the enter button and am greeted with:

 Welcome to Bedlam 
A website for institutional investors

This has got to be a put on. Welcome to Bedlam?
I go back and Google a couple more of their papers. They're erudite and comport with my understanding of markets, economics, finance etc....
Here's their website
From Bedlam:
Summary 1
Section 1: Correlations (or lack of) between economic growth and equity market returns 2-5
Section 2: China. A new banking crisis 5-7
Section 3: Gold. What price money? 7-9
Section 4: Equity market outlook and recent purchases 9-11

A feeble world economy
There is a bull market in hyperbole: “Slovakia squeezes Europe’s wind-pipe” or “World on a financial precipice”. The reality is more prosaic. In the 12 months to 30 June 2011, world GDP increased 3.5% to a record high both in absolute terms and per capita (after 4.6% in calendar year 2010). True, a few advanced nations fared less well, with income per head 1-2% below its highest level in history, but this was hardly worthy of such shrieking headlines.

Yet all is not well, for three well-publicised reasons. Firstly, much growth since the early 1990s has been fuelled by rising national and personal debt. Total government debt amongst many of the world’s major players is unsustainable relative to GDP. In almost all of the 27 EU nations, Japan and the US, the government debt to GDP ratio varies from 85% to over 200%, and continues to rise. Simply refinancing this debt has proved troublesome, despite miniscule and often negative real interest rates.

The next reason is political. The leaders in these countries are in a “denial trance”. They recognise that debt levels have to be reduced (deleveraging) but without exception, every government has increased expenditure by varying degrees. Some have even tried to portray a lack of financial discipline as a virtue. The last reason lies in the banking system, especially across the EU where banks became highly over-leveraged with inadequate capital, poor management and over-exposure to irredeemably bankrupt national, and personal borrowers.

This summary is uncontroversial and widely accepted. The solutions too are as well-known as they are inevitable: selected sovereign default; the recapitalisation of weaker banks (through merger, nationalisation or private sector fundraising); and the restructuring of government finances (laying off employees and reducing the government’s share of GDP), along with pumping up inflation. The results will be that the global economy and most leading nations will at best expand modestly - well below the 20-year average - and consist of incremental increases with occasional, sharper contractions.

There is little benefit in re-cycling what is known and agreed. The issue is, does slow economic growth matter to investors in listed businesses? For if there is a close correlation, investors should flee stock markets (although where to, given cash and bond yields, is a tough call). If there is little correlation, then better to discuss where to invest rather than irrelevant theory.

Thus this review has four brief sections. The first addresses the key correlation question. Section two covers China, undoubtedly one of the fastest growing nations, now drifting into its own financial crisis. The third section analyses what drives the gold market, whilst the last deals with the outlook for equity markets, largely through recent stock purchase examples....MORE (11 page PDF)