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Cenkos News 21st May 2012 Long Hot Summer As we pass through May, it appears that Europe could be in for another “long hot summer”. In the 1958 movie, the interrelationship between family members, residents of Frenchman’s Bend and newcomer Ben Quick (Paul Newman) is complicated; but nothing in comparison to the relationship between members of the Eurozone! The movie concludes with father, Will Varner (played by Orson Welles) and son reconciling after Will was trapped in a barn that had been set alight by his son. In Europe we certainly have the environment for the fire, but can we find reconciliation? It'll be a long, hot summer And it's already 95 degrees in the shade With apologies to Girls Aloud Marine Le Penn Celebrates: The Guardian Source: Cnn.com Rise of the Greek far right So far this summer we have had the collapse of the Dutch Government, the fall of the centre-right (Sarkozy), rise of the left (Hollande) and also the far-right (Marine Le Pen) in France, the rejection of austerity (big surprise!) and the inability of Greece to form a Government. This leaves two key Eurozone countries without leadership, another ablaze and plenty of others (Spain, Portugal, Italy and Ireland) on the brink. GaveKal published a great quote from Michael Cembalest the CIO of JP Morgan recently “by the time a member country see a GDP decline that rivals the US Great Depression, suffer youth employment greater than 50% and elects communists and neo-nazis to its Parliament, something has gone horribly wrong”. BBC 2 recently aired “Michael Portillo’s Great Euro Crisis”, which I found fascinating because it highlighted, despite the pain and austerity imposed on the populace (from central bankers to Greek electricians), just how pro-Euro members of the Eurozone remain. After much discussion – during which Portillo inevitably highlighted the intrinsic problems the Euro faces – he concluded each interview by asking the interviewee if they would prefer the Euro or the Drachma/Deutschmark. In every case but one, the answer was the Euro. This was a revelation for me and I can only assume that it means that a breakup of the Euro will be resisted far more vehemently than one might rationally expect – there is a huge emotional attachment. From our perspective it is difficult to see how the Eurozone will remain together. In simple economic terms, never mind the cultural challenges, the differences are clear to see. Germany recently posted a positive Q1 GDP figure of +0.5% whilst most other EMU nations saw declines Germany has the lowest level of unemployment for 20 years, whilst Spain has 50% youth unemployment and Greece has ever-increasing queues for soup kitchens. Germany’s industrial powerhouses are benefitting from globalized revenue streams whereas the PIIGS have very little in the way of exports. In addition, the revenues that they do have are made uncompetitive by the strength of the Euro (albeit declining of late) and the high cost of labour. Germany has reduced its overall cost of labour substantially over the last 15 years, while elsewhere the trend has been in the opposite direction. Surely le grand projet is doomed? And there lies the problem: nobody knows what’s going to happen and the choices look stark. A break-up of the Eurozone would, we are led to believe, be a catastrophe. The corollary, Euro survival, can surely only be accomplished by the ECB printing trillions of Euros. And yet such an enormous injection of borrowed cash, while giving the markets one hell of a sugar rush, would still need to be paid back – but by whom? Across the pond, the US economic data hasn’t exactly been rosy, but it has been steadily improving. This coincides with good corporate earning numbers for Q1 which also, by and large, beat analysts’ estimates. Put simply, it isn’t all doom and gloom. As we have pointed out many times, we do not know how the game will play out. Indeed, we could easily argue that a break-up of the Euro would be a good thing and that markets would react positively. But who’s to know? It would merely be speculation. For us, investing is not about guessing and we continue to stick to our knitting: identifying and investing into sustainable, long-term, investment themes via funds, stocks and bonds. Unfortunately, we have to accept that any returns will be buffeted by a fitful market as investors fluctuate between greed and fear, driven mainly by the relentless news flow from Europe. On the whole, the investment strategy for our portfolios remains largely unchanged from earlier this year. While there is a good likelihood that the summer will be both long and hot, we believe that it is important to stay focused on fundamentals: to hold assets that offer the potential for strong long-term growth and to buy them at good prices. Trying to second-guess or time markets in such a politicized world is futile (although undoubtedly some will get lucky) and, of course, you stand as much chance of losing money as you do making it. In our opinion, that isn’t investing. Balanced Portfolios* Our balanced portfolio has been reasonably steady since equity markets began rolling over on European concerns at the end of March. Thus far, it has fallen by approximately half as much as the MSCI World index, which was down by about 6% mid-month (May 14); the FTSE 100 was also down by about 7%. Obviously, giving back some of this year’s gains is irritating, but the portfolio remains firmly in positive territory year-to-date (4%+) (again this is based on a mid-month value) whereas the FTSE is now firmly in negative territory. As has been the case for some time now, the core of the portfolio is focused on the reliable cash flow of great companies via their corporate bonds and equity. We have a 30% weighting to corporate bonds and a 30% weighting to core (typically large-cap, global-brand) equities. A further 30% of the portfolio is allocated to equities that focus on our central themes such as healthcare, technology, emerging markets, commodities, Japan, and emerging-market debt. Our portfolios have benefitted in the downturn because we have avoided exposure to the sectors – financials and commodities – hit the hardest. We have very little financial exposure (no equity of western banks) and have reduced our commodity weighting to approximately 5%. On the whole, we are relatively comfortable with this stance (albeit that is never particularly restful in falling markets!) and are preparing to pick up some bargains in our preferred sectors, particularly global brands. Source blogs.dogtime.com Cautious Portfolios* Our cautious portfolios have had their ‘risk dial’ turned down for some time. We have concentrated on where we see the most value (relative to inflation) coupled within the least amount of volatility. We see the most compelling value in corporate cash flow and have positioned our portfolios towards investment-grade corporate bonds and blue-chip equity dividends. Where possible, we have reduced direct Euro currency risk. However, the global nature of the businesses we invest in means that they will inevitably have at least some operational exposure. We cannot decouple our investments completely from the Eurozone as it navigates its way through these difficult times. So we have sought comfort in the fact that we have aligned ourselves with businesses that have very strong balance sheets, products that are in demand, global exposure and management that continues to crack new markets. The key to these investments is operational cash flow. While emotion will continue to whip stock prices, cash flows will underpin the true value of the company. Once serenity returns, we expect to see stock prices reflect the fundamentals. From an asset class perspective, we are overweight investment-grade corporate bonds – touching 50% in most portfolios. Our second largest position is blue-chip equities at 30%, with the remainder split between emerging-market and high-yield debt and sovereign bonds. The strategy thus far has reduced portfolio volatility while producing an income stream that competes with the current rate of inflation (in sterling terms). However, in the darkest hour of any crisis there will come a time when riskier assets look too compelling to resist. We are some way away from this at present, but we will be prepared to reduce our investment-grade positions and take positions in emerging-market and high-yield debt when the opportunity arises. This move will increase the income yield while giving us quality assets that we have purchased at a reduced price – thereby increasing the probability of capital gains. Growth Portfolios* Since the end of March our growth strategy has experienced an elevated level of volatility as global equity markets have fallen approximately 8%. Growth portfolios always have a higher weighting to equities in order to capture long-term growth opportunities so will inevitably also tend to experience greater swings in performance. We believe that not all equities behave equally and that it is possible to identify certain companies, sectors or regions that demonstrate defensive capabilities, e.g. bluechip companies with global brands, attractive valuations and strong cash flows. During times of political and economic uncertainty, such companies can offer some protection from tumultuous markets. We also have a weighting of approximately 30% to investment-grade corporate bonds, which provide a yield in excess of the rate of inflation and help to protect capital in difficult market conditions. Away from the Eurozone, economic data remains encouraging and we intend to use further market weakness as an opportunity to reduce cash levels in favour of over-sold, good quality companies. Moreover, our (very) long and (very) hot summer will undoubtedly provide plenty of opportunities! Mark Bousfield Cenkos Channel Islands Investment Management Ltd. * Portfolio commentaries reflect our model portfolios and are not representative of all mandates. Cenkos Channel Islands is a trading name of Cenkos Channel Islands Limited (“CCIL”), Cenkos Channel Islands Investment Manage ment Limited (“CCIIML”) and the registered business name of Cenkos Jersey Limited (“CJL”). Cenkos Investment Management is a trading name of CCIIML. CCIL is licensed and regulated by the Guernsey Financial Services Commission and is a member of both the London Stock Exchange and the Channel Islands Stock Exchange. Registered Office: PO Box 222, Level 5, The Market Buildings, Fountain Street, St Peter Port, Guernsey, GY1 4JG. Registration No. 42906. CCIIML is licensed and regulated by the Guernsey Financial Services Commission. Registered Office: PO Box 222, Level 5, The Market Buildings, Fountain Street, St Peter Port, Guernsey, GY1 4JG. Registration No. 49397. 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