Musings of a cynical optimist

Despite the endless gloom a little ray of sunshine is surely present in these markets.

PORTFOLIO POINT: I’m going against the doomsters forecasting the end of the world. I can see a ray of sunshine in the markets.

In all of my 50-some years of direct involvement in investment markets around the world, I have never experienced an environment as negative as the present one.

The messages of doom and destruction are relentless. On a typical day l receive, excluding those from friends and family, about 60 emails – 50 of which relate to investments and markets. On a good day for the markets, about 95% of these are full of gloom; on a bad day the same proportion are full of doom '¦ The other 5%? At best neutral!

To escape this constant mental bashing, I now enjoy reading the remaining 10 or so emails that, typically, offer great deals on Viagra, pleasant letters from Russian/Polish/Albanian women who would like to test my prowess in various areas and even those from the generous folk in Nigeria who wish me to have some of their millions.

Apart from these minor distractions, the world is seemingly fraught; there is no respite.

Why then, I ask myself, is the stockmarket still so “expensive”? Why is anyone buying anything at all? With such negativity why have stockmarkets not collapsed, given the adage that the market anticipates events some 12–18 months ahead? Then, I ask myself ,why is the VIX Index of the CBOE, which measures volatility (ie, fright and panic), consistently in the low 20s, whereas at the height of the GFC in 2008 it hit 60? In fact, over the past five months, as the European crisis worsened, the VIX index halved.

There is a clear mismatch here. Either the markets are ignoring the situation and will soon melt down, or they are telling us that “'she’ll be right” and she will be.

So how do I resolve the dilemma of choosing sides?

Well, let me examine the mystery.

With almost 100% of pundits forecasting – at the very least – a substantial recession if not a major global depression, investors have not heeded their warnings. I have to say that I cannot readily dispute much of what they say; Europe is an almighty mess, drastically overloaded with debt, sluggish economies and facing the necessity to – most urgently – continue with ever tougher reforms.

The US is in (relatively) better shape, a major reason being that Americans attacked the problem early and they have a single central bank that dictates to the whole country (“go hard, go early and go households” sound familiar?) Oh, and this is an election year.

So, is there hope for the EU? I have to say that they appear to understand what needs to be done, and are moving towards it, albeit millimetre by millimetre. There is the acknowledgement now that: the crisis is massive; resolving it is ever more urgent; and Germany and France are steadily turning the screws on the others, the UK excepted. It remains to be seen whether a major breakup can be prevented (I think it can) and, if a few countries do go (Greece first) what the collateral damage will be (I think not too bad).

Second, despite massive sovereign debt loads which, on the face of it, cannot be repaid, there is, in fact, no shortage of cash around the world. Indeed, corporations, banks and individuals are drowning in it – banks because of the largesse of governments, corporations because of tight management and efficiencies, and individuals who have been selling down their portfolios and have largely changed from being investors to being savers. The problem is therefore not one of liquidity, but one of confidence; the reluctance to lend to those who actually need financing, doing so only where there is a perception of little or no risk.

And here lies the nub of my reasoning for not joining the ranks of the doomsters. Look at the US situation: since its credit rating was downgraded last August (implying greater risk), there has been an unprecedented flood of money into US dollars, and interest rates have dropped substantially, thus providing obvious benefits to its economy. Without oversimplifying the reasons that relate, in part, to relative risk, we have just seen that anticipation of a downgrade (after a short knee-jerk reaction) was by far worse than the actual downgrade – almost a sigh of collective relief. This has exposed another major market factor which we often forget, but which is a very old adage, that the rumour is often worse than the fact.

So, looking ahead to the EU situation of multiple downgrades, the rating agencies are no longer being taken as seriously as in the past and for very good reason. They failed abysmally to call attention to the myriad developing financial problems; they should, as far back as 2003, have been raising alarms. In fact, just the opposite occurred. They gave their blessing to the very instruments that caused the GFC by rating them much too highly.

Talk about a conflict of interest – being paid by the producers of those instruments to rate them! As an aside, I am flummoxed that no one has sued the rating agencies for some of the trillions of dollars lost in and after the GFC as a direct result of their misleadingly sanguine ratings. I learned about their ineptitude and lack of depth first-hand back in the mid-1980s when I was raising fixed income funds in the US and Canada for investment into Australia.

So my hope is that in the post- downgrade-no meltdown environment, those with money will be less reluctant to lend and the market players themselves, seeing some hope for a recovery, will be more confident.

And I also hope that the pundits will slow down on forecasting the end of the world. After all, this has been confidently forecast by many for thousands of years but has not happened.

Oh, one final thought: I could be wrong.

Laurence Freedman has spent his entire career in investment markets, initially with the Gold Fields Group, then BT Australia.

In 1980 he founded the EquitiLink Investment Management Group, which grew to a global company with operations around the world and over $3 billion under management when sold in 2000.

He was a member of the syndicate that bought the Ten Network, of which he became a director, taking it out of receivership and helping to make it the most profitable media network in Australia for some years, before selling it in 2004.

He currently manages his private investment portfolio of international shares, property and fixed income securities and mentors a number of resource, biotech and technology companies.

He is chairman of The Freedman Foundation, a philanthropic foundation that assists and supports young Australians and finances a broad range of medical and scientific programs and organisations.

In 2001 he was awarded the Order of Australia for service to the community, to medical research, the arts, and to business and investment in Australia.

Laurence Freedman will be an occasional contributor to the Eureka Report when, according to him, “I have something to say.”

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