What if Keating is right?

PORTFOLIO POINT: Whether you are a bull or bear depends on which way you see the European game panning out.

At our first Eureka Congress in Melbourne yesterday a multitude of Eureka readers came up to me concerned about the News Limited takeover. (In case you missed it, our holding company AIBM was bought by News Limited earlier this week).

Would my writings be affected by the new owners? Let me assure you that my independence and that of Alan Kohler and all the Eureka writers will be totally unaffected by the new owners. I personally negotiated a three-year contract with News Limited CEO Kim Williams and he wants us to maintain our separate identity and independence, which is necessary for our publication to flourish. There is no way I would negotiate a three-year contract with anyone if there was the slightest chance that I would lose my independence. The Eureka team that started this publication are staying for the long run: Alan and James Kirby, managing editor, have also signed extended contracts. Alan will write about this matter further in tomorrow morning's email.

I will be attending the Sydney Congress tomorrow, and at both events I am looking at how I should invest some of the proceeds of the sale. I will write about my conclusions next week.

At tomorrow’s conference, Eureka readers should listen carefully to the reasoning of Paul Keating. The former Australian Prime Minister and Treasurer has concluded that the only way out of the European mess is for Greece to leave the euro. He believes that it is not possible to make the adjustments required to gain competitiveness by decimating people’s standard of living. The way to make that adjustment is via the currency, which means Greece must leave the euro.

If Keating is right that this is the likely long-term solution to the problem, then it will cause great turmoil on markets. A fall of 10 or 20% would be on the cards. Paul Keating also expressed great reservations over the US economy and it was those reservations that Wall Street embraced last night.

But other speakers at the congress believe that it is much more likely that Germany will move in behind the European borrowings and create confidence in euro bonds. So far the Germans have refused to commit the great wealth they have built up in post war years to saving southern Europeans and Keating doesn’t think they will do it.

I don’t claim to have a crystal ball in this area, but if you asked my opinion I would be on Keating’s side. However, I recognise the Germans have already committed substantial funds to saving the euro, and it gains great benefit from the fact that the euro is much lower than it would otherwise be due to the Greek, Spanish and Italian presence. And a split in the euro would cause monumental banking losses, much of which will be centred in Germany. If Germany does commit its funds to backing European borrowing, this will be a strong bull point for the market.

What makes me think that Europe will end badly is the ad hoc nature of the decision-making process that we have so far seen. For example, an earlier European rescue effort channelled money into Spanish banks and they were encouraged to buy Spanish bonds. Then the next rescue attempt money was loaned to Spain, ranking ahead of the Spanish bonds that the banks had been buying. As a result the bond prices fell and the banks losses were compounded.

In the total scheme of things this is not a killer blow, but it shows that there is an element of panic in the decision-making process and not enough long-term thinking. Over in the US earlier this week the speculation of another quantitative easing was driving markets. But last night’s Wall Street fall was a recognition that while quantitative easings are great for speculators they have only a marginal effect in the real economy. And I suspect the US Federal Reserve must now understand this and be at least conscious that every time they undertake such an exercise much of the money ends up in commodity speculation and in turn pushes up the costs of oil and other products, making life tougher for the average American.

After the presidential elections, America faces severe spending cutbacks which have already been legislated for. If these cutbacks are not reversed, then the US will encounter a downturn that will affect stockmarkets. Last night’s fall was linked to this effect. Longer term I believe the USA will undertake an enormous program of investment in gas reticulation as they harness the wealth of the American shale and coal gas deposits to propel their transport vehicles and develop an active chemical industry. In the process they will also reduce their carbon output. But, for the moment, whether you are a bull or bear depends on which way you see the medium-term European game panning out.

Finally, self-managed funds have poured large sums into bank term deposits. In my fixed interest portfolio I found that given the Commonwealth government guarantees that are part of bank term deposits, those yielding close to or above 6% were very attractive. But now shorter-term bank deposits are falling below 5%, so it is becoming increasingly difficult to get a 5% return on bank deposits. Once that happens they become a less attractive investment for long-term interest-bearing security segments in portfolios.

Investors who are keeping money in cash to later invest in equity securities will be less concerned. It is worth researching the second rank banks for interest rate bargains while remembering to keep exposure to below $250,000 to be eligible for the government guarantee. In an earlier Eureka edition I mentioned the Rabo Bank (link), which is now offering 5.8% for five-year money. That is substantially better than the rates being offered by the larger banks. Given the government guarantee, those interest rates are very attractive and the bank has also slightly lifted its five-year rate in the last few days.

Australian banks are priding themselves on how they have boosted the amount of funding that Australian deposits finance. But, in my view, they have quite a surprise coming to them as self-managed funds begin to look elsewhere, including assembling portfolios of corporate bond and mortgage securities.

Next week I will combine the lessons I have learned from both the Melbourne and Sydney congresses, and I look forward to seeing many readers in Sydney tomorrow.