Global markets posted a fairly flat week. The big news for the week was the Greek debt restructuring that was approved on Friday. Private holders of Greek bonds, who for the most part are banks, hedge funds and the like, agreed to a “haircut” of up to 74%. Greece had as much as 85% of the bond holders agree to the debt swap, but had to use a collective action clause (CAC) to force the hold outs to enter the agreement. The indirect consequence of triggering the CAC is that by forcing holdouts, it has been declared a “credit event”; credit event is a fancy way of saying default. The significance of the credit event being declared is that now those people that insured their investment in Greek bonds through the use of “Credit Default Swaps” (CDS) can collect their money. A CDS is simply insurance against the default of a bond. The problem in the recent past, specifically with AIG insurance company, was that the companies that insure the bonds (AIG) did not have the money to payout in the event of a default. So, it remains to be seen if the $3 billion in CDS’ held on Greek bonds cause trouble.
The problems in Europe are far from over. The banks are still insolvent; we know this because 800 banks took the recent lifeline of money from the ECB. The other problem that now arises is what will happen when another heavily indebted nation like Spain, Portugal, or Italy wants to erase some of their debts like Greece? I think the term is moral hazard?
I am going to start this section with a few definitions of speculations. First, I will turn to Merriam-Webster’s dictionary:
Assumption of unusual business risk in hopes of obtaining commensurate gain.
Webster’s definition strikes me as a little stiff. Let’s now try the definition put forth by the famous value investor, and Warren Buffett teacher, Benjamin Graham. For those who do not know, Benjamin Graham literally wrote the book on stock analysis, ‘Security Analysis.’ From Mr. Graham’s book, we get his definition of speculation:
An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.
Two of the more common items I have heard from the financial media has been about the evil speculators in the oil markets driving prices up; similarly, there have been a number of folks stating that we investors are all speculators now. If the speculators are bad, and we are all speculators, are we all bad? Let’s back up. I find it disingenuous for media commentators to jump all over the boogeyman speculators for driving up oil prices, but not a word when gold or silver prices get chopped at the knees four minutes before a significant news release from the Swiss national bank. Also, consider the farmers and airlines that have to “speculate” on food or gas prices to hedge against losses. And finally, consider that very few people blame speculators when oil prices go the other direction and plummet. We all have to remember there are two sides to every trade and, apparently, nowadays the speculators are only the ones who are buying up gas prices.
I will get more to my point on speculation. I do believe there is some truth to the comment that we are now all speculators. I think this for three reasons – First, in my opinion, Benjamin Graham’s definition is pretty accurate. Second, most assets today are moving together, the holding period for stocks has dwindled to an average of about a year, and most investors are paying more attention to what central banks are doing than the fundamentals. Lastly, the record low interest rates are causing distortions in the market, and causing (pushing) investors to take much higher risks than they normally would take. This last sentence ties together the two definitions presented above – unusual risk, little analysis and little safety
So long as the central banks of the world are calling the shots, all investors are playing a dangerous game. The longer rates are held low, the longer failures of certain businesses (countries) are not aloud, and the higher the debts we carry, the faster the wall will arrive.
I do my best to look for sound investments for clients and avoid speculative areas. In the current environment of inflationary money printing, bailouts, and indebtedness, safer ground can be found in resource-based investing, high-quality dividend paying stocks, precious metals, select areas of the bond markets, and short-term cash holdings. These items are not only the least speculative in my opinion, but also historically sound investments for similar periods in history. As a side note, I do think a sprinkle of speculation is ok for those willing to assume the inflated risks, but a strategy must be present to capture gains, or cut losses, in these manic markets.
Do you have an investment strategy that seeks to protect your portfolio against volatile economic conditions? Call me to schedule a free review of your current investment portfolio – 913.402.6099.
John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals. For more information, visit http://www.chladekwealth.com.