Investment Commentary – July 2015

“It’s Déjà Vu…All Over Again”

Noted for its wide-ranging applicability, the “golden ratio” appears to transform the complex into the simple. Take, for example, the intricacies of a spider’s web or the spiraling arms of the Milky Way galaxy. Quite elaborate, yet their construction is seemingly governed by a straightforward, common design – a recurring pattern throughout nature. In an effort to gain an investment edge, some analysts even turn to these patterns (also known as Fibonacci sequences) in an attempt to forecast market movements.

Of course, using history as a crystal ball flies in the face of conventional investment theory. As any mutual fund material will remind you, past performance is not indicative of future results. Nonetheless, as investors continue to fixate on Greek economic woes, there are a number of recurring themes and historical parallels emerging. It seems that while history may not repeat itself, it does sometimes rhyme.

This year began with equity markets continuing to trend higher, largely due to the efforts of central banks. As noted, the rally was interrupted when Greek solvency issues resurfaced in the second quarter. After much political drama, Greece received the financing required to stave off calamity [at least for the time being], in return for promising further austerity measures. This leaves nearly all investors confused about the future, given that the consensus view is that Eurozone leaders merely “kicked the can down the road.”

This describes developments thus far in 2015, although it could have just as easily been copied and pasted from a 2010 or 2012 market report.






The good news is that we have been here before. Taking a long-term view, Harvard University professor Carmen Reinhart points out that history provides numerous examples of countries that successfully dealt with sovereign debt overhangs. Encouragingly, there are common themes running throughout. Combating rising debts by demanding more austerity only exacerbates the problem (see “The Paradox of Thrift”). What is required is some leniency from creditors, which allows a country to focus on resurrecting economic growth.

Greece stands as the most recent instance, where a 53% write down of debt in 2012 led to a nascent economic recovery. However, the most notable example from the past is Germany, which literally rose from the ashes six decades ago.

The top left picture shows Hermann Josef Abs, head of the German delegation, signing the London Agreement in 1953. This treaty effectively halved the debt owed to Germany’s foreign creditors and proved to be an underpinning for the country’s road to recovery. The Brady Plan in the 1990’s provided a similar experience. Following years of solvency issues and little economic growth in Latin America, creditors agreed to cut debt burdens of countries in this region by an average of 36%. This relief enabled governments to focus on long-term economic growth rather than the short-term demands of bondholders.

While the way forward seems pretty clear, history also shows that it can take a while for creditors to come around. For instance, the London Agreement came after a long era of turmoil in Europe, while several years of half-measures preceded the Brady Plan. After more than a half decade of eleventh-hour deals and emergency summits, this appears to be the strategy of European Union leaders today.

There are, however, signs of progress. Apart from Greece, most Eurozone economies have turned the corner. Major countries are registering modest economic expansions and, similar to the US experience a few years ago, monetary stimulus by the European Central Bank has reduced the threat of spiraling deflation. Most importantly, foreign banks and private investors have significantly lowered their exposure to Greece, suggesting that the risk of financial contagion is also lower. While the markets could certainly experience heightened volatility going forward, we believe that any further Eurozone “drama” is unlikely to have a meaningful impact on your portfolio’s long-term returns.

It has been said that the best way to determine the future is to create it. Although it is extraordinarily difficult to predict political machinations or short-term market movements, at T.E. Wealth we believe that there are strategies that will enable you to reach your financial goals over time. For more than forty years, we have treated investment management and financial planning as a marathon, and not a sprint. In our view, investors who maintain a long-term plan and a diversified portfolio have historically come out ahead.

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