Markets this week have been dominated by two political crises: one big one in the US, and a rather smaller one in Europe.
How to play the US shutdown
The big story of course, is the shutdown of the US government. It’s certainly affecting a lot of people, with 800,000 civil servants sent home without pay.
But as Ed Bowsher pointed out in Thursday’s Money Morning, this is just a sideshow. “There have been similar shutdowns in the past. None has inflicted any lasting damage”.
The real problem is the debate over the debt ceiling – here “the consequences could be a lot more serious”.
The debt ceiling is “the maximum amount the government is allowed to borrow to fund its various obligations”. If Congress refuses to raise it by the middle of this month, “the government will be in a mess. Legally speaking, it won’t be able to borrow money to fund its spending”.
That will have serious knock-on effects. “Companies that are very reliant on the US government, such as Boeing and Lockheed Martin, could be hit especially hard”. On top of that, “if government employees and those on welfare aren’t getting any money, it could hit spending and growth”.
In the worst-case scenario, “the US might default on its government bonds”. If that happens, “holders of Treasuries might ask for their money back, only to be told they can’t have it. The government might even fail to pay some interest payments on its debt”.
Now, “no one knows for sure what would happen if the US were to default”. But it’s certainly not good news for wider markets. Indeed, this could kick-off another crisis “similar to 2008”.
Of course, chances are that a deal will be cut somehow. But as Ed points out, considering the risks (he thinks there’s a one in three chance the ceiling won’t be raised), “investors are way too blasé for my liking”.
Sounds scary. But don’t panic. You don’t need to flog every asset in your portfolio. “The US market looks pretty overvalued just now, but the ones we’ve been recommending that you buy – Japan, Italy, various emerging markets – don’t”.
However you might want to think about keeping some cash to hand. This will protect you from any market related falls and allow you to scoop up any bargains.
Another reason to avoid the US
As Ed points out, US stocks are overpriced. Tim Price told his Price Report readers the same thing. But what makes him think they’re overpriced?
Well, according to Tim, there are two indicators you should pay particular attention to. Firstly, there’s the cyclically adjusted price/earnings ratio (aka CAPE). Regular MoneyWeek readers will know all about this one, as it’s one of our favourites.
As Tim explains, “CAPE is similar to the simple price/earnings ratio, but it’s taken across the stock market as a whole, and it uses an average price over the prior ten years, which smooths out the shorter term volatility and noise”. In other words, you don’t run the risk that you are measuring the market’s value based on one year of freakishly high or low earnings.
The other measure is the ‘q ratio’ – (Tobin’s q). “This looks at the market value of the companies listed on the stock market relative to their replacement cost (ie if you sold all of the companies’ assets and wound them up)”.
Both measures are well above their historical averages. Tim thinks that you also need to factor in interest rates, which can only go higher, and the fact that the market is dependent on central bankers. This makes it hard to avoid the conclusion that “if there were ever a time to have all your investment eggs in one basket, now is not that time”.
Instead you should, “diversify sensibly across asset classes”. While you shouldn’t ditch the stock market, “limit your equity investments or funds to those with compelling valuations and defensive characteristics”. You should also consider “absolute return funds, for example, and real assets, such as gold and silver”.
Tim has much more on his views on asset allocation, and where you should have your money right now, in this Price Report newsletter. You can find out more about it here.
Berlusconi’s gamble reveals euro weakness
The US dollar has been taking a hammering amid all this worry. But it’s not the only part of the world locked in political crisis.
At the start of the week, Silvio Berlusconi engaged in a massive game of chicken with the Italian government. As I said in Monday’s Money Morning, his recent conviction meant that “unless he pulls something dramatic out of the hat, he could potentially lose everything”.
As a result he threatened to pull out of Italy’s “rickety” coalition, bringing down the government and leading to fresh elections.
In the event it proved to be a roll of the dice too far. Thanks to a revolt from within his own party, he was forced to do an embarrassing U-turn and back the government, which easily won a vote of no confidence.
However, as I pointed out, Italy’s economy is “still going backwards”. Negative growth, shrinking sales, high unemployment and a big deficit all suggest that things are far from sorted. The same applies to other countries, with political turmoil in both Portugal and Greece.
This all means that “while the eurozone has managed to stay out of the headlines this year, this might not last for long… One way or another” the Germans “will have to pay to keep the Eurozone together”, probably through money printing.
Indeed, if you look the detail of Draghi’s statement, the European Central Bank (ECB) is already “clearing the decks for action”. At the same time, “the recent fall in eurozone inflation will give the ECB more room to take action”. As a result, “now looks a good time to buy into those markets that have been slapped down by political fears in the region”.
Two ETFs that you may want to buy are the Lyxor ETF FTSE Athex 20 (PARIS: GRE) and the iShares FTSE MIB (LSE: IMIB), which tracks the Italian stock exchange.
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Is energy really that expensive?
The currency and bond markets are not the only things being affected by politics at the moment. Shares in energy companies have been hit by pledges to cap the price of gas and electricity.
However, as our editor-in-chief Merryn Somerset Webb points out, one key fact has been overlooked: our prices are actually not that expensive.
Indeed, as she writes on her blog, “the average bill in the UK is around €1,550. In France it is €2,500 and in Germany it is €3,200. Only in Finland do gas prices come in lower than in the UK, while we are the third-cheapest country in Europe for gas and electricity combined”. Given the pound’s weakness and the renewable mandate, this is “rather amazing”.
So arguably there is no reason to cap prices in the first place. In any case, price controls are “the kind of politics we had thought we were finished with after the 1970s”. While they are billed as “temporary”, Miliband says that they will be extended if companies don’t cut their prices.
This posturing has serious implications. After all, “capital investment in the UK is pitifully low already (largely thanks to the short-termism forced by pay incentives) and this isn’t going to do much to help that”.
After all, “If the energy companies can’t make money, or think they can’t make money”, there simply won’t be enough power. Overall, “this talk of price freezing is a stunt – and a pretty stupid one at that”.
As you might expect, her blog generated a fair few comments. ‘Alastair MacMillan’ agrees that the plans are “economically illiterate” and risk making energy shortages a “self-fulfilling prophecy”. Overall, he thinks that it “sounds like time to buy a generator and some diesel”. However, ‘razor’ thinks that price caps will help “many normal working class and middle class in this country”.
Why you should consider crowdfunding
‘Crowdfunding’ is a buzzword you may have heard around the financial press – but what is it? Ed took a look at the sector in Monday’s Money Morning.
Crowdfunding is where companies raise money from lots of individual investors in small amounts, rather than from a few big investors in large amounts.
While it has a reputation of being highly risky, it is actually “less risky than you might imagine”. It’s true that equity crowdfunding, buying shares in start-up businesses, is only for those who are prepared to lose their investment.
However, debt crowdfunding, which involves lending money in return for interest payments, is somewhat more secure, since you have a more senior claim on the assets.
Clearly, it’s still risky – these companies can go bust. But Ed thinks he’s “spotted a particularly interesting opportunity on debt crowdfunding platform Abundance. This enables you to lend money for solar power projects in the UK, and get a fixed income in return”.
The project, run by Sunshare, involves “solar panels on 20 different buildings in Nottingham. The managers need £900,000 to refinance the panels and it’s easy for anyone to invest. The minimum amount is just £5”.
It’s bit complicated but, “in return for your cash, you’ll get a 19-year debenture (similar to a bond) that will pay out an effective interest rate of 6.65% a year. And you’ll get capital repayments too. So over the whole term of the bond, your effective interest rate is 6.65%”.
Low risk doesn’t mean risk-free. Inflation could reduce the real value of the returns, while deflation could hit Sunshare’s ability to repay the loan. And if something does go wrong with the company, “you won’t get a government bail-out, and you could lose all your money”.
Of course, Ed notes that, “the Abundance platform isn’t the only way you can lend to businesses”. You could also take a look at a website called Funding Circle, which offers “a pretty good return – roughly 5.8% a year – by lending to businesses on the site”.
As an added bonus, “on Funding Circle you’re not tied into a 19-year bond. That means it’s easier to get your money back if you need it. You can also get decent returns from two other peer-to-peer sites: Zopa and RateSetter”.
We’ll be looking at these sites in more detail in MoneyWeek very soon. If you’re not already a subscriber, you can get your first three issues free here.
• Tim Price’s The Price Report is a regulated product issued by Fleet Street Publications Ltd.
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• Tim Price’s The Price Report is a regulated product issued by Fleet Street Publications Ltd.