Each week, a professional investor tells MoneyWeek where he'd put his money now. This week: Simon Marsh, parner with Killick & Co.
European politics continue to take centre stage with Greece and Spain dominating the headlines. Aside from the impact this crisis is having on markets there is also the enormous social cost. Youth unemployment has passed 50% in Greece and Spain, which is stoking a rise in political extremism across the continent, as disenchantment with mainstream politics grows. This, of course, is all the more ironic when you consider that the euro project was designed to foster harmony.
Whatever direction the crisis takes now, the costs for Germany will be high, and the free ride it has enjoyed over the last decade by attaching its export machine to an artificially competitive exchange rate is over. Germany must now settle the bill for the advantage it has enjoyed. For the project to continue, it will have no option but to support the direct re-capitalisation of much of Europe's banking system and commit to some form of debt mutualisation. Without this, it is difficult to see how the euro in its current form can survive.
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The problem for the market is that the German public does not support such largesse. Angela Merkel will therefore do everything to avoid settling the bill' for the rest of Europe until after the next federal election, which under German constitutional law can only be held between 27 August and 27 October 2013.
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In the US and UK, the longer-term objective (and only viable policy option) will be to keep interest rates artificially low in order to reduce the real debt burden through inflation. Holders of government bonds stand to take much of the pain and the adjustments required to bring debt-to-GDP ratios back to manageable levels will take decades.
However, it is worth remembering that we have been here before. In 1946, Treasury yields stood at 1.5% and remained low until the early 1950s to enable the government to finance the debts accumulated as a consequence of the Second World War. Inflation was then allowed to do the heavy lifting and, by the early 1980s, the US government had managed to reduce the debt-to-GDP ratio from 120% immediately after the war to below 40%.
For equity investors, the coming months are likely to remain volatile and unpredictable, but we sense we are edging closer to an inflection point, and if history does indeed repeat itself, patience is likely to be rewarded. Here are three shares I expect to outperform in the current environment.
Amlin (LSE: AML), on a prospective yield of 6.5%, is a non-life and reinsurance underwriter on the Lloyd's market. The shares offer a straight play on hardening insurance rates and shouldn't be too impacted by a deterioration in the macro environment.
Rolls-Royce (LSE: RR), on a prospective yield of 2.2%, is the pre-eminent manufacturer of aero engines. It will continue to benefit from one of the world's most enduring growth stories air travel. The company's long-term maintenance contracts also provide the group with an unusually high level of earnings visibility.
BAT (LSE: BATS), on a prospective yield of 4.2%, is a cigarette manufacturer with a truly global franchise, offering high barriers to entry (advertising is banned) and a defensive earnings stream.
