What Happened? (When the Domestic Became Global)
Occasionally, it's a good idea to get out of town, travel to another part of the world, and sample how others view the issues we often think of as so uniquely affecting our own country. Viewed from France these past two weeks (Paris, Verdun, Nancy, as well as Strasbourg), the concern, of course, is the Greek bail-out and whether the Germans should shoulder the main burden of its financial cost; the ultimate worry being whether the contagion will spill over into the other southern tier countries of the European Community.
The Greeks, for years addicted to government-provided benefits paid for by fraudulent accounting, corruption and accelerating fiscal deficits, are feeling withdrawal symptoms and the realization that the free ride has ended. They face a life of diminished expectations and austerity during the 3-5 years ahead if national bankruptcy is to be avoided (an unenviable prospect if you thought it was your birthright to retire at 55 and collect a pension at your final salary level for the remainder of your life). The Greek pension math just doesn't work: how can one contribute while working an average of $150,000 to fund a lifetime of benefits of $3.4 million? So the big questions today are . . . can the European Union of 27 nations survive the strains of its profligate outliers who have been dubbed, rather unkindly, PIGS (i.e., Portugal, Italy, Greece and Spain), maintain the integrity of the Euro, and unite politically to confront the evolving economic power of emerging China and a struggling once-superpower U.S.?
The EU bureaucracy that has evolved to implement the founders' pan-European vision (part of which is located in a massive complex in Strasbourg) continues to strive to prove its relevance. But rationalizing immigration, agricultural, antitrust, environmental, and trade policies for 27 national entities, all of which start with traditions (never mind inbred animosities) often precluding compromise, is a difficult task for mere functionaries. If one agrees that economics underlies all politics and that, as Tip O'Neill used to lecture, all politics is local, then the EU's path toward a more perfect economic and political union will continue a difficult saga.
Today, this internal EU governance and fiscal struggle is at the heart of our current global financial market turmoil. Abetted by the uncertainty growing out of the UK parliamentary election results, high frequency program trading on U.S. exchanges, and technical computer glitches (some would suggest a cyber attack) in our electronic investment marketplace, another "perfect storm" last week once again conspired to undermine investor confidence. Today's psychological crisis may take time to play itself out. The global equity market correction may continue while Eurozone sovereign debt default risks are assessed by investors.
As we suggested earlier in the year, world-wide equity market expectations may have already exceeded realistic earnings recovery possibilities in the near term; and if known cash needs are pending short-term, we would set the reserves aside now. Although the near term may be a bit uncomfortable, longer-term a full weighting in U.S. and international equities should be maintained because of the expected strong earnings growth rebound projections in our strategic model for the next 18 months.
The U.S. Is Not Europe and Certainly Not Japan (At Least Not Yet)
But with our Grecian-style government deficits and Federal debt-to-GDP ratio approaching 90% (with little indication of the political will required to rein in entitlement spending), can we avoid a downgrading of U.S. sovereign debt and the global financial market chaos which would surely follow? For investors today, it's important to distinguish short-term prospects from later probabilities. Financial markets tend to focus on the next 12-18 months, unless an issue like the Greek tragedy intrudes. Today, the U.S. economic recovery seems to be gaining traction and global equity market valuations appear to be reasonably discounting 2010-2011 earnings prospects. When the presently volatile emotional fog lifts for yet-to-be-fully-invested-portfolios, this current sharp price correction may well prove to have been an intermediate buying opportunity.
Long term, however, the essential issues would continue to appear to be more political than economic. This makes the potential outcome far less certain for U.S. investors whose timeframe is a secure retirement lifestyle. If an inflation-adjusted annuity from current investment resources is the goal, then in the marketplace both capital and labor need reasonable flexibility to seek optimal returns. The Europeans and Japanese have abdicated these choices to their politicians and bureaucrats with verifiably sub-optimal outcomes. The American psyche, when faced with such a hand-off, seems less likely to entrust such power to public servants. In the long run, how this political struggle plays out will have a profound impact on the return investors earn on their financial resources. If a reasonable return on one's portfolio capital is the objective, elections do matter.
Your thoughts, comments, questions are all welcome.
Jim Joslin is President of TFC Financial Management, a Boston-based money manager.
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