Investors should stay defensive

DESPITE having spent US$10 trillion in trying to stimulate their economies and fighting financial crises, central banks are still faced with the prospect of slower global growth and loads of debt.

“The tidal wave of cheap money has played a huge role in generating growth in many countries, cutting unemployment and preventing panic.

“But it has not been able to do away with days like Monday (June 29 – banks were closed in Greece on the eve of its default to the International Monetary Fund), when fear again coursed through global financial markets.

“The main causes of the steep declines in stock and bond markets were announcements (relating to inability to repay debts) out of Greece and Puerto Rico.

“And in China, the precipitous declines in its stock market were also a sobering reminder that stubborn problems lurked in the global economy,” said the New York Times (NYT).

Both Greece and Puerto Rico are extreme cases, but high borrowing, either by corporations or governments, is also bogging down the globally significant economies of Brazil, Turkey, Italy and China.

And economists say that central banks and their whirring printing presses can do only so much to alleviate the burden, said the NYT.

Central banks can make debt less expensive by pushing down interest rates. Crucially, though, they cannot slash debt levels to bring much quicker relief to borrowers. In fact, lower interest rates can persuade some borrowers to take on more debt.

Many countries are now in a position where their governments and companies live in fear of an increase in interest rates.

Forgiving debts is another way to lighten the dead weight on economies. Writing off debt can hurt banks, but defaults can also clear the system of doubtful loans and accelerate a recovery. But lenders are not always willing to give big breaks to borrowers, said the NYT.

No doubt people are attributing the global markets’ fall to the debt situation in Greece.

“Forget Greece ... While the world may be fixated on the fiscal and political challenges confronting Greece and the European Union, it’s the US$2 trillion loss in the market value of China’s mainland shares and tumbling share markets around the world that should have investors worried and propel them into action, said the Sydney Morning Herald (SMH), quoting a report by Societe Generale Cross Asset Research.

Quoting analyst Andrew Lapthorne, the SMH said losing money was “inevitable” for investors this year as high asset prices were constrained by weakening economic growth and falling company profits.

“Losing the least amount of money may be the best source of success this year,” Lapthorne was quoted as saying. “The slowing global economy is the elephant in the room.”

Societe Generale’s report came less than a week after Gavekal Capital issued a stark warning about a broad equity markets correction over the past 200 days, the SMH noted.

About 42% of the MSCI World Index’s stocks retreated more than 10% off recent highs, putting them into a technical correction. The MSCI Pacific Index featured the most stocks experiencing a correction, said the SMH, quoting analyst Eric Bush, with 46% compared with North America’s 43%.

The MSCI Europe had just over a third of its equities, 36%, in a correction. And the number of stocks in the MSCI World Index that have entered bear market territory is also growing, with 15% of shares down 20% off their peaks, including nearly one in five of the index’s North American stocks.

Emerging market growth is also slowing. The International Monetary Fund warned in April that global economic growth would improve only slightly in 2015.

Following Britain’s tough rule on bankers’ bonus clawbacks, the US Securities and Exchange Commission (SEC) has proposed a rule requiring senior executives of companies that publish faulty financial statements to give back some of their compensation as punishment for the accounting missteps, said the NYT.

The rule, required by the Dodd-Frank financial overhaul law, which the US Congress passed in 2010, is aimed at increasing accountability within corporate America and focuses on executive bonuses, also known as “incentive-based compensation.”

The size and payment of bonuses typically depend on whether a company meets or exceeds certain financial metrics, like stock price performance or earnings. As it stands, an executive may get to keep a bonus even if the company artificially inflated those metrics and then corrected the missteps by issuing new financial statements, said the NYT.

The new rule would enable a company to “claw back” bonuses when the financial statements have been restated.

“These listing standards will require executive officers to return incentive-based compensation that was not earned,” SEC chairwoman Mary Jo White was quoted in a statement. “The proposed rules would result in increased accountability and greater focus on the quality of financial reporting, which will benefit investors and the markets.”

The fact that there is a limit to what central banks and governments can do in the face of slowing economic growth and debt piles, indicates to investors that they should not drive financial markets to dizzying heights.

Against fundamentals, the fall in the markets can be pretty steep and potentially damaging.

With reports warning of the potential loss of money this year, investors should look to stay defensive as well as undertake risk allocation and diversification.

Soon, “bonus” in Britain and the US will become a well-earned concept where one can take pride in bringing home a clean and well-deserved reward for true and hard work.

The authorities are making sure that the quality of earnings and financial reporting reflect the true state of affairs at banks and companies and executives responsible are deserving of the rewards for that.

Columnist Yap Leng Kuen is reminded that depending on how one looks at it, money can be the source of evil, stress and happiness.