Exclusivefocus Summer 2012.pdf - National Association of ...

investingPIIGS on the Wing (and other sightings)By Marcus BrudererImay be dating myself a little bit herebut I remember Pink Floyd’s 1977 album“Animals” with songs titled “Pigs”and “Pigs on the Wing”. The four bandmembers must have known somethingwe are only now beginning to realize.Government Deficitsand Public Debts35 years later we look at a number ofcountries, namely Portugal, Ireland, Italy,Greece and Spain – now commonly referredto as PIIGS – dominating muchof the economic news because theirgovernments’ spending habits, whichhave caused their national debts to reachcritical levels. The European Union hasbeen struggling for the better part of twoyears with the crisis and there is no endin sight.The key factors being considered aretheir respective budget deficits as a percentageof the Gross Domestic Product(GDP) and the government debt as apercentage of the GDP.The obvious problem for Greece andItaly are the very high levels of governmentdebt at 120% (Italy) and more than160% (Greece). Adding to the pain isGreece’s budget deficit of nearly 8% ofGDP. Riots have become a regular occurrencethere and one retiree even sethimself on fire publicly because of hisdesperate situation. There are eerie similaritiesto the Argentinean default in2001, which led to widespread turmoil inthat country.The European Union is trying veryhard to avoid a spread to other countries,most notably Spain and Italy as they representmuch larger economies, to keepthe situation under control. But early lastmonth, countries in the Eurozone foundthemselves approving a bank rescue planthat could cost up to $125 billion to bailout the Spanish banking sector.What should very much concern usis that the PIIGS could take wing andland in our own front yard. As a matterof fact, the U.S. is not in a much betterposition than some of these countries(see chart below).Low Interest RatesWith budget deficits projected to continueat the current pace unless drasticmeasures are taken, the mid to long-termprospects for the U.S. economy becomerather clouded.Bill Gross, Warren Buffet and LarryFink have contrasting views of how toposition their investments. Bill Grossbought back U.S. Treasuries for the bondmutual funds and ETFs he is managingat PIMCO (after having sold themin the spring of 2011). He believes thatinvestors will favor U.S. Treasuries overother countries’ debt in light of the ongoingtroubles in Europe.While inflation is not perceived asa current threat, there may be externalfactors that could lead to higher bondyields. Except for Ireland, which is makingprogress towards stabilizing its fiscalposition, the other PIIGS countrieshave seen rising yields being demandedby investors in order to issue new bondsfor their governments. Meanwhile, thestronger countries such as Germany,Sweden and Switzerland are being rewardedwith lower borrowing costs (seechart on page 42).The day may not be too far away whenChina and Japan demand better returnsas a condition of their buying more U.S.Treasuries.Both Warren Buffet (the chairman ofBerkshire Hathaway) and Larry Fink(the head of BlackRock) believe thatyields have moved so low that bonds areunattractive and even represent a signifi-Summer 2012 Exclusivefocus — 41