What Did Not Happen in the EU Bailout

We know! Everyone is tired of hearing about the mess Europe got itself into.  But the media appears to be missing the bigger picture as Cramerica encourages mom and pop to scoop up the unlimited “bargains” created by “isolated” problems in Greece.  This is bigger than Greece.  The eventual breakup of the Euro is a realistic probability.  Are domestic equity markets trading within 4% of 52 week highs and 22x normalized earnings discounting this risk?  Hardly.

Larry Jeddeloh, the founder of TIS Group, has been a tremendous resource for our office for years now.  Larry is one of the most non-consensus thinkers we have come across, which is precisely why we enjoy reading his work.  Some say Larry is too “outside the box.”  We say, Larry gets it.  His April 2007 Barron’s Interview titled “Bracing for Trouble” was a well-timed warning to investors.  We think his piece today is an important read and have asked his permission to share it with our friends and family.  We thank Larry for granting us permission to do so.

TIS MIR 05.11.10

In this particular case, Larry is not alone in his thinking.  John Mauldin offered his readers the following thoughts this week in, The Center Cannot Hold:

The entire eurozone is in for a double-dip recession, if it is not there already. And one country after another is going to have to convince foreigners to buy its debt. But if they make the cuts, their GDP will fall, ironically increasing their debt-to-GDP ratio and making investors demand even higher rates, which becomes a very vicious spiral.

As Reinhart and Rogoff wrote: “Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang! – confidence collapses, lenders disappear, and a crisis hits.”Bang is the right word. It is the nature of human beings to assume that the current trend will work out, that things can’t really be that bad. The trend is your friend until it ends.

Previous sovereign crises have all involved debt restructurings.  We do not know of any examples in history, where a debt crisis was repaired by piling on more debt. Falling nominal GDP, amid a rising debt load can easily develop into a vicious cycle, keeping solvency risks elevated despite the approval of a “rescue” package.  The Euro crisis is deflationary in nature and as such, will continue to place downward pressure on G7 interest rates.  Investors should resist the urge to “bottom fish” and consider allocating a portion of capital to what BCA has deemed the Protector Portfolio, consisting of Treasuries, Gold and Dollars.

Hope is not an investment process.