UK PLC is on the ropes… and you need to protect yourself. Today, I’ll show you how.
We’re on the cusp of the worst economic embarrassment since 1976, when Britain borrowed £2.3 billion from the International Monetary Fund (IMF) to counter “exceptional” levels of inflation and unemployment.
However, as I’ll show you, the consequences of today’s bombshell are likely to be much more damaging…
Britain could soon be stripped of its triple-A credit rating. It would be the first sovereign debt downgrade in the UK’s history. And, in another extraordinary parallel with 1976, our Labour government is ignoring the warning.
Back in 1976, less than a year before the then Prime Minister Harold Wilson went cap-in-hand to the IMF, he was warned of “possible wholesale domestic liquidation” by ministers from within the Labour party.
Today it is the Conservatives warning Gordon Brown from across the despatch box.
David Cameron is currently pushing the idea of an “ age of austerity.” In practice, that would mean cutting the public sector right back to “keep the cost of public sector pay only as high as the country can responsibly afford.”
Incumbent governments are notorious for stealing the opposition’s best ideas and passing them off as their own. Doing so nullifies the threat posed by the opposition. It would be a good idea for Gordon Brown to steal this very good idea from the Conservatives and take an axe to the public sector. If he doesn’t, sovereign downgrade could be Brown’s lasting legacy.
Let’s explain exactly what’s at stake here…
Sell gilts and keep selling the pound
Public debt is in danger of eclipsing annual production. That’s what led to Canada and Japan losing their triple-A ratings.
S&P, the ratings agency, last week lowered its outlook on Britain to “negative” from “stable” and conceded that the country faces a one in three chance of a ratings cut as debt approaches 100% of GDP:
“We have revised the outlook on the U.K. to negative due to our view that, even assuming additional fiscal tightening, the net general government debt burden could approach 100% of GDP and remain near that level in the medium term.”
There are two major threats from such a downgrade:
No.1: Yield spike – The first casualty would likely be the UK government bond market. Paying a lousy yield, as government bonds do, is fine if the bond itself is the safest-of-the-safe. Unfortunately, the further down the ratings ladder a bond falls, the higher the yield the market expects to receive. If no higher yields are forthcoming, we could see a negative feedback loop…
If the only active buyer in the government bond market is the government itself then the quantitative easing – money printing – will have to get bigger and bigger, a potential inflationary nightmare.
No. 2: Flight risk – The pound in your pocket is at threat, again. Though you wouldn’t think so, listening to bullish investors. The consensus among bulls seems to be that the pound is regaining lost ground having fallen so far in the last 12 months. That isn’t a good enough reason. The key fundamentals of the currency markets – interest rates and relative value – are still both very negative for the pound. Hence, the pound has no business in rising. It seems that currency traders are buying the same "green shoot" hype that the stock markets are. Against S&P’s warning, such optimism seems dangerously misplaced.
How to protect yourself
The first risk, in the bond market, is very simple to avoid. Don’t buy gilts.
However, it’s more difficult these days to hedge against further falls in the pound. Not 12 months ago, my recommendation would have been to buy into the more robust European Monetary Union, i.e. go long Euro to go short UK. However, there has been a great coming together of all economies and there is no longer a clear winner among G7 economies.
Sure, the UK is in poor condition, but the same can be said of the US, Japan, the Eurozone and Switzerland. In 12 short months the members of the G10 have slashed interest rates by a stunning 1790 basis points, completely flattening the macroeconomic landscape. In so doing, the dollar, yen and euro are now exposed to the same frailties as the pound. All nations are contending with recession, inflation and quantitative easing (QE) and that makes it difficult for us Brits to effectively hedge against the risks of a weak pound.
Hence, we no longer see the euro as a safe sterling hedge. Using the euro as a hedge is now like buying insurance on the Titanic from someone else on the Titanic. What’s an investor to do? We recommend you buy a new hedge against the sterling. Indeed, it is a hedge against all paper “fiat” currencies: Buy gold.
The argument does not need to be made again, gold is a safe haven play, and that is something all British investors need now as the threat of downgrade becomes ever more dangerous.
Best wishes,
Theo Casey
For The Right Side
Editor’s recommended action: Theo Casey first warned of a looming British sovereign debt downgrade back in March, way ahead of the mainstream press. And he’s prepared specific guidelines for how you can protect yourself from the damage this could do to your wealth. Click here to access Theo’s report in full, including his top way to own gold .
MARKET NOTES
Better opportunities in small caps
BY SHIVVY ARORA
If you’re willing to take on extra risk, greater opportunities exist among small cap stocks rather than their larger peers. Increasingly optimistic investors are starting to come back to equities. And previously bruised small caps are outperforming large caps.
A lack of liquidity had greatly hurt small caps during the onset of the financial crisis. But they’re seeing a turnaround now. Last month, we said small caps were leading the market. Investors have realised that these stocks are greatly undervalued - and they’re waking up to the potential profits to be made from this sector.
The chart below shows the FTSE Small Cap Index (red line) versus the FTSE 100 (dark green line) for the year-to-date. Small caps have more-than-doubled the performance of the broader market over the past two months. They’ve gained 27% since April, while the FTSE 100 has shown only a 10% rise for the same period.
Strong ground - small caps are in a good position at the moment
Source: Financial Times
Small caps typically provide a higher rate of return than large caps, compensating for the higher risk in investing in small firms. Harry Nimmo, manager of Standard Life's UK smaller companies fund, sees smaller British companies continuing to lead the market higher as investor confidence rises.
Other experts also observe that buyers are coming in for small caps - and there are few sellers, so the prices keep on being marked up.
While it’s early days yet to call a return of the bull market, the upturn among smaller companies looks very promising indeed. So long as investors’ current appetite for risk doesn’t disappear, small caps are likely to keep growing in strength.
Editor’s note: Small cap expert Tom Bulford has some straightforward rules to reveal, in helping you scope out the small firms reaping big rewards. To find out how the "Mattress Syndrome" could bank you gains of 86% by April 2010, click here.
Forecasts are not a reliable indicator of future results. Your capital is at risk when you invest in shares, never risk more than you can afford to lose.
The Daily Reckoning – The worst credit risk in the world
BY BILL BONNER
London, England
Wednesday, 27 May 2009
Stocks were up yesterday... the Dow rose 196 points.
What were investors thinking?
“Home prices fell more than forecast,” reports Bloomberg. They’re still going down at a 19% rate. Unemployment is still rising too.
The state with the biggest economy in the nation is going broke. So is the nation’s biggest manufacturer. Profits are falling. And the government is racing to put in place a form of state-sponsored socio-capitalism much like Mussolini’s Italy... or Peron’s Argentina.
These do not sound to us like ideal conditions for a bull market.
Did we say thinking? There’s not much thinking going on. People don’t often think... not if they can avoid it. And it’s probably better that they don’t. Who knows what opinions they might come to if they put their minds to it?
Instead of thinking, they react. And after a big drop in stock prices, they bounce. We’re now in an extended bounce which could last until mid-summer... and could take the Dow back to 10,000.
That is to say, there is nothing unusual about this kind of stock market action. Au contraire... it’s classic.
Investors are also reacting in the bond market. They’re buying Treasury bonds in reaction to bankruptcies, defaults and falling asset prices. Investors feel they can put their money into Treasuries and not worry.
But maybe they should spare a thought or two about what is really going on. Lending money to the US government is no sure thing. Far from it. In fact, under the present circumstances, lending money to the feds is asking for trouble. Recently, you could put your money in T-bills and get zero yield. “An extraordinary thing... ” said Warren Buffett, so extraordinary that he was “not sure you’ll see that again in your lifetime.” The US Treasury market is in a bubble. Like all bubbles, it will pop.
On the numbers, the US government is the worst credit risk in the world. You determine a man’s creditworthiness by looking at his balance sheet. Add up his assets and subtract his liabilities. Do that to the federal government and you get a very big number with a minus sign in front of it. Even if they were to sell off the Capitol building and all the federal lands west of the Mississippi, the feds would still have a hole in their finances larger than any other in the entire world.
While the balance sheet looks awful, the cash-flow is worse. In the current year, the feds will take in about $1.9 trillion in taxes and spend $3.6 trillion. In other words, the feds aren’t just living beyond their means...
Read on…
To read the Daily Reckoning in full, click here.
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