the risk on is cheap dilemma for investors

Such is the state of Europe right now, the relatively risky trades are cheap whereas defensive ones are more expensive. John Husselbee asks why this is so and how investors can take advantage of it.

the risk on is cheap dilemma for investors


When I was a young child my grandparents used to recite this nursery rhyme to me. A while later, when they assumed I was old enough to understand, they  told me that its origins stemmed from the Great Plague which took place in the 17th century.

They explained that the ‘ring of roses’ referred to the red rash that heralded the disease, posies were carried for protection and the sneezing was the sign that death was imminent. Small wonder I brought up my children on the less grisly ‘Round and round the garden.’  I don’t believe that this rhyme has a similar ‘horrid history’.

A ring, a ring o’ Euros,
A pocket full o’i.o.u.s,
Greece, Portugal, Ireland too
Italy, Spain, the Eurozoo
At issue, at issue, we all fall down!

Perhaps in years to come our ancestors may be singing a rhyme based on the plague of sovereign debt crises threatening to bring down the whole of the eurozone. In this plague the common symptoms are high borrowing costs, an unpopular government, a severe austerity plan and a lack of economic growth.

The authorities are aware of the epidemic and are searching for a cure. In an attempt to prevent contagion, they have tried handing out billions of euros to the sickest patients on the periphery of Europe. Interest rates have been cut and the European Central Bank (ECB) has helped to refinance banks by lending €1trn at low interest rates.

No long-term solution

However, although the prescribed treatment has brought sufferers some short-term relief, a long-term cure has yet to be found. The long-term refinancing operations programme, introduced late last year and earlier this, was received with much optimism, but this has waned with the recent elections in France and Greece.

With no long-term resolution forthcoming, the treatment remains the same, although the euro dosage grows bigger and bigger. Surely the issuance of eurobonds, a measure backed by all eurozone members, would serve to stop the euro falling?

This would sharply reduce the cost of borrowing to the weaker nations, although the core of Europe would pay more. However, this is a tough decision for Germany which has the most to lose from a potential downgrade.

The alternative is to let the weaker nations leave the single currency. In the case of Greece, the short term would be painful but beneficial in the longer term under its own fiscal and monetary steam. The likelihood of this happening is increasing. 

Fundamental analysis in these markets has proved futile of late. Politicians have been driving the market. Valuation has often been disregarded with uncertainty leaving the investor a binary choice, either risk on or risk off.

However, here is the dilemma for long-term investors – those asset classes which most participate in the risk on trade look cheap, while defensive assets are expensive. 

‘Round and round the garden’…….or should that be ‘up the garden path….?’



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