The first thing we’ve done is to avoid “ground zero” exposure. The portfolios, especially the fund portfolios, have little exposure to international equities. Interestingly, European stocks are among the short-list of asset classes that we would consider “buyable” based on recent market performance. For the moment, however, we’re not real interested in adding what could be the next “Lehman Brothers” back into the portfolio. We’ve owned it in the past. We’ll own it again in the future. Right now, however, we remain skeptics.
We recently took steps to reduce or eliminate our exposure to the insurance sector as well. The big problem with the profligate spending habits of Greece, Spain, Portugal and other large governments running disastrous deficits (which shall remain nameless, just in case there remains one more clueless U.S. Treasury buyer; I wouldn’t want to be the one that causes our own house of cards to tumble prematurely) – the problem is that the eventual default by Greece may threaten many European banks with insolvency.
If a European bank defaults, and that bank is a counterparty to a credit default swap (CDS) owned by a U.S. bank, then the virus jumps over the pond faster than you can say “derivative.” Furthermore, since we haven’t done much of anything to restrict CDS gambling by the best and the brightest on Wall Street (probably former Lehman bankers hired by Citigroup), then the risk of what the Fed calls a “systemic problem” remains a huge risk. And because we bailed out most of the criminals responsible for the sub-prime crisis, there remains little incentive for the banks to have cut back on their gambling with depositor savings. This includes a great deal of gambling with big, “safe” European banks on the other side of the bet.
Once the banking crisis re-starts, it will likely impact nearly all big banks in the sector because 1) they are all “black boxes” and 2) can’t accurately measure their CDS exposure and 3) have lied to shareholders so many times that no ones believes a word of what management says. Our guess is that the sell-off will once again spill over into the insurance sector, which demonstrates some of the same tendencies toward gambling that hurt the banks and investment companies in 2008.
We’re not saying that the sell-off will definitely be a repeat of 2008, but only that it could be as painful. Moreover, the insurance stocks would be much too close to the center of the crisis. Finally, the insurance stocks – although they have generally tracked the overall market since we purchased them in February – this past week have begun trading down more than the market, along with the banks. We believe that the problems in Greece are the reason, and until we can see that the crisis in Greece isn’t ramping up, we would rather reduce or eliminate that particular risk from the portfolio.
“What to buy with the proceeds” remains a problem. The market remains very narrow, although a few new asset classes have risen to “buyable” status. In general, however, the market is becoming very defensive, for whatever reason. If that is signaling further weakness ahead, perhaps holding a bit of cash will help preserve capital, instead of using it to buy “defensive” stocks that merely fall less than the market in a sell-off.
A year ago, we made a mistake during the first Greek crisis by being more defensive than we should have, given 20/20 hindsight. We may be about to make that same “mistake” again. It’s difficult to know what to hope for at times like this. We are “hoping” that the bureaucrats in Europe find a solution to the Greek problem. However, we are not comfortable relying on them to do so and have de-risked the portfolio a bit over the past few months just in case the Greek crisis continues to get worse.
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .
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