US Update

Wise Words from Citywire:
http://www.citywire.co.uk/money/us-debt-crisis-what-should-investors-do-now/a512540?ref=citywire-money-latest-news-list

Stock markets are jumping today at relief that US politicians appear to be coming to their senses and are close to a deal on the debt ceiling talks.
[IG: This after the market slides on Friday and my extraordinary email to clients on Wednesday]


Fingers crossed, the compromise hammered out between Republicans and Democrats in the Senate and House of Representatives will avoid the US sliding towards a default on its government bonds.

Although the risk of the US not paying the interest on its debts has looked remote, the mere thought that the world’s biggest economy could screw up so badly has rightly rattled everyone – investors, consumers and businesses.

After a terrible week for shares (US down 4% and FTSE 100 down 2%) last week, Asian and European markets have bounced back today.

What is 'risk free'?

However, even if the deal gets through Congress by tomorrow’s deadline, the problems are not over. The leading credit rating agencies have made it clear that the US could still suffer an historic downgrade and lose its cherished top AAA rating.

This takes investors into uncharted territory. Although US treasuries may not slump immediately, no one is sure. This is highly significant as US government bonds have traditionally been the ‘risk-free asset’ and the benchmark against which all other investments are priced. If ‘risk-free’ is no longer that, what does it mean for other classes of investment, principally bonds, shares and commodities? Expect a period of turbulence as the world works through this one.

Ironically, the bad economic data that came out of the US on Friday may support US treasury prices. The US remains the biggest and most liquid market in government bonds so investors will presumably keep faith in it, particularly if interest payments (coupons) are no longer under threat.

However, if the US administration responds to the alarming sluggishness of the US economy with more quantitative easing (that is, printing money by buying back assets such as bonds to inject cash and confidence into the financial system) then all bets may be off. Quantitative easing may, or may not, have succeeded in saving the financial system but it sure as hell has distorted investment markets by creating a bubble in UK and US government bonds.

Greek tragedy in Europe

Meanwhile, [IG: As regular readers of the monthly market commentary will know] the eurozone’s debt crisis rumbles on. At the risk of being fatalistic it looks to me that whatever the European Union, European Central Bank and International Monetary Fund (the 'troika') decide to do, the Greek tragedy will unfold painfully as the debt excesses of the past are dealt with.

Greece has been bailed out for a second time but in such a way that the financial stability of the banking system is again being questioned (thanks to those bond ‘haircuts’) while Spain and Italy are still in the firing line with a European bailout fund that is currently too small to help them.

What it boils down to

So what does this mean for investors worried about their Sipps, pensions and ISAs? Having surveyed the recent comments of leading fund managers, I think it boils down to keeping your eyes peeled to see what happens next, staying cautious but holding your nerve for now.
[IG: I will be doing just this and writing toclients with an update and any recommended actions as soon as I think it appropriate]

Cash: The next few weeks and months may be turbulent so it is probably a good idea to have a cash buffer in your portfolio - [IG: as I recommend all clients do - I make sure of this when financial planning], to protect its value if markets fall but also to give you some fire power to invest if markets recover

IG: Nice to have my work validated and see that what I wrote out last week to clients is pretty much being echoed by a leading company such as Citywire this week