VCG Forex.com Blog

Every time I sit down to write a commentary it seems that some new debacle has emerged that threatens the markets. Each has its own unique versions of potential peril and the newest one often seems more dire than the last. Yet the prior dilemma, however intricate and scary it must have been at that moment, has been overcome, or at least postponed. Nevertheless, money managers face new issues almost daily as the struggle between progress and restraint continues. What's important, and what sets Warren Capital apart from its competitors, is how we handle issues in this constant battle.

In my 2010 outlook piece, I predicted that risk would become a factor again as several countries would be unable to roll their debt as they have become overwhelmed from absorbing the losses of their respective banks. As we've noted in the past, simply moving bad debts from one balance sheet to another doesn't mean the debts disappear. We knew a day of reckoning was coming and it looks like Greece is first in line.

Greece is currently in a major fiscal hole and the yield on two-year Greek notes, which started at 5.21% this year, has blown out to 14.5%. While this may look insignificant to some, this is a colossal change in terms of sovereign debt. Greece will not be able to roll its debt without European Union or International Monetary Fund aid. I would be willing to bet, however, that many Main Street investors are just becoming aware that Greece is on the brink of default and they are have no idea what this means to them. Investors are relying on their professional advisors to steer their assets through the Greece fire. The question becomes whether or not that reliance is the right decision. Therefore, I offer our analysis.

The first thing we do when a problem emerges is try to determine the effect of the worst case scenario. From our perspective, Greece is currently a relatively isolated issue. It is a miniscule portion of the total sovereign debt of the world, and European banks most likely would absorb the default. (This is probably why there is no actual policy in place to aid Greece of yet as rhetoric has been the only tool implemented). Nevertheless, we have no Greek debt and we've avoided Portugal and Spain as well, who are next in the default line as contagion spreads. Up until the last few days the debt yield of all of these countries hasn't come close to reflecting the potential default risk we believed possible. In addition, we can only speculate about a short-term remedy as too many players are involved. Some of our sources indicate that Greece will be dropped from the EU, revalue its own currency versus the euro and re-enter sometime down the road. But this, of course, does absolutely nothing to fix the real problem in Greece. Which brings me to my second point: How can we use this incident to our investment advantage?

When we strategize about specific events affecting investment policy, we look to use those events to make a large gain with reduced risk or to protect principal from unforeseen consequences. The Greek incident offers opportunity for both.

The short term causes of Greece's problems are all too common. Greece borrowed too much money, manipulated the manner in which it disclosed those borrowings and collateralized its borrowings with its most prime assets. This type of irresponsibility leads to default. But it's important to remember that investors don't buy sovereign debt to take on risk. Most sovereign debt purchasers are willing to accept smaller interest payments in return for assurance. So, the possibility of Greek default requires us to examine the safety of even the most assured investments.

In normal times, sovereign debt would be considered the safest asset. But global recessions constrain economies. With enough pressure, long-term fundamental issues bubble up and their bursting is accelerated. This is precisely what's occurring in Greece.

Most economists assert that Greece overextended itself this last decade and the spending on which Greece embarked to combat the recession pushed it to the brink of default. While we agree that Greece is overextended, this bland assertion does nothing to identify how Greece got here. To find out why, we compared economies that are performing well against those that are constrained or contracting.

In 1980, the total population of Greece was about 9.7 million. Today it stands at approximately 10.7 million. That's an 11% growth in population over 30 years. When compared to India, Brazil and Indonesia, whose populations have all grown nearly 60% or more over the same time, the fundamental reason why Greece is faltering becomes obvious: its population is not growing as vivaciously.

In terms of growth, there are no major economies other than China that can compete with the growth of India, Brazil and Indonesia over the last few decades. Given the table below, it doesn't take much to recognize the correlation between population growth and economic growth.

(Note that the United States also enters into the growth arena as its percent of population growth has slightly eclipsed China.) Accepting this fact, if we can determine the similarities between countries growing in population, we can simultaneously identify areas of the world where the odds of investment return are increased and avoid areas where a government guarantee has limits.

After some serious inspection of a world map, the first two things I noticed were that all the aforementioned growth nations have massive amounts of land at their disposal and they all have direct access to the ocean. Therefore, they have room for population expansion and they can directly access the seas for shipping routes. The next similarity was a little less obvious at first but just as vital.

In India, the domestic currency is the rupee. Brazil has the real. Indonesia has the rupiah. China has the yuan, and we all know about the dollar. What's important is that each of these countries has a central bank tasked to maintain the "value and stability" of their respective currency. Defining exactly what that task means in terms of respective policy for these central banks is beyond my ability. But one thing I do know is that each of these central banks has the capability to print their own currency in times of strife and all of them did during this last crisis. Greece, on the other hand, is part of the EU and, therefore, does not have the ability to print its way out of this corner. The EU can print Euro's and they probably will. However, that's way beyond Greece's influence. So, the Greek government has little control over its own fate. In the long run, austerity and restraint are the real solutions to a national budget problem. But that doesn't comfort anyone holding Greek debt right now. The only way we can prosper in the long term is to make sure our money is around in the short term. To my knowledge, no one has mentioned any of these root issues that are pressuring Greece. But these basic points are way too stark to be coincidental.

In recent weeks many scathing headlines have come out about the manner in which investment companies manage their clients' money and where their moral responsibilities lie. I completely understand this scrutiny as we are in a high profile business, and the ethics and performance track records of many of our competitors are less than stellar. But let this piece stand as proof that not all of us in the industry are highly overpaid regurgitators of modern investment theory who simply spout the "buy and hold" mantra until a portfolio is decimated. Some of us actually enjoy applying thought and discipline to investment strategy. Land mass, direct access to the seas and central bank independence are factors that, I believe, increase our odds of success as we determine where in the world to deploy capital. I also realize that these observations might counter the opinion of the average investment professional. But that's the point and why we will continue to produce original thought and results that better the average in this constant battle.

As always, I appreciate your continued trust and confidence.

Joseph Warren

CEO & Founder

Warren Capital Group

2 Wisconsin Circle, Suite700

Chevy Chase, MD 20815

p. 888 262 1040

This commentary has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy. Information in this report does not pertain to any Warren Capital Group product and is not a solicitation for any product. Investing in securities involves risk, including potential loss. Foreign investment involves specific risks including greater economic, political, and currency fluctuation risks, which may be even greater in emerging markets. Indexes can not be invested in directly, are unmanaged and do not incur management fees, costs or expenses.