Opportunity lies under ruins of global economy

By Vikram Barhat | July 22, 2011 | Last updated on July 22, 2011
4 min read

Unprecedented geopolitical and economic changes have left a trail of destruction, but they’re also breeding new investment opportunities around the world. A panel of investment pundits discussed where those opportunities lie and how to capitalize on them at Franklin Templeton’s 2011 Investment Forum, in Toronto.

Discussion rarely strayed far from the usual suspects: the debt crises in the U.S. and Europe; the rise of China and other Asian markets; and the power shift in the global economy. What was different—refreshing, even—was the faith reposed in the good old Europe as an attractive investment destination against the current tide of market sentiment.

Philippe Brugere-Trelat, executive vice-president, Franklin Mutual Advisers and co-lead portfolio manager of the Mutual Discovery Fund led the pro-Europe charge.

“U.S. equities are somewhat more expensive so it is not totally illogical to have a bigger exposure right now to Europe,” he said. “Equities are cheap in Europe because they carry a high level of risk, but some are cheap for totally unjustifiable reasons.”

He admits that the troubles in Europe are “very serious” and are not exaggerated by the press. But he pointed out that it is an entirely a political issue which can be resolved.

“There’s enough money to do so, it is the largest economic bloc in the world. All it needs is political will to put together a closer coordination of fiscal and budget policies and come up with a crisis resolution mechanism which is durable and credible,” he said.

What is needed is pressure on the governments of Europe to act. The fact that the focus is shifting from Greece to the much larger economy across the Ionian Sea, bodes well for the bloc. “If Italy is not resolved, the Euro goes belly-up and that would make Lehman bankruptcy look like a benign event.”

While he makes the case for European equities, Brugere-Trelat doesn’t paper over the clear and present danger of the contagion spreading to the highly connected banking system. If that happens, he said, no place on the planet is safe, “except for farmland and gold.”

“There’s no doubt,” said Brugere-Trelat, “banks are on the front line of the debt crisis [although] some are in better shape than others.”

The panel discussion around banks naturally grew into the subject of interest rates and inflation. The current extremely low interest rate environment has been causing many investors to worry about the future possibility of rising rates and its impact on fixed income investment.

Michael Reed, vice-president, institutional portfolio manager, Franklin Templeton Fixed Income Group, offered some solutions.

“There are ways to protect yourself from the rising rate environment,” he said. “In the corporate area, there are the traditional high yield bonds, but also floating rate bank loans, the latter of which carry much lower interest rate risk.”

Let’s not forget interest rates are a reflection of inflation expectations, said Reed. “If we all think inflation is going to go up, chances are it will put upward pressure on interest rates as well.”

And one thing that pushes inflation up is commodity prices. Not surprisingly, investors are shunning equities and are instead buying commodity-based currencies as a hedge.

Australia, said Reed, is a good example of it. “Australia is a great country to invest not only from a currency standpoint, but it is also a country that is sitting on a massive iron ore reserve.”

Australia, he explained, has an edge over even Canada, although the two countries have very similar dynamics—great central bank, relatively young populations and demographics. “We prefer Australia rather than Government of Canada bonds, [although] both of those [are] similar sorts of allocations, we just pick Australia over Canada.”

In addition to being the world’s leading suppliers of commodities, the two countries share something else: China.

The world’s largest importer of commodities, however, is making investment experts increasingly nervous. Some are wondering if the Chinese demand for commodities is largely a function of speculation.

Could it be that China, as many suspect, is stockpiling to ultimately control, and manipulate, pricing in global commodities markets?

Martin Cobb, executive vice president, Templeton Global Equity Group and lead manager, Templeton Global Smaller Companies Fund, said China, along with India, Brazil and the Middle East, is one of the greatest consumers of commodities today. Countries hoarding commodities is nothing unusual, he added.

“Nations do it; countries stockpile metals, aluminium, copper, etc., it’s just part of natural environment of a growing economy,” said Cobb. “There are times when it’s a little bit excessive, which can be fixed. But it’s not just China; it’s the rest of the world, too.”

China is also increasingly seen as having designs on the coveted global reserve currency status, currently held by the U.S. dollar. Could it then be the renminbi a couple of decades down the line?

“It’s a long time away,” said Reed. But he knows better than to take it lightly. “[What] we’ve started to see, in China in particular, is the development of a basket of currencies [to counter the U.S. dollar as the world’s reserve currency].”

Hong Kong is already issuing debt denominated in the renminbi. Reed says “that’s a pretty big change.” But not big enough for Brugere-Trelat who doesn’t expect the yuan to dethrone the greenback as the world’s reserve currency. The reason for that, he says, is that there is, at the moment, no alternative.

“The U.S. is the biggest market in the world where you can invest trillions of dollars without a problem; nobody wants to invest in the euro, and there’s nothing else [to consider],” he said.

Vikram Barhat