Broker Check

Investor Letter January 8, 2013

We had another wild ride in 2012, though perhaps less wild than the past few years.

But overall we had a decent year, certainly due in part to timely verbal intervention by global central banks along with central bank easing. The USA, Japan, China, Eurozone & Australia all eased in 2013 & risk globally has continued its primary trend upward.

While easier policy has helped another reason remains a lack of alternatives to taking risk, because of central banks & inflation, which make cash a risk asset. Real rates are still negative up thru the 10 year part of the US Treasury curve. Negative real rates will continue to provide for support for stocks, gold and other risk assets.

The continued upward trend in risk assets is also due in part to still friendly valuations of stocks globally and generally risk averse investors. Not to mention that many companies which went into the financial crisis bloated and overleveraged in 2008 are today lean, mean, restructured & re-capitalized cash machines. Equity prices have yet to catch up to the earnings growth, leaving P/E’s globally quite friendly.

Geographically, Europe’s economy actually seems to be bottoming. It won’t take much in the way of good news for those markets to rally hard in 2013, even after a decent performance off the lows in 2012. By way of comparison, in the US the S&P is near 4 year highs while the Spanish stock market is still 50% off of 2007 highs. Easy to see where the relative value is.

China’s domestic stock market hit three year lows in the 3rd quarter of 2012 and has since rebounded, along with its economic data. We recently began buying Asia again, including China and Japan, and continue to like that exposure.

Overall, and barring a significant policy erro by a major economy or a large "force majeure" event, stocks are likely to continue their rise in in 2013.

Gold has been in a sideways range for 14mos or so now. A break of $1800 on the upside or $1525 on the downside will likely precipitate a large move. Better to be long volatility than gold itself this year, though we still recommend that our clients hold 5% or so of their overall investable assets in gold as a hedge against the potential for continued devaluation of fiat money and negative interest rates.

Fixed income remains anchored by the FED and other central banks, so until we see a move toward the "exit" rates are likely range bound, barring a major attack by the bond market vigilantes.

Which brings up what we feel is the major potential threat facing the markets over the next 24 months.

The US and other developed countries are clearly on an unsustainable path as regards growing public sector debt and deficits. While growth, inflation and time are all helpful, the sheer size of the debt suggests that this will not end well. For now the day of reckoning still lies in the future but it could well be closer than we would like to think. We are thinking specifically of a catalyst for that, in the form of Japan, and the policies of their new Prime Minister, Shinzo Ato, and his new finance minister, Taro Aso.

As many of you know Japan has the worst debt/GDP ratio of any developed country along with dismal demographics. We think Japan is the biggest threat the global markets face over the next 24mos, in terms of macro impact on the global economy.

The new government is intent on creating inflation - by any means possible. A weaker yen and higher inflation will, on balance, mean higher interest rates. At what point will higher rates mean Japan will be unable to service its debt and be forced to monetize even further? Could this be the catalyst for the long awaited collapse in Japanese government bond market? Could there be 2nd order effects, in the form of a contagion spreading to other developed country sovereign debt, like the US Treasury market?

The world has already entered into the realm of absurdity where we have one department of government issuing debt only for another to buy we will be paying attention to the Japanese government bond market you can be sure.

Meantime Harborview Capital likes the short yen trade, along with its corollary exposure, long Japanese stocks.

There is an old saying, don’t tell me what markets to buy or sell, tell me when. And timing remains the key to successful active investing.

With the rise of social media and the continued technology revolution one big change to the markets the last few years has been the ability of ALL market participants to respond to unfolding events in real-time. Investors (ie humans) are instantly struck with data that emotionally is quite hard to digest & discount accurately.

We at HarborView Capital try to take advantage of the market’s volatility by reducing risk in surging emotional "risk-on" type markets and adding risk back when the inevitable emotional "risk-off" opportunity allows. This more "active" approach helps us reduce overall portfolio volatility & generate excellent risk adjusted returns. And it helps us and you, our client, sleep at nite.

Best wishes to you and your loved ones in 2013,

Best Regards,
Paul Brian Gibson
Partner, Harborview Capital Management LLC