At the time of writing, the Greek crisis has entered an intense phase. A clash between political logic and economic reality. The logic of coaxing Greece back to the European bosom is compelling, as is the domestic logic of remaining in the Eurozone (on better terms), when compared with capital controls, ejection from the euro and the attendant risks of social breakdown. However, when thinking this through, we remain focused on the simple weight of debt set against the underlying weak drivers of the Greek economy, rampant capital flight and the lack of a prospect of material forgiveness. These combined suggest that, at a later stage, default and capital controls are more than likely.

Throughout the negotiations, markets appear to have assumed, to a greater degree than is perhaps warranted, that some form of “extend and pretend” strategy will prevail. This, plus the lack of planning on either side for default, capital controls and a host of consequential events, leads us to be somewhat cautious in predicting any resolution.

Paul Donovan of UBS expresses the key issue well when he writes: “A broad membership of the euro was never likely to be viable in economic terms, as the euro was originally structured. Prior to the introduction of the euro, economists regarded the formation of the euro as a political rather than an economic construct. It seems increasingly likely that if a solution to the current crisis is to be found it will have to be political rather than economic. This finds echoes in Greek Prime Minister Tsipras calling for a heads of government meeting rather than an Ecofin meeting to try and bring the current situation to a successful resolution.”

Generally speaking, the other most cited risk is that of the first increase in US interest rates since 2006.

On this, Janet Yellen appeared clear and confident in her answers to the press on 17th June. There were less of the hallmark obfuscations that were so characteristic of her two immediate predecessors. Her acknowledgement of the IMF’s different viewpoint on interest rates was so prosaic that it removed any sting from the bold Lagadere intervention. The Fed was able to present an unchanged expectation of 50 bps rise in the policy rate this year: a confirmation that did not immediately effect the value of the dollar on international exchanges.

Quite the contrary, the dollar has had a hard time recently keeping up with the British pound, which is once again within a hair’s breadth of 1.60. We put this down to the apparent momentum in UK wages data which suggests that non-accelerating inflation rate of unemployment (NAIRU) is being approached. If this conventional economic explanation is reached by the majority of the Bank of England’s Monetary Policy Committee, with whom the decision on rates lies, then a UK interest rate increase is also on the cards, perhaps sooner rather than later.

Irrespective of the timing of a first rate rise, we would agree with Janet Yellen that the overall path is of greater consequence for the long term evolution of financial asset prices. On that, our core expectation remains that the path will have a shallow gradient on account of the tendency for economic growth and inflationary pressures to be low against a backdrop of very high debt levels.

We have introduced a page on our web-site that contains all the salient information regarding our core investment strategy. We are happy to report this strategy’s annualised, three-year trailing returns (our self-imposed key metric of performance) have reached +12.8% per annum after fees and stand at the top of our peer group on this measure.

Some data with respect to this performance is captured in a table overleaf.

Finally, two short texts follow this letter. Defining Megatrends: Demographics & Debt is an introduction to the first in a series of chart books which illustrate very long term trends that we believe to be of consequence – debt and demographics being the first.

The second is a thought-provoking piece on the subject of leverage. Intuitively, one might assume that leveraging returns on a rising market is a good strategy to enhance returns. Not so. Fay Ren, a member of the Investment Team at Cerno Capital, explains why in a piece which owes its origins to James Montier.

James Spence
Managing Partner