Government securities are the default safe haven in times of heightened risk aversion. But what happens when Government finances are the cause of the tension? Where are the safe havens then?
I wrote a few weeks ago that I feared a Great Disorder and that I remain bullish on ‘safe havens’. But what exactly are suitable safe havens for such a circumstance?
What constitutes a ‘safe haven’ changes over time. It’s important to remember not only that government bonds aren’t always the market’s safe haven, but that that there will always be a safe haven somewhere. For all the headlines about the billions wiped off stock market values during market routs, that money had to go somewhere. It doesn’t just disappear. It will go into whatever the safe haven is, which in normal times will be bonds. But what happens when government bonds themselves fall victim to the primary ills of the day? In the 1970s, bonds were no place to seek refuge from the inflation and so the safe haven mantle passed to gold. This is one reason I remain a gold bull.
The eurozone throws up other interesting examples. Before the crisis, Spanish investors, for example, would normally have considered their sovereign bonds a safe haven on ‘risk-off’ days. But that stopped working when their sovereigns became the source of risk rather than a shelter from it. German bonds undoubtedly caught some of that safe haven bid, but did the very high quality, zero debt, local-champion-made-good retailer Inditex catch a similar bid too?
A similar picture emerges with the standard quality equity names in countries afflicted by the eurozone sovereign crisis. For example, Hellenic Bottling (Greece), Luxoticca (Italy) and Kerry Group (Ireland) all followed a similar pattern, outperforming their domestic equity indices and performing the safe haven role vacated by their government bonds.
So besides gold, another candidate for safe haven status in the event government bonds become unreliable are equity securities in high quality and robust businesses. I therefore remain very bullish on these too.
Expected returns should be consistent with the long-run average return for quality equities, which has been around 6-7%. That’s hardly a once in a lifetime return, but for now, and for a potential safe haven I find it quite attractive because it comes with an embedded robustness. Suppose I’m all wrong in my fears. Suppose that we go all Japanese and the next decades are low-growth environments. A 6-7% return isn’t a bad prospect at all.
Now suppose I am right, and government bonds cease acting as safe havens. Owning such equities implies owning the new safe havens (especially if the rest of the portfolio is made up of cash and gold). So we’re on high ground with this strategy, and have a degree of robustness to the reality that we just don’t know what the future holds. That doesn’t guarantee survival from the worst case scenario, but it gives a better chance.