03/20/13   The Cyprus Experiment

Editor’s Corner

Ron Rowland

The tiny country of Cyprus became front page financial news this week, causing many investors to pull out their world maps.  It is an island nation located in the eastern Mediterranean about 50 miles south of Turkey, 100 miles west of Syria, and 250 miles north of Egypt.  It is the most eastern and most southern constituent of the 17-member European Union.  While not the economically smallest member, its GDP represents less than 0.2% of the EU total.  Its bailout needs are just €10 billion (about $13 billion in U.S. dollars).  To put this in perspective, Apple (AAPL) had $137 billion in cash at year-end, enough to bail out Cyprus ten times.

Given the relatively small amount, you may be wondering why the financial world is even concerned.  The answer lies in the proposed resolution – namely to confiscate funds of private citizens and other bank customers.  The proposed plan involved taxing Cypriot bank deposits to the tune of 6.75% on deposits of less than €100,000 and 9.9% for larger deposits.  This extremely controversial approach of “private sector involvement” met with such a vehement and predictable reaction one has to wonder why it was even suggested.  The only reasonable answer seems to be that it was an experiment, and if the EU could make it work for the small Cyprus bailout, then they could apply the solution to larger problems.

Banks and markets were closed in Cyprus on Monday for a holiday.  Bank closures were extended until parliament could officially reject the proposal, thereby hoping to avoid the inevitable run on the banks.  Yesterday, the Cypriot Parliament firmly rejected the plan.  Still, depositors are nervous and the nation has few options left to avert financial disaster.  Much damage has already occurred, and bank runs will just add to the problems.  Meanwhile, banks are still closed while the country devises a new plan.  One option is to ask Russia for help.  Depending on the collateral offered, Russia could find it enticing.

Without a solution, Cyprus may be forced to exit the European Union.  Over the past couple of years, the so-called problem nations didn’t include Cyprus and were given the acronym PIIGS, representing Portugal, Italy, Ireland, Greece, and Spain.  Now, Cyprus has taken center stage.  For Europe, the Cyprus bailout amounts to nothing more than a rounding error financially, but politically it will likely establish precedents to be applied to other bailouts.

Investor Heat Map: 3/20/13

Sectors

The top four sectors are identical to last week’s ranking.  Financials remains on top, although Industrials closed the gap.  The Financials sector was knocked around this week both by events in Cyprus and a probe into last year’s disclosures made by JPMorgan Chase (JPM) regarding its $6 billion in trading losses.  Health Care and Consumer Discretionary are holding on to third and fourth, although Utilities moved up a notch to put itself in a virtual tie for fourth.  Consumer Staples is right behind, which clusters the three defensive sectors in the upper half of the rankings.  Materials and Energy swapped places with Materials taking a slight advantage this week.  The bottom three are unchanged.  Real Estate heads up these laggards, with Telecom being next in line.  Technology still has a lock on last place.

Styles

We have a new leader in the Style rankings today with Micro Cap jumping two spots to claim the title.  Mid Cap Value, the former top spot occupant, only slid one notch to second, and Small Cap Growth remains hot on its heels in third.  Small Cap Blend and Small Cap Value round out the top five, placing all three Small Cap groups and Micro Cap in the upper echelon.  This is further evidence of the shift to Small Cap we noted in previous updates.  Mid Cap Blend comes in at sixth, and Mid Cap Growth is at eighth.  Other than those two, the lower half is dominated by the Large Cap groups.  Mega Cap remains on the bottom.

Global

Japan widened its lead over all other Global categories this week.  A month or two ago, we noted a change in leadership was underway with Japan and the U.S. both climbing the rankings while the former leaders of China and Europe were falling.  That process is now complete with the U.S. moving up a notch to claim second place.  EAFE jumped ahead of World Equity to grab third.  Pacific ex-Japan fell three places from second to fifth as Australia, Hong Kong, and Singapore all suffered setbacks.  The U.K. moved up two spots to sixth while Europe slid to seventh.  The bottom four categories are all indicating negative trends this week.  Canada, which barely achieved the positive side of the ledger a week ago, is once again slightly negative.  The three emerging market categories are on the bottom this week with China decisively in last place across all equity classifications.

 

Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

 


“There are a lot of uncertainties and difficulties. At this point we are not seeing a major risk to the US financial system or the US economy.”

Fed Chairman Ben Bernanke when asked about Cyprus, 3/20/13


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