Greece is seeking a two year extension of its latest austerity program, arguing that the additional time would improve its chances of ultimately bringing its debt down to a sustainable level. This is hardly news. Many observers had already concluded that the latest plan was as unworkable as prior ones. But it does illustrate that the inconclusive, status quo can persist indefinitely. As with the penalties envisaged in the Maastricht Treaty that ushered in the Euro, fiscal penalties on sovereign states are a nuclear option and as such are only valuable until they’re used.

While many analysts have forecast that Greece will either be dumped out of the Euro or will leave voluntarily, regardless of who initiates such a move the consequences are huge and unpredictable. As long as neither side miscalculates, it’s quite plausible for this seemingly perpetual round of renegotiations in which the Greeks seek forms of debt forbearance but stop short of provoking the EU to kick them out and the Germans keep squeezing but stop short of driving them out. As unsatisfying as this may seem to an outsider, why would it ever end?

By reducing the odds of an imminent Euro disaster it makes equity markets somewhat less risky, and bonds less attractive. Of course we still have to contend with the looming fiscal cliff in the U.S., a potentially far more damaging event for the U.S. economy and one whose resolution has been pushed off to a post-election lame-duck Congress with highly unpredictable results. Whatever your political leanings, virtually everyone must agree that this is an abrogation of responsibility by America’s leaders.

In late July I had the opportunity to present the ideas in my book, The Hedge Fund Mirage, at the CFA Institute’s Financial Analysts Seminar in Chicago. Flying to Chicago for the day afforded me time to catch up on some reading, and some new ideas.

From time to time we’ve written about the Equity Risk Premium and how it makes stocks a far better investment than bonds. The earnings yield on the S&P500 (which is the inverse of its P/E) is around 7.6% (consensus earnings of $105 divided by current S&P500 level of 1,385). Ten year treasury yields are 1.5%, so the resulting 6.1% gap was last this wide in 1974 following the Yom Kippur War, OPEC oil embargo and rampant inflation. Or to put it another way, as we’ve written before, it only takes $22 invested in the S&P 500 (yielding around 1.9%) to generate the same after-tax ten year return as putting $100 in ten year treasuries (all assuming unchanged dividend yields and 4% annual dividend growth compared with a 50 year average of 5%). The remaining $78 of the $100 could be left in 0% yielding cash and the Math still works. This is how expensive is the relative safety of fixed income. To describe bonds as being for wimps would risk provoking the Market Gods to swiftly prove otherwise, so I won’t go that far. But they are for those willing to accept a guaranteed loss of real wealth after taxes and inflation.

However, the Equity Risk Premium has remained more or less historically wide for some time, and it’s not exactly a secret. Martin Brookes and Ziad Daoud of Fulcrum Asset Management, recently offered a possible explanation. In a paper titled “Disastrous Bond Yields” reported in the Financial Times, they construct a risk/return framework for investors that extends the more normal economic state of two scenarios (expanding or contracting economy) to include a third (“disaster”, a “large decline” in GDP). Such disasters were far more common prior to World War II, and the authors theorize that the subsequent 60 years of comparative serenity caused investors to undervalue the safety of government bonds in such cases, an oversight we might now conclude has been corrected. To the layman, people are scared. Or, as a retired bond trader and friend of mine observed recently, investors are not buying ten year treasuries because they think they’re a great long term investment. I won’t do the paper justice here and it’s worth reading, for the authors go on to show that at a certain tipping point of economic distress the credit risk in government bonds overwhelms their safety. Empirically, when the default probability of a country exceeds 3% its bonds and stocks start behaving far more alike as correlations flip from negative to positive. Greece, Spain, Italy and (interestingly) France have all crossed this threshold.

At the CFA event in Chicago my presentation directly followed that of Professor Robert Shiller, author, Yale professor and co-creator of the S&P/Case-Shiller Home Price Indices. Clearly my inclusion showed the organizers’ flexible standards on speaker selection. Professor Shiller spoke about his recent book, “Finance and the Good Society”, a review of which I had coincidentally just read on my flight. The book makes the case for the benefits of financial innovation to broader society, a lonely position given recent history. One novel idea was that the Federal government should borrow money by issuing securities whose coupons are directly linked to GDP. Specifically, one such bond would pay annual interest equal to one trillionth of GDP, or about $15.09, hence the name “Trills”. I thought it was a clever idea; many investors would surely find use for a security tracking nominal GDP, and while the government’s cost would be pro-cyclical (i.e. fall when the economy’s contracting) it would be less volatile than if the Treasury issued exclusively short term treasury bills and would also provide an inflation hedge to investors. Of course, Professor Shiller noted that TIPS (Treasury Inflation-Protected Securities) were first suggested about 100 years before they became reality so we shouldn’t expect to see these novel securities soon. But I thought it was an intelligent suggestion.

One new idea would be for Congress to resolve the looming “fiscal cliff” before the election, thus acknowledging the supremacy of the economy compared with their respective campaign plans. But any new idea I suggest here will be too dripping in sarcasm to be serious. Suffice it to say that, as we sit here watching the weeks tick by to November with no pre-election solution in sight, it is with a feeling of stunned amazement that we regard the oblivious disregard of Congress for the private sector. Planning for 2013 hiring and capital spending decisions takes place well before the lame duck Congress will limp back to Washington DC in mid-November. Anecdotally, companies are increasingly curbing their long-term commitments until fiscal policy becomes clearer. While we don’t try and time the markets, many companies’ quarterly earnings have shown very weak European demand across varied products and services and a cautious outlook globally. In our Deep Value Equity Strategy cash is a relatively high 10% as a few names have reached price targets we felt fairly reflected their value.

MLPs had a nice month in July following six months of zero total return. The sector had become steadily more attractive as we noted last month, and July’s results made up some lost ground. We think MLPs  remain attractively priced with distribution yields still above 6%.

May 17^th, 2012 was the 30^th anniversary of my arrival in the U.S. On that day back in 1982 aged 19 I arrived for the first time in New York City fully expecting to be mugged as soon as I stepped off the plane such was the city’s reputation at that time. Although I grew up in England I had spent Summers in Toronto with my father as a teenager and the contrast between middle class North American life and strike-plagued Britain in the 70s could scarcely have been sharper. The IMF had come to Britain’s rescue while I was in school, and gloomy prognostications on the economy were the norm. America was dynamic, exhilarating, the world’s focal point in so many ways. I concluded that the future lay west, and New York’s financial markets drew me here. I needed to move to the U.S. more than anything I’d ever wanted – like all immigrants, I found a way to make it happen. I was part of the biggest wave of immigration the U.S. had seen since the huge influx of new citizens leading up to World War I in 1914. I became a permanent resident in 1985 and a citizen five years later, the shortest possible route for one with no family connections or refugee status.

During those thirty years I have never once doubted that I made the right move. The passage of time has balanced my perspective; London’s a great city too, and I’m very proud of my English heritage. While I doubt I’ll ever live there again, I love returning and one doesn’t always have to focus on the future; nostalgia can be wonderful too. But few Americans appreciate how their country appears to those on the outside wanting to get in. I remember well my urgent desire to go where the prospects were greatest. From afar, perceived through its culture, its impact on world events and unfailingly wealthy American tourists, one sees a place of huge opportunity, excitement, energy, surprises, danger and optimism. It’s an enthralling vision for anyone looking for those things.

In assessing the balance of potential investment returns and risks around the world, my experience is that many non-U.S. investors hold a keener appreciation for the power of the American story. You can talk to wealthy people from almost every corner of the world save North America and you’ll learn they need only reach back a couple of generations to recall war and existential threats, loss of democracy and civil rights, periods of lawlessness and moments when the future was most dire. The comparatively long political stability, rule of law and military security enjoyed in the U.S. are far better appreciated by those who haven’t always lived here. In addition, the dynamic economy fueled in part by a steady influx of type-A immigrants is widely envied. President Reagan was my first president, and his sunny optimism was uplifting for Americans as well as this immigrant just arrived from the Old World. It was then, and is always, Morning in America.

Which is not to discount America’s many challenges, of which the fiscal and political ones remain seemingly insoluble and therefore threaten much that is great. Top-down investment analysis can easily arrive at pessimistic conclusions. The Math of America’s federal and state deficits defy easy solutions, and increasingly partisan politics seems determined to court disaster by avoiding compromise.

Except that (and here’s the still starry-eyed immigrant talking) things have always worked out in the past, and they probably will this time too. It didn’t take me long after I moved here to recognize the difference between the European and American reaction to the insurmountable. Europeans glumly accept what they cannot change; Americans eventually get angry, and the national psyche dictates that when confronted with an apparently overwhelming challenge a commensurate response dedicating attention and enormous resources alters the path of history.

Successful investing combines a belief in a positive future with a healthy respect for the possibility that in the short run things may not work out as expected. The world’s a big place to be sure, but a constructive outlook expressed through U.S. companies represents a sound long-term approach to growing one’s savings faster than inflation. Market timing is ephemeral at best; our analysis of securities is bottom-up, focused on good businesses with low debt that we believe are attractively priced. The risk profile of our portfolios is largely driven by the opportunity set among the individual situations we’ve analyzed. Of the big picture we are perennially cautious optimists. To be so is to remain squarely on the right side of 236 years of history.