Younes: The Whole World Is Greece

Jason Stipp: I'm Jason Stipp with Morningstar. The European markets this last week wiped out most of the gain that they've got for this year. I've got on the phone, I'm lucky enough to be speaking with Rudolph-Riad Younes.

He's a former Morningstar manager of the year and the manager at Artio International and Artio International II. He has a lot of expertise in investing in Europe. He's going to tell us a little bit about his thoughts on the situation there. Thanks for joining me, Riad.

Rudolph-Riad Younes: Thank you for having me, Jason.

Stipp: Sure. First question for you. I think when some of the issues a few weeks ago started to be persistent in Greece, I think for a lot of investors they thought this was going to be a situation that was contained.

It seems over the last few weeks it has really spilled over to become more of a regional problem. Some folks think more of a global problem. Obviously, I think a lot of the sell-off that we were seeing there is related to this.

Do you think the extent that the markets are down is justified based on the sovereign debt issues that we're seeing in Europe?

Younes: The key starting point to understand is that there is not just one Greece. The whole planet is Greece. Every government you look at today, and you hide the name, they look like Greece, even worse.

From the U.S. to U.K .to Japan. I mean there are very, very few countries, maybe it could be counted on one hand, who you could say are reasonably solvent as governments. What happened is the market many times tends to ignore fundamental deviations.

Like, for example, valuation-wise you could see Nasdaq going to crazy valuation in the late '90s. Then, finally, people wake up and react to something they should have reacted to many years before.

Likewise, last year the markets rallied despite many fundamentals [that] were very ugly. And today the logic, this year, finally the market is trying to attack the weakest countries.

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Today, the weakest countries are not the ones with the worst fundamentals, but are the ones who cannot print their own currencies. That's why you're seeing the pressure on Greece and spreading into the other southern European countries, named the PIGS for their first initial for the country names.

Then the next potential vulnerability is going to be in the U.K. Because today, although they can print their money, they're going to have a hung parliament. Therefore, the government might be very indecisive in the way they're going to tackle their deficit and budget problems. Therefore, we could see weakness there.

Ultimately, Japan could be after that and ultimately it's going to be the U.S. as well. Right now the focus is only on that region. It's not just Greece or southern Europe, it's global governments. That's why gold is the best solution so far.

Stipp: Would you say that the sell-off then, it sounds like you're saying that the sell-off may in some cases be justified? Do you think the market reaction has overreacted to the issues that we're seeing? And it sounds like you're seeing a cascading effect here.

Younes: The only thing that has surprised me many times in the market is just the timing. If nine months from now we see the same thing with the U.S. Treasury, it will not surprise me. What will surprise me is what took them that long to attack the U.S.

So this is the key, is all these governments are similar to Greece, if not worse. The market is panicking right now on Greece and the others like Portugal and Spain because they feel these countries cannot print euro and, therefore, it's highly unlikely they'll be able to be paid in full.

Stipp: Riad, one of the investment theses that you had followed in the past was centered on some of the more Eastern European countries or the developing European countries that were going to be joining the Eurozone.

Do you think that the problems that we've seen with Greece create a different situation for those countries and for the Eurozone as a whole?

Younes: Yes, definitely. Definitely today. I mean for the past 10 to 12 years--or even 15 years--we've been living in what we call a convergence trade. A lot of yield spread converging and fundamental converging between many satellite European countries versus the core European countries like Germany and France and Netherlands.

Now, we're seeing what we call the divergence trades, at least in the short term, where the market is looking at the fundamentals of these countries. They're saying wait a second, the spreads have narrowed dramatically, but in reality the fundamentals have never been worse or so bad.

Definitely, the convergence trade right now is in reverse in the medium-term, short-term. But ultimately, I think this is good. Any time you try to address a problem early on, usually the price is small. The more you delay something, the bigger the price is.

Stipp: Riad, for the companies in your portfolio, do you think any of the situation has changed for them? How do you see them holding up?

Do you think that your valuations on them may need to come down a little bit because of any of the action that's happened in Europe? How are you thinking about your holdings right now?

Younes: Well, definitely, I mean, we've been, from a valuation perspective and from a medium-term perspective, we're very much in favor of Europe. That has been our overweight in the portfolio.

But, at the same time, we understand the short-term catalysts and this development--short-term--is most negative towards European economies until this has been resolved.

As a result of that, we have been reducing significantly our exposure to the euro currency, as well as to the European financial and some other European sectors. We have significantly increased our gold.

I think the most, medium-term, I think the biggest winner is going to be definitely, in our opinion, is going to be precious metal. Because, as we said earlier in the conversation, the real disease today is we had the private sector globally committing big mistakes.

Especially the financial sector, and governments around the world have socialized those losses by putting them on their balance sheet. And in addition to that, they threw trillions of dollars into their economy. Therefore, preventing the loan losses to increase in the banks.

So right now, the sickness has moved from banks to governments around the world and now we are starting to pay the price for that. Therefore, ultimately, governments have very limited choices.

We see that the hard choice, like we see in Greece today, the choice of increasing taxes and decreasing spending, is going to be revolted against. Therefore the easiest solution for politicians is going to be to print money.

So the risk of printing is going to be very high around the world, and therefore as an investor, your best insurance and your best safety today is gold and other precious metals.

Stipp: Riad, you mentioned the banks in your answer there. I think there's some concern that we could potentially see in Europe a situation with some of the sovereign debt that maybe we saw with sub-prime mortgages in the United States.

Where there is this debt that can't really be sold, that's somewhat toxic, and it creates a credit crisis. Do you see that playing out in Europe as well?

Younes: Definitely. This is definitely... That's a very big risk. Especially that you have the Germans who are basically the most influential player in that crisis, and the Germans are very dogmatic, in terms of financial discipline.

They have a very, very difficult ideological and political problem of monetizing the sins of others. Here, we have no problem here in the U.S. to do it because of the lobbying, but in Europe I think the likelihood of forcing banks to take a haircut on many of the debts they have has risen dramatically.

And not only haircut on the government debt they own, also, if many countries are forced to take austerity measure, it means you're going to have...loan growth is going to be challenged, if not negative, plus you're going to have quality problems in loans.

Definitely, Europe is being forced by the bond market vigilantes to address their fiscal situation and the implication on the banks cannot be underestimated. And the question only is when will the bond vigilantes move their attacks from Europe into U.K., from continental Europe towards U.K., Japan, and the U.S.? That is really the next question.

Stipp: Last question for you, Riad. You had mentioned in your answer then, you talked about several developed countries; U.K., U.S., Japan. You also have invested in emerging markets.

I'm wondering your take on the effect on emerging markets of some of the issues that we've been seeing in Europe and maybe seeing in other developed countries. How will emerging markets come through this?

Younes: Well, what's happening today is very enlightening for many people to understand that the reason the emerging market has done so well in the very near, recent history, is because the West has been living beyond its means, and that's why we have accumulated all this debt.

If the West is forced to live within its means, it's going to have very negative implications on emerging markets. I don't think their domestic economy will even partially be able to offset the weakness we're going to see in the rest of the world.

So the short answer is right now the most vulnerable sector is going to be financials all over the world. You want to be basically in sectors and companies who can withstand another global recession that could hit us soon enough.

Stipp: Riad, thanks so much for joining us today and for your insights. I appreciate your time.

Younes: Thank you very much, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.