JUL 27 2011 – Dixon Mitchell Commentary on Foreign Holdings & US Debt Turmoil

The following commentary comes from one of our Investment Counsellors, Dixon Mitchell:

“As the debt ceiling sideshow reaches a crescendo in congress (and Standard & Poors stokes the fire by suggesting that US bonds might be due for a rating downgrade), we’ve fielded several calls seeking reassurance that the foreign equity holdings in DM portfolios are “safe”. While current political jousting will likely be remembered as a financial non-event with the passage of time, it’s worth considering the implications – and prudent courses of action – should a worst case scenario play itself out.

At the moment, refuge seekers are once again bidding up the price of gold, confident that the yellow metal will provide a store of value should other alternatives come under pressure. Aside from the fact that an allocation to gold is always speculative (i.e. the prime drivers of marginal price are psychology and sentiment), this asset is now vulnerable to good news – in other words, if a debt deal is reached in the US, all of the doomsday capital flowing into the commodity will likely exit just as quickly. Counterintuitively, US blue chip stocks, may actually provide a more effective hedge against current hazards than traditional financial shelters. Consider the following:

If political gridlock leads to a technical US debt default, the bonds of many of these companies would instantly be seen as preferred credits to the US treasury itself. Names such as Johnson & Johnson and Microsoft are already rated triple-A, while most of DM’s other foreign holdings fall in the A to double-A range. In the event of financial disorder, these companies may become safe havens for capital themselves, making their funding sources even cheaper than they are today.

DM has intentionally weighted foreign allocations toward companies which generate significant revenue outside the US. McDonald’s, 3M, and International Flavors & Fragrances, for example, all earn more than 60% of their income in non-US jurisdictions and in currencies other than the US dollar. Should the greenback plunge in the wake of default, these offshore assets and income streams would become even more valuable in domestic currency terms.

Collectively, the US stocks owned in DM portfolios trade at reasonable valuations and pay healthy dividends (in fact, the average dividend yield on our foreign holdings currently exceeds the interest yield offered on the 10-year US Treasury Bond). If a debt agreement is reached between Republicans and Democrats, these stocks will remain attractive and may even be pushed higher by a wave of relief buying … they won’t, however, be ravaged by capital flight under such a good news scenario.

Though it is difficult to imagine that US lawmakers won’t reach some sort of debt agreement at the 11th hour, in the case that they don’t, we are confident in the integrity of our US equity holdings. Aside from the fact that people will continue to eat Big Macs, use Post-it Notes, and take Tylenol, regardless of how current financial events play out, the US companies owned by DM are distinguished by their capital strength and diversification across global markets and currencies. In an environment of financial uncertainty, these attributes bolster the strength and stability of the foreign equity allocation in DM portfolios.

Don Stuart
Dixon Mitchell”

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