If we thought things within the market were too quiet, along comes the small Mediterranean island nation of Cyprus to disrupt the relative tranquility. An initial plan by Cyprus lawmakers to tax deposits has added a wrinkle to the otherwise quiet Europe. Cyprus, by way of background, is a nation of approximately 800,000 and an economy less than $18 billion, or .2% of Europe’s Gross Domestic Product (GDP). Currently, Cyprus is under siege from the rapidly deteriorating banking sector, which by some estimates is eight times its annual GDP. Unfortunately, Cyprus banks held a lot of Greek bonds and the write down on that debt created major losses, which is why Cyprus needs assistance from the European Union and possibly its bank depositors.
The vast majority of depository accounts are international individuals and businesses. With the promise of service, privacy, and low taxes, Cyprus became a little Switzerland for some. (Many of those international account owners are Russians, which explains the willingness of the Russian government to offer several billion dollars in loans in recent years.)
The initial plan by Cyprus lawmakers was to tax deposits at a certain rate. Deposits under 100,000 euros will be taxed at 6.75% and those above at 9.9%. This revenue source would provide a foundation to receive eurozone rescue loans. Lawmakers, recognizing that they have now created a run on Cyprus banks, have backtracked off the initial plan and are scrambling for a more amicable solution, especially for those small account holders. There are very few bondholders that can assist in the bailout or rescue plan, contrasting that with other nations such as Greece who did not have to take this precarious route for assistance from Europe. Ultimately the plan is dangerous, but Europe is looking for solutions that do not aid the more unscrupulous offshore depositors. Fortunately, the markets were relatively modest in their reaction to the news; and as such U.S. markets were only down slightly and international a bit more. The negative reaction has come on the heels of a strong start to 2013 market returns.
At Fragasso Financial Advisors, we recently reduced our international exposure for two reasons. One is that after robust international gains last year, it is generally prudent to reduce those sectors as they typically have a reversion to the mean. Secondly, Europe is not completely out of the woods and remains a fragile place for investors. While we have no clairvoyance as to what markets may do from day to day, we agree that rebalancing back to an agreed upon model and taking gains where appropriate can be a prudent mechanism for our valued clients.
Daniel Dingus is Director of Portfolio Management at Fragasso Financial Advisors, a Pittsburgh-based investment and financial planning firm. Due to industry regulations, comments are not permitted on this blog. If you would like to contact the author, please email us at firstname.lastname@example.org. Dan can also be reached for comment at 412-227-3200.