Reflections

19th September 2012

Four years have passed since the beginnings of the global financial crisis - the worst in the post war era. To many fund managers, investors, global leaders and central banks it must feel like more than a lifetime. When Lehman Brothers filed for bankruptcy in September 2008, the world quickly slid into a systemic financial meltdown which we have been trying to recover from ever since. `

From time to time, it is helpful to sit down and reflect on just how far we have come since the equity market lows of 3rd March 2009, when the FTSE 100 Index closed at 3,512.09. Since then the market has recovered over 60%, hovering below the 6,000 level, but standing far short of the previous peak of 6,730.70 where it closed on 12th October 2007.

 

These past four years since the start of the crisis have been quite a white knuckle ride - but in three clear and separate market stages. First, the sell-off, from September 2008 to the market low the following March. Credit markets and trade froze, sending the global economy into a recession. With the resulting aggressive and unprecedented global monetary and fiscal stimulus, interest rates remain at record lows today. The financial markets declined sharply, with the FTSE 100 Index losing almost 40% during this initial stage, whilst government bonds and gold benefitted as deemed safe havens for fearful investors.

 

The second stage was the strong market rally from March 2009.  This lasted over a year as world leaders and their central banks bailed out the banking system to stabilise the financial markets. The FTSE 100 Index rebounded to 5,825.01 (+60.0%) - a similar level to today - and other cyclical asset classes improved as the continued monetary and fiscal stimulus kick-started an economic recovery. Although most investors were rewarded in this stage, it took a courageous approach to participate as the markets had been plummeting in early 2009.

 

The final stage, what we have been living through since then, has been the most volatile phase - the so called "risk on/ risk off" market. Initiated by the first signs of trouble in the Eurozone as the Greek economy was bailed out, fears of contagion then spread bringing into question the viability of the single currency without fiscal and political unity. Treasuries, Gilts and Bunds have been a profitable trade as the majority of equity markets have been swinging within a range with the further deterioration in the Eurozone, a stumbling US recovery and fears of a hard landing in China. With each significant decline in business confidence and financial markets, policy makers have shown a willingness to intervene with further stimuli of ever increasing magnitude. Quite recently the ECB announced its intention to defend the Euro at all costs, whilst the US Federal Reserve expressed its determination to reduce unemployment with further unlimited money printing. This is big policy and we may have entered the next market stage. Until then, whilst the global economy is deteriorating, equity valuations are cheap and liquidity will trump all in the medium term.

Calm before the storm

24th August 2012

This blog first appeared in Portfolio Adviser on 28th July 2012 and is available online at:
http://www.portfolio-adviser.com/comment---analysis/the-calm-before-the-euro-storm

Temperatures during the British summer may have swung wildly but financial markets have remained remarkably calm.  Equity market volatility has fallen to its lowest level since the Lehman Brothers crisis allowing the majority of global equity markets to grind higher, whilst the US stock market has just reached its four year high.  This new air of calm was initiated by ECB President, Mario Draghi's speech ahead of London 2012, in which he committed "....to do whatever it takes to preserve the Euro."  This was further supported by Angela Merkel.  But should we be wary? Was this a ploy to allow politicians to enjoy their family summer holidays this year without disruption?

 

I suspect this may be the calm before the storm and that September will see volatility pick up as investors are reminded that the global economy is still slowing and that problems in the Eurozone have probably worsened rather than gone away. Over the last month, Draghi's positive words have prompted both Spanish and Italian bond yields to fall and their equity markets to rise. There has been virtually no news as to how the ECB intends to tackle the sovereign debt crisis, although we know that any jointly issued Eurozone bonds will harbour conditions. As we head into autumn, we are about to discover how acceptable those conditions will be.

The direction of both equity and bond markets will continue to be driven by how politicians and their central banks deal with government debt. Not only will this influence markets, it will shape the future of the Eurozone and the speed of global economic recovery. Policy makers continue their delicate balancing act in fostering economic growth.  At one end of the scale, peripheral Europe has embarked upon severe austerity to reduce debt, at the other, the US has printed enormous amounts of dollars to keep bond yields low in order to stimulate growth.  Whilst the US approach has produced better, relative economic growth it has come at the cost of ballooning government debt. The UK has attempted the middle ground, but has suffered from a large number of its trading partners funding themselves in recession, coupled with a weaker, scandal-ridden banking sector.

We have recently raised our cash weightings in client portfolios as we suspect the next few months will be fairly turbulent. The US presidential election campaign, now in full swing, has become a debate on fiscal policy and the role of government in society. History shows that the best outcome for equity markets is a win for the incumbent. However, polls are showing candidates neck and neck as Obama's hope for a pick-up in economic growth fades. Back in Eurozone - hard decisions and compromises will have to be made if the ECB is to intervene to reduce the cost of borrowing. If this does happen, it will create a better entry point for us to buy equities, which we continue to believe will be higher a year from now.

John Husselbee

 

Climbing a great wall of worry

15th August 2012

 

After a brutal May, equity markets have quietly been enjoying a steady rise over the summer months. Initially led higher by the defensives, the rally has broadened of late with cyclicals taking up the running and stretching the lead of equities over other assets classes in the year to date. Since early June, the FTSE All Share has now advanced by over 12%. What makes this all the more impressive is that this has occurred in the face of a deteriorating global economy and the continued threat of a full blown Eurozone breakup.  

 

In what now seems like a scarily similar year to the previous two, optimism surrounding global economic growth at the turn of the year has slowly evaporated. Once again a knife has been taken to GDP forecasts, with the Eurozone and UK already slipping back into recession. Purchasing Manufacturing Indices (PMI’s) are pointing to a contraction in output, with the Eurozone unsurprisingly witnessing the sharpest decline. China’s manufacturing sector has now contracted for nine months in a row, whilst the last two ISM’s have highlighted even the US is not immune. Jobs growth remains subdued and whilst there are signs of stabilisation in the US housing market, it is hardly going gangbusters.

 

One could easily be forgiven for thinking risk assets would struggle in such an environment. So are equities burying their head in the sand or are they once again climbing a wall of worry and identifying a brighter future round the corner? Aggressive monetary easing has undoubtedly been hugely supportive to asset prices of late. China and the ECB have cut interest rates, the Bank of England has pulled the trigger on more QE and expectations of further money printing in the US are now firmly baked into markets. There are also signs that although undoubtedly weak, the economic data is beginning to stabilise. When is a 6.2% contraction in GDP taken as good news? Well, when it isn’t 7%. The better than expected Greek GDP figures in Q2 are irrelevant in the greater scheme of things but highlight that when expectations are severely depressed and investors positioning is deeply defensive, even apparently weak data can be viewed positively. More relevant is that global manufacturing PMI’s stabilised in August whilst services data actually improved. Similar to last year the recent fall in the oil price along with inventory rebuild, could give a notable boost to global GDP in the second half of the year.

 

Equity markets are traditionally optimistic and appear to be assuming further QE in the US is a certainty, the global economy escapes a serious slowdown and the Eurozone continues to muddle through. Bond markets, although arguably manipulated, suggest at least one if not more of these outcomes will fail to materialise. Who will be proved right only time will tell but given the bond markets track record the recent strength in equities may prove short lived.

 

John Husselbee

Let the Games begin

27th July 2012

London 2012 is here - seven years in the making, costing billions of pounds of UK public money with thousands of workers regenerating Stratford, in the East of London, into a world class sporting venue. The foundations are in place for a spectacular festival of sporting achievement complete with medals, records and tears. Come the closing ceremony, there will have been sobs of joy and those of choking disappointment as the winners take gold and the losers are left with nothing. The UK Government is keen to use the Olympics as a showcase to attract further foreign investment and foster economic growth.

 

Meanwhile in Europe, there is no sign of a closing ceremony to the Eurozone games. There continues to be winners and losers within the single currency, which is causing great division. The foundation of the Euro was based on a belief by seventeen nations that everybody would be winners with access to cheaper credit and a larger marketplace in which to trade. The economic theory that Europe would be stronger, bonded together by a common monetary policy and single currency, has been fiercely defended by politicians. However, in reality, just like the Olympics, there have been medals, records and tears.

 

Germany has been the main beneficiary of the Eurozone, sitting on top of the medals table in terms of economic growth, employment and productivity. Whilst periphery nations enjoyed some early successes with access to cheap credit, this has proven unsustainable. One of those nations, Greece, has the highest borrowing costs with record levels of debt and a growing budget deficit. They are not alone in creating records. Spain too is struggling to recapitalise its banks and is now dealing with the threat of bankruptcy in the regional governments. The Spanish, and others, require bailouts and access to further cheap borrowing to reduce these record debt levels in order to compete again on the international stage. This will be a challenge whilst the price of Eurozone support is austerity. There will be further lamentation as governments slash spending and raise taxes to correct budget deficits.

 

Surely the theory that everyone can win from a single currency has been well tested and proven to be pure fantasy. The proposed fix that would cheer the market is further and deeper unity on fiscal and political terms. In practice that would equate to the sharing of debt within the Eurozone and the European Central Bank effectively acting as lender of last resort. Following the election of François Hollande as President in France, Germany has lost its only ally to fiscal responsibility.

 

The games will continue over the summer months until Germany makes up its mind about whether it wants to stay or leave the Eurozone. In reality rather than the Olympics, the Eurozone games resemble more “Jeux sans Frontieres,” the European TV game show of my youth. I can still remember Europeans dressed in giant foam costumes weaving and tottering to the sound of Stuart Hall’s laughter as they scrambled to win the coveted title.

 

John Husselbee

Don’t blame it on the sunshine, blame it on the good times!

 

Meteorologists tell us that the heavy rainfall in the UK over the past three months is due to being on the wrong side of the jet stream. This mysterious driver of our weather, which travels west to east, usually sits much further north during the summer months - thus pushing areas of low pressure northwards and we avoid the bad weather. Not so this year. The period April to June has been the wettest on record. Repeated downfalls have caused flooding in many parts of the country. Our gardens are greener than usual for the time of year, but industries that rely on summer trading are suffering in economic conditions which are already challenging. There is nothing to be done but to sit and hope for sunny days.

 

The economic misery felt in the Eurozone for almost three years continues. In this case, the blame lies in the availability of cheap credit under a single currency which allowed weaker economies to leverage both public and private balance sheets. With the declaration in the last few weeks that both Italy and Spain need help, the Eurozone debt crisis has entered a new, perhaps more critical phase. This was the main agenda item at the most recent summit. Headlines inspired the markets for a few trading days with the apparent agreement that members’ bailout funds could be used directly to recapitalise banks rather than via governments. In principle, this is a step in the right direction, but the lack of detailed terms leaves us sceptical, with more questions than answers.

 

So the misery in the Eurozone is set to continue unless the key issues of debt, growth and competitiveness are addressed. It seems for now that the markets believe that further unity is required to resolve the Eurozone’s issues. Investors would like to see the European Central Bank act as lender of last resort and flood the market with cheap Euros to bring down the overall cost of borrowing. Yet this is highly unlikely without an agreement on further fiscal and banking unity, especially when each member faces a loss of sovereignty in following this federal path.

 

The Eurozone represents around a fifth of the global economy and has the ability to drag down the pace of its recovery. Indeed the International Monetary Fund (IMF) has recently warned of this danger. It also commented that Emerging Markets, the global growth engine of the past decade, were slowing and might be incapable of sustaining high growth rates in the future. US growth has also stalled in recent months, with unemployment remaining stubbornly high, ahead of the Presidential Election.

 

The expectation is that there will be further global stimulus. Indeed, we have already seen interest rate cuts in China and Europe, plus further money printing in the UK. However, in an environment where household deleveraging clashes with government reflation efforts, the law of diminishing returns applies. The lasting effect of each round of stimulus is diminishing. Policymakers need to tackle the structural issues of debt, growth and competitiveness to create a brighter future.

 

John Husselbee

18th July 2012

Diamond is forever?

 

The credibility of the British banking system has suffered another major blow. Barclays has been fined £290 million by the regulator for attempting to manipulate Libor, the London Inter Bank Offered Rate. This is the daily calculated rate at which banks in London lend money to each other for the short-term. Libor is therefore an important benchmark not only in global financial markets but it also heavily influences the cost of all loans and mortgages in the UK.

 

Barclays Chief Executive, Bob Diamond, has admitted that the bank’s control systems should have been much stronger. Certainly, this event, along with the debacle the week before which left NatWest and RBS customers without access to money, is further evidence that banks still remain too big to fail, too big to manage and too big to regulate.

 

Arguably, the Bank of England has been openly involved in its own manipulation of long term interest rates through Quantitative Easing. This buying of government issued gilts has been successful in keeping down the cost of long term borrowing is to the benefit of the nation’s economy and as such, is acceptable practice. But the authorities must draw the line. Corporate manipulation purely for profit is not.

 

The recent revised numbers from the Office of National Statistics showed that output in the UK shrank by 0.4% in the final quarter of last year. We remain in the midst of a double dip recession, albeit a shallow one. Talk that we are following a tough austerity programme is not matched though by a reduction in government spending which is estimated to have risen 1.9% in the first quarter. Without that effect the current recession would be deeper. Quantitative Easing has failed to re-ignite the real economy, hence the recent announcement from the Governor of the Bank of England and the Chancellor to support bank lending. A creditable working banking system is vital to the health of any market economy, especially one struggling to grow. What we didn’t know was that British banks were about to be downgraded by the rating agencies and that the FSA was investigating Libor manipulation.

 

Barclays share price has been hit hard and record fines of £291 million will dent the bank’s profits. However, there is no such agreement with investors and corporate clients, who have already launched a class-action lawsuit against Barclays in the US.

 

The FSA’s summary of the case with its incriminating emails between celebrating traders will give their lawyers plenty of ammunition to pursue their case. The total cost of litigation could easily dwarf the size of the fines. The FSA has not directly accused any of Barclays’ senior management of misconduct. Yet calls for the resignation of a contrite Bob Diamond are growing and in a ‘Shareholder Spring’ this may be the ultimate price. However shareholders would do well to remember his many strengths and finding a suitable replacement CEO would be no easy task.

 

John Husselbee

29th June 2012

So Greece is saved?

This article was first printed in Professional Adviser on 5th July 2012 and available online at http://www.ifaonline.co.uk/professional-adviser/feature/2189243/greece-safe

So Greece is saved? Well, actually I am not so sure of that. The result of the second Greek Election has, as yet, changed little. The New Democracy party, that supports the terms of the Eurozone bailout, won through, but failed to poll sufficient votes to govern. Nonetheless, it has the right to form the next government, in spite of anti-austerity parties having gained 60% of the vote - so much for Proportional Representation!

What lies ahead is the tortuous task of forming a credible and stable government. Obviously, this will be a coalition and necessitates the New Democracy Party making peace with old political adversaries. So whilst the coalition will come together on the acceptance of austerity, there seems little doubt that there will be a collective attempt to dilute the terms of the bailout. 

Greece has long lived beyond its means. Government spending has spiraled out of control whilst widespread tax aversion has hit government income.  The country has limited cash to pay its bills and needs additional funds by mid July if it is to avoid national bankruptcy. Normal borrowing channels are not open to them, the only lenders being the so called Troika - the European Union, European Central Bank and International Monetary Fund. In February, they collectively agreed a further Euro130 billion bailout but subsequently withheld the money due to election uncertainty. So, there is limited room for renegotiation on austerity especially as, since February, there has been little effective reduction of the Greek budget deficit and capital continues to pour out of the domestic banks.

The election result has not diminished the risk of a Greek default, banking collapse and departure from the Eurozone.  Once again, investors are looking to central banks to provide the necessary liquidity should this occur.

A couple of weeks ago, the Spanish government accepted a Euro100 billion bailout to support its country’s banks, reeling from the aftermath of a cheap credit fuelled property bubble. Spain had hoped that this move would reduce the cost of their borrowing, but bond investors failed to distinguish between the risk posed by Spanish banks and sovereign risk. This is mainly because Spanish banks had previously taken the cheap money lent to them by the ECB last December and again in February this year, to load up on their government debt.  As I write the cost of ten year debt is above the critical bailout level of 7%.

There has also been a pre-emptive move in the UK, announced by the Governor of the Bank of England at his traditional Mansion House speech. Funding for lending as well as reducing the limits on holding cash for UK banks was a deliberate policy to provide further liquidity to the market. Central bankers, like Sir Mervyn King, appreciate that the route to the only credible solution to the Eurozone crisis (that of fiscal union) is very lengthy indeed. But that calls for a big change of heart in Berlin towards sharing the Eurozone debt burden and allowing more stimulus rather than greater austerity.

John Husselbee
20th June 2012