Banking Crisis Rumbles On

Posted on: 06 October 2008 by Gareth Hargreaves

The banking crisis, investor protection and riding out a tough market are Graham Kerner's concerns this week.

Global equity markets suffered their most volatile weekly performance in over a decade as the full effects of the credit crunch continue to hit investors hard.

In a week that saw another heavyweight US financial institution succumb to an all too familiar fate, the US Congress finally approved the $700 billion bailout of its failing banking system.

On Monday, global markets felt the shuddering impact of the House of Representatives rejection of the initial rescue package, with the Dow Jones index recording its biggest ever one-day loss of 7 per cent.

Despite gaining back more than half of those losses in the subsequent trading session, the Dow Jones index closed the week down 5.5 per cent representing a fairly torrid week of trading.

In London, the FTSE100 closed down 2.1 per cent reflecting the same fears of US investors. News that the Bank of England would offer three-month loans against a wider range of collateral steadied sentiment as the banks struggled to secure credit from each other, even on overnight deals.

Continued reports of Lloyds TSB takeover of HBOS offered gains in the banking sector, with the latter adding 17.9 per cent in Friday's trading.

Elsewhere the FTSE Eurofirst Index fell -1.3 per cent despite a strong performance in Friday trading amid more banking rescue deals and the prospect of further interest rate cuts from the ECB as the economy weakens.

In Japan, the Nikkei was down 8.0 per cent on the week, closing below 11,000 for the first time since May 2005, with investors spooked by the prospect of global financial meltdown and the weaker US economy.

Investor Protection Increased

Gordon Brown announced an increase to the level of protection offered to savers as the amount of cover from the Financial Services Compensation Scheme (FSCS) was increased from £35,000 to £50,000 for deposit savers. Despite calls for the protection to be increased further, and unlimited from some commentators, it appears unlikely that the Prime Minister will go this far for the moment.

This pressure was intensified over the weekend as Greece and Denmark joined Ireland in guaranteeing 100 per cent of depositor's money in bank deposits. The situation unravelled further as calls for an EU-wide compensation scheme provoked support and dissention in equal measures. Sweden have increased the level of compensation for depositors, whilst the German Chancellor, Angela Merkel, prompted confusion by making the political commitment that no German savers would lose money.

Tip Of The Iceberg

As the week drew to a close and markets collectively drew a breath of relief, leaders of Iceland's central banks were meeting to thrash out details of a €10 billion rescue plan for its ailing banking system.

The impact of this latest crisis from a country of just 320,000 inhabitants may be misunderstood by many, but the implications are far reaching and posed a potential problem for some of Britain's most familiar brands.

The talks have been triggered by concerns about Kaupthing, Iceland's biggest bank and financier to well-known UK companies including House of Fraser and Hamleys. Earlier in the week, Glitnir, Iceland's third largest bank, were rescued by the Government prompting fears that UK retailers, already struggling under current conditions, could be put up for sale as liquidity pressures force the controlling investment companies to sell their stake. These fears have been eased somewhat, as it became clear that the investment companies held most of their assets - and much of their debt - outside Iceland.

City Bets On Rate Cut

The financial pages of The Mail on Sunday reported on the likelihood of a cut in the UK base rate when the Monetary Policy Committee meets on Wednesday of this week. Disappointing financial data highlighting further deterioration of the labour market and continued depression in the manufacturing sector indicate that a 0.25 per cent cut is becoming more likely.

Whilst a reduction in the cost of borrowing represents an obvious benefit to companies struggling to meeting interest payments on loans or unable to take finance due to the costs of repayments, it is not immediately clear that this cut will be passed on to mortgage debtors.

A further cut would be good news for the wider economy, allowing companies to maintain their earnings, increasing confidence in the sector and potentially providing a catalyst to turn-round the current gloomy climate.

Heavy Metal Haven

The current market malaise affecting both equities and fixed interest securities has provoked many investors to look at alternative homes for their money, in the short-term at least. Concern regarding the global banking system and the perceived safety of bank deposits has, once again, brought gold in to focus.

Traditionally one of the safest havens during periods of financial turmoil, the accessibility of alternative assets, such as gold, provides investors with the opportunity to shelter from the global credit storm. An article in The Sunday Telegraph highlighted its resilience to wider economic factors and pointed out that historically the price of gold shows little correlation to equity markets.

Buying physical gold assets directly presents a number of obvious obstacles, but indirect exposure can be achieved through Exchange Traded Funds which offer an easy way for investors to gain exposure to gold without ever owning it.

Emerging Market Opportunities

With the so-called developed world's financial institutions lurching from one crisis to another, FT Money section demonstrated the resilience of emerging market debt and suggested that the problems encountered during the 1990s may have been left in the past. From the Mexican currency crash of the mid-1990s, the Asian collapse in 1997 and more recently the Russian and Argentine debt defaults, emerging markets built up a reputation for instability.

Many emerging market countries have refinanced, cleaned up their balance sheets and are enjoying a liquidity boom from commodity prices. Sovereign debt in these regions offers attractive returns and, given the strength of the issuer, gives investors renewed cause to look again at an area offering surprising levels of capital security.

The Perfect Blend

Getting the right blend of defensive and growth assets is key to protecting your pension portfolio from the recent market turmoil, according to an article in FT Money. Selecting the right strategy to match your age, objectives and risk-profile will prove a more successful approach.

For investors closer to retirement, advisers are encouraging them to avoid making hasty decisions to sell equity positions at the current depressed prices, missing out when markets recover, and instead look at alternative sources of retirement income, at least in the short-term. Using tax-free income from ISA investments or interest from savings accounts may enable those nearing retirement to defer annuity purchase until the current market conditions improve.

Younger investors should be advised to allocate more to equity-based investments as share prices look historically cheap and the probability that markets will recover in the long-term very strong.

Time In, Not Timing

The old adage of ‘time in, not timing' the market has come to the fore again as Antony Bolton, the legendary UK fund manager, disclosed last week that he had been putting some of his own money into the market despite the latest round of financial horror stories.

"For the first time in a couple of years, I've started to feel optimistic. What markets have done in the past two or three days are all signs of a low, but whether it is the low is hazardous to say."

The Observer pointed out that despite most areas of the economy suffering as a result of the credit crunch, there are still sectors which, to some extent, have avoided the worst of the fall out. Traditionally defensive sectors such as utilities, tobacco and pharmaceuticals have been less affected and have provided some respite for investors.

Neil Woodford of Invesco Perpetual, and manager of the St. James's Place UK High Income fund has identified this opportunity to benefit from the current conditions and holds just under a quarter of funds assets in utilities companies including British Energy and National Grid. This defensive position has protected the portfolio from the wider economic backdrop, whilst the fund has fallen -7.0 per cent over the past month the FTSE All Share index has plummeted by -13.2 per cent over the same period.

In a recent interview, Stuart Mitchell of S.W. Mitchell Capital and manager of the St. James's Place Continental European funds commented, "The markets are very difficult at the moment but as a fund manager the important thing is not to make knee-jerk decisions, so I am being very disciplined and sticking to my long-term strategy which I am confident will see us making good returns over the next two to three years."

"The portfolio continues to be defensively placed - I own telecom stocks, utility companies such as RWE and I have a large holding in Unilever."

"There are several sectors where company share prices have been badly mauled and so I have added to the portfolio at these low levels. The market is assuming the worst in terms of future earnings and this negative sentiment is fully priced into share prices - in my experience, when we look back the actual outcomes are rarely as bad as the market thinks. So for now it's a question of remaining patient whilst the markets work through the current crisis."

6th October 2008

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