The banks bounce back

Posted on: 02 February 2009 by Gareth Hargreaves

Financial expert Graham Kerner finds there is considerable value to be found in the markets at this time.

After being badly beaten up the previous week, UK banking stocks fought back, leaving short sellers – speculators who seek to make a profit from falling share prices – with a bloody nose.

Barclays led the way, after the beleaguered bank put an £8bn figure on the scale of its credit write-downs and insisted that it would not be raising any additional capital.

This assuaged investors’ fears that there was worse to come. As a consequence, Britain’s blue-chip banks staged a dramatic recovery with, as The Sunday Telegraph pointed out, the prices of Barclays, RBS and Lloyds doubling in value.

Unfortunately, the good news was marred as the week wore on with fresh evidence of a deepening global downturn emerging - resulting in a wave of leading global corporations announcing more than 70,000 job cuts in one day alone.

The Financial Times said that the cuts came across the board, from large US groups such as General Motors to Dutch electronics giant Philips, along with UK steelmaker Corus.

Against this backdrop it came as no surprise that Lord Mandelson, business secretary, announced a deal to offer a £2.5bn lifeline to Britain’s car industry although he stressed that there was no blank cheque on offer. But the package was seen as inadequate by businesses and unions alike who warned that tens of thousands of jobs were at risk and ministers subsequently came under fire for the paucity of the measures.

The Moving Finger

As the economic outlook darkens it comes as no real surprise that the finger of blame should be pointed by politicians of all colours at those they see as culpable. The Times reported that hedge funds were accused by MPs of gambling against the taxpayer when they bet that share prices of British banks would fall last year.

Appearing before the Treasury Select Committee, four leading hedge fund managers came under particular attack over the practice of short-selling but they denied they were responsible for the government being forced to intervene in saving the UK’s leading banks.

The Select Committee then moved on to criticise the government’s handling of the crisis and subsequent recession; saying action to limit the severity of the slowdown has failed to work. In a hard hitting report the Committee says that, “We are concerned that piecemeal measures introduced by the Government may not be adequate in the face of the crisis in lending”.

But not everyone is in agreement. Leading economist Anatole Kaletsky, writing in The Times, believes the latest round of government initiatives will work, saying that finally the Government has done the right thing by offering bullet-proof insurance for all the assets in Britain’s banking system.

Adding to that, just as importantly, it has promised to extract from the banks legally binding and enforceable guarantees of specified levels of lending growth to households and non-financial businesses.

Mr. Kaletsky argued that these are, finally, the right policies to cope with the crisis. The Sunday Telegraph opined that the bail-out has addressed the two urgent requirements of capital and liquidity in one blow.

Guarantees of £200bn on new lending and the Bank of England’s £50bn asset purchase scheme provides capital while the insurance scheme for toxic debts restores the banks’ capital ratios. And data seems to support the optimists: according to Reuters, investment grade corporate debt issuance rose to levels not seen for six months in January and the spread (premium) of corporate bonds over gilts has begun narrowing.

The improved environment in the corporate bond markets mean that not only can companies find the funding they need, but it also enables investors to lock into high income streams with prospects of capital growth if spreads narrow further.

Schroders’ chief economist Keith Wade recently explained the company’s asset allocation strategy.

“In terms of the economic cycle we’re actually in the phase of the cycle where normally you would expect to see risk assets start to perform quite well.

“The reason for this is that very often, after a year or so of slowdown, the markets have usually sold off quite a lot and we’re in the position where valuations are very attractive and people begin to gain more confidence and go back into the market.

“The area where we are most keen to add risk has been the corporate bond area. The sell off in investment grade and high yield bonds has been so severe that the valuations now are attractive and we feel that they do actually already discount a very poor economic environment, probably more than a recession has already been discounted in those asset classes”.

A Chill Wind

It’s that time of the year when the world’s leading politicians, bureaucrats, financiers and businessmen come together on the top of a Swiss mountain to rub shoulders and exchange ideas at the World Economic Forum in Davos.

This year, all minds were focused on the global economic slowdown, but as The Financial Times noted, the idea of ‘globalisation consensus’ was under strain as never before. Instead of further promoting international economic integration as the path to ever rising prosperity, it appears the financial crisis is creating the threat of global depression as countries increasingly look to protect their own position first.

Coinciding with Davos, the Institute of International Finance forecast that the global economy would contract by over 1% this year – more severe than the recent IMF forecast of virtually flat growth. And if there was any doubt about the gravity of the situation this was dispelled last week when figures emerged showing that Japan, the world’s second largest economy, suffered a record 9.6% fall in industrial output in December coupled with a large rise in unemployment.

So the pressure was on for world economic leaders at Davos to present a united front – which they didn’t, as The Financial Times pointed out. The paper observed that China is most displeased at being accused by President Obama of ‘manipulating’ their currency and thus are making it clear both in private and public, that they blame the current crisis on the US.

There was more dissent too, with union leaders accusing politicians and business executives of failing to tackle the crisis and the latter then stepping up their assault on the bankers.

The situation was best summed up by The Telegraph, which described enemy number one as protectionism – identified by Gordon Brown when talking about the retreat of banks from overseas markets as a form of financial protectionism. And, more transparently, there is a threat to trade as the World Trade Organisation highlighted, saying “We are witnessing a huge drop in trade flows, which in turn generates unemployment”.

But it was not all bad news. Bill Clinton argued that the US fiscal stimulus package would mark the turning point for the US financial system.

Meanwhile back in the world’s stock markets, investors’ minds were focused sharply on the reality of the current slowdown with the release of worrying US labour market and housing data coupled with falling business and consumer confidence figures in the eurozone.

In the US, fourth-quarter GDP figures showed that the economy shrank at its fastest pace for nearly 27 years, although the headline contraction of 3.8% was less than feared.

So once again, markets were volatile and although the Dow Jones index retreated a little on the week, in London share prices advanced over 2% on the week as fears over the banking sector ebbed. Likewise, sterling enjoyed a better week, buoyed by the improved sentiment, making some progress against the dollar, yen and euro.

Thoughts For Investing

With the BoE’s Monetary Policy Committee due to meet this week, expectations are for another half-percent cut in interest rates to 1%.

Borrowers will no doubt applaud but savers are getting a rough deal as returns on deposits tumble and the papers shared a few thoughts on what investors might do. The Sunday Times drew its readers’ attention to the fact that following the nationalisation of Anglo Irish Bank – which has attracted as much as £10bn from British savers via the likes of the Post Office – the bank has withdrawn from the UK Financial Services Compensation Scheme.

Whilst depositors are protected by the Irish government’s pledge to guarantee 100% of deposits, savers are, it seems, fearful over the health of the Irish economy and withdrawing funds.

The Financial Times alerted its readers to the fact that yields on index-linked savings bonds are falling fast as inflation tumbles. When inflation was 5% last year, National Savings & Investments were paying 1% over RPI, but with the latest figures showing RPI down to 0.9% future returns from these and similar bonds look less than attractive.

The Sunday Telegraph picked up on the merits of investing in corporate bonds – as discussed earlier – despite the likelihood of rising corporate defaults which many experts say are already priced-in.

So where do professional investors see the opportunities for this year? Edward Bonham-Carter, CEO of Jupiter Investment Management shares a few thoughts.

“With ongoing uncertainty, markets are likely to remain volatile, swinging between periods of pessimism and optimism. However, a lot of bad news is already priced into shares. While indices may go lower, investors are, in my view, starting to be paid for taking the risk of investing in equities on a three to five year time horizon.

“So with share prices likely to remain volatile in the short term, averaging in exposure to the markets by using regular savings schemes is particularly attractive for those investors who do not have a short term requirement for cash.

“The other significant question for investors is where they can get their income from. With interest rates in many countries at historic lows and likely to fall further, investors’ income will have dropped to critical levels.

“To achieve higher incomes, investors will have to take more risk. Given that the credit crunch has exposed many complex ‘manufactured’ products as flawed - with capital often being sacrificed in pursuit of income - investors are more likely to seek out traditional income products, such as corporate bond funds and equity income funds.

“Profit warnings will undoubtedly increase. Some companies will have to cut their dividends and the overall yield on the market will fall as some banks put their dividends on hold.

“But there are still plenty of large, well-managed companies that will be able to maintain their dividends even in a recession. Being able to buy their shares on high yields looks significantly more attractive than the returns investors can get elsewhere."

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