Uncertain Financial Outlook

Posted on: 25 November 2008 by Gareth Hargreaves

Financial expert Graham Kerner analyses a mixed week for markets and the economy, and potential deflation.

Truly Global

The Sunday Times pointed out that this could be looked back on as the week that the crisis went truly global, as even the most hardened optimists realised that the short winning streak had come abruptly to a halt as equities fell, interest rates look to be sinking, and jobless queues lengthen seemingly daily.

Even China, an emerging economy that most hoped would plough on through this crisis a few short months ago, saw state officials describe the country's employment outlook as "grim" as unemployment in the cities grew, and would grow again throughout 2009. To stimulate growth, the Beijing government approved a £373 billion package to pay for construction of roads, railways and other infrastructure, in order to keep economic growth at the targeted 8 per cent.

In the US, unemployment rose to above 4 million, its highest level for more than 25 years. Thousands more are expecting to lose their jobs in the 'Motor City', Detroit, even if the car-making giants can succeed in persuading congress to donate $25 billion to stave off bankruptcy.

In the US, this is the week that retailers usually would anticipate as one of their most profitable, with the Friday after Thanksgiving usually known as 'Black Friday' because this is traditionally the point where these companies would go into the black in their accounts. However, the early signs are not that good, and retailers are trying their utmost to stimulate spending by the consumer.

Around the world, there were a series of announcements from various Governments designed to boost economic activity.

In Russia, Vladimir Putin announced a $20 billion stimulus package and urged Russians not to panic as wage arrears rose sharply. Iceland borrowed $10 billion from the International Monetary Fund, roughly equal to a year's Gross Domestic Product for the country.

Nicolas Sarkozy pledged £17 billion to protect France's strategic industrial assets from both the credit crunch and state takeover.

Finally, there were reports in Italy that the country's top 10 banks require a combined €21 billion to bring their financial strength in line with their European competitors.

Flight To Safety

After a short period of cautious optimism following October's extreme volatility in equity markets, the turmoil returned with a vengeance this week as growing concerns over the severity of the global economic slowdown took their toll. In the UK, the FTSE 100 ended the week down 10.7 per cent at 3780.96, while shares in the US hit an 11 year low on Thursday amid renewed fears for the automobile industry. This caused The Financial Times to comment that investors were trading on emotion at the moment, rather than fundamentals, causing drops that could be argued as being exaggerated.

However, in the last couple of hours of Friday trading, there was a strong rally from the US stock market after reports that Barack Obama will be naming Timothy Geithner as his Treasury Secretary caused shares to jump 6.5 per cent. The appointment of Geithner, who has been working closely with Henry Paulson during the current crisis and has been playing a crucial role in recent activity around Lehman Brothers and JP Morgan, is seen as a positive step because it takes a lot of uncertainty out of the market.

As pointed out in The Times, President-elect Obama had been under increased pressure to exert more influence on current Government policy. Indeed, many commentators are saying that if he doesn't outline exactly what his economic plans are, then by the time he does, it will be too late to prevent deterioration much the same as 1932-33 during the transition from Herbert Hoover to Franklin Roosevelt.

It wasn't just equity markets under stress, as commodity markets continued to be pressured.

Oil sank to a 3 year low of less than $50 per barrel, continuing to slide due to grim forecasts of a prolonged global recession, which would reduce demand substantially.

The sharp price decline caused the head of commodities research at JP Morgan to comment, "Prices have been savaged by the most aggressive bear trend in commodity market history."

One area that was strong over the past week has been the traditional safe haven of gold, which rose 6.9 per cent on Friday alone, as a surge of demand saw the price rise to $796.35 per ounce.

Better News For Sterling

The pound recovered from a record low against the euro and a 6 year low against the US dollar. The Financial Times reported that the UK currency had been undermined by the recent aggressive interest rate cuts from the Bank of England, as well as the avalanche of gloomy economic data. However, there was a brief rally this week as the pound rose 1 per cent to $1.4899 against the dollar and climbed 1.8 per cent to £0.8425 against the euro, on hopes that today's pre-Budget report would include tax changes that would make repatriating overseas earnings a more attractive proposition for UK companies.

Elsewhere, the Japanese Yen strengthened significantly as further turmoil on all asset markets pushed investors towards this low-yielding haven, whereas emerging market currencies suffered as the increasing risk aversion caused foreign investors to repatriate funds. Suffering the most were the South Korean Won and the Brazilian Real, which reduced 6.7 per cent and 10.4 per cent against the dollar respectively.


A common theme among the weekend press was the fear of deflation hitting the UK over the next 12 months. Consumers are encouraged to defer spending in the knowledge that prices will continue to fall and the real value of debt worsens.

As discussed in The Sunday Telegraph, we are not there yet but last week's large fall in the Consumer Price Index from 5.2 per cent to 4.5 per cent, combined with a dramatic economic slowdown, have made it likely that inflation will fall below zero. Negative inflation, or deflation, will mean a period of falling prices across the board. At the moment, prices of items like petrol and certain foodstuffs are falling, but remain higher than 12 months ago.

History suggests that deflation is kinder to government bonds and corporate bonds - which already have running yields of between 6 to 12 per cent - but perhaps not so good for riskier assets. However, one commentator in The Sunday Telegraph pointed out that there will be a particular point where the risk of deflation is eliminated or has run its course, and that point will be "the best opportunity in a lifetime to invest in stock market investments. However, timing such things is so uncertain that moving entirely into one asset class is very unwise."

Always Stress The Long-Term

History suggests that trying to second guess the peaks and troughs of equity markets is notoriously difficult, a point emphasised by Martin Wolf, Chief Economics commentator for The Financial Times, who stated, "The fundamental rule of investment is to buy when other are frightened and sell when others are confident. The economic position looks ghastly, but for those with sufficiently long-term time horizons, the investment position does not."

As The Financial Times pointed out, before this past week, many international investors thought they may get some respite before Christmas. With stocks having dropped so fast, there was even hope of a 'bear market rally' which is defined as a short-lived increase of more than 10 per cent, before markets could take stock in the New Year.

This week may have changed those thoughts, highlighting the fact that no-one can truly predict short-term fluctuations and only hindsight is 20:20.

At St. James's Place, our fund managers always stress the value of investing for the long-term, in companies that are best placed to get through the current turmoil and come out stronger on the other side. In their recent reports to Stamford Associates and the Investment Committee, several St. James's Place fund managers commented on exactly this.

Andrew Green, manager of the St. James's Place GAM Managed funds, says, "Over the weeks ahead, world markets will undoubtedly remain volatile until the scale and certainty of the US Government's rescue of the financial system becomes apparent. At that point, attention will turn to the impact the turmoil has on real economic behaviour."

"Selectively, there are secure, high quality companies operating in areas that may be affected by the downturn but are not threatened by it. Their current valuation, on anything other than a very short-term perspective, may be unnecessarily cautious and provides the opportunity to build performance for the future."

Ian McVeigh, lead manager of the range of St. James's Place Jupiter Cautious funds states, "We maintain our underweight stance in bank equity as the prospects for this asset class have been undermined by state involvement. However, in other sectors, we continue to focus on bottom-up company specifics and not on macro forecasts. There are companies that are doing well even at a time when GDP contracts. Strong balance sheets continue to be essential for our investments"

"Share prices had recently recovered somewhat from the October lows as government measures to inject liquidity have started to feed through the financial system. However, markets are likely to remain volatile in the short term due to uncertainty regarding the depth and duration of the global economic slowdown. While corporate earnings are likely to grow more slowly in the next year, valuations are attractive even relative to these more moderate expectations."

Alex Stanic, manager of the St. James's Place Newton Managed funds, reports, "Short-term volatility in all capital markets makes running portfolios containing any risk assets extremely difficult. Bear markets and financial panics are characterized by periods of extreme volatility and intense intra-market rotation. All positions, even the most benign and defensive, are inexorably affected and this makes investing for the longer term extremely uncomfortable. It is at times like this that having an investment process that is grounded in a broad global perspective is invaluable."

Richard Oldfield of Oldfield Partners, one of the managers of the St. James's Place High Octane funds, comments, "We do not know what exactly is coming economically. We can be pretty sure of more market turbulence, with ups as well as downs. We have no idea when markets will bottom, but we feel there are dozens of companies with strong balance sheets and cash flows which, when the world emerges from its present phase of difficulty, will still be around and winning, and whose shares, taking account of serious falls in profits, are now unduly cheap."

24th November 2008

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