World Markets: The Obama Factor

Posted on: 26 January 2009 by Gareth Hargreaves

Financial expert Graham Kerner looks at recent upheaval in the world's markets.

It was a week with very little to cheer about for global markets as a raft of poor economic data and continuing fears about the cost of bailing out a weakening financial system sent investors fleeing from equities, sterling and even long-term government bonds.

A second consecutive quarter of falling output confirmed what had been suspected by most commentators for some time; the UK has followed the US and fallen into recession for the first time since 1991.

There was further evidence that other global economies face a harsh recession, with Korea, Japan and China reporting a slow down in growth and weaker exports.

In the UK, the FTSE 100 index fell by 2.3% over the week with the banking sector suffering most as yet more bad news did little to shore up investor confidence for the ailing industry.

News that the government’s stake in Royal Bank of Scotland would rise to nearly 70% was the biggest story of the week.

Overseas, the picture was painfully similar. The Nikkei 225 index dropped 5.9% during the week to its lowest level in two months, with the Hong Kong and Korean markets suffering a similar fate. The FTSE Eurofirst index fell every day, sliding 5.6% in total and closing at a six year low.

Emerging economies that had been the main drivers for growth in the past also suffered as Russia, India and Brazil each posted losses of 9%, 7% and 4.2% respectively.

In the US, the Dow Jones index fell 2.2% and the Nasdaq lost 2.7% - the third consecutive weekly loss posted by the high-tech index. However, those figures do little to demonstrate the volatility of the markets with violent swings encountered over each trading session. Many traders cited uncertainty over the Obama administration’s plans to shore up the stricken financial sector as the root cause of the volatility.

Inauguration Leads To Fresh Stimulus

Tuesday saw the inauguration of Barack Obama, America’s 44th and first African-American President. After clearing up a small administrative issue, in which President Obama was forced to take the oath of office twice, the President set about bringing a positive conclusion to plans for the financial stimulus plans in the US.

Speaking before his first White House meeting with the House and Senate leadership, the new President said that negotiations were ‘on target’ for legislation to be signed into law before the President’s Day holiday on February 16.

Meanwhile Congressional leaders stated their commitment to work across party lines on the $825 billion bill. The Weekend Financial Times reported that whilst the Republicans are pushing for a suite of tax cuts to put more money in the hands of the American citizens, the Democrats favour spending on infrastructure in a bid to kick start the economy. However the
solution pans out, there is no doubt that the economy needs swift and decisive action to begin the process of recovery.

Manager of the St. James’s Place North American fund, Jeff Bronchick, recently commented that ‘regardless of the circumstance of the moment, the problems faced economically and financially remain the same now as they did a week ago; re-establishing some sort of credibility in financial markets by stating a defined plan of action and sticking to it must be seen as an improvement over the constant change we’ve seen in the past six months’.

'Tis The Season

As many life assurance companies begin to declare the level of annual and terminal bonuses applicable to their with-profits plans, many of the weekend’s papers took a closer look at the impact of a tumultuous year for equity markets.

In recent weeks, Friends Provident has announced cuts to bonus rates on its book of 1.2 million with-profits plans by up to 20% and on Friday, Norwich Union followed suit, declaring that it was cutting bonuses by 15% after its main fund had suffered a 12% reduction during 2008.

The Mail on Sunday was predicting an equally gloomy statement from Standard Life, citing performance over the first nine months of the year as a likely indicator of full year returns. Each of the seven different with-profit funds available from Standard Life lost ground to the end of the September, with the best performing making a loss of 5.1% and the worst performing (its Stakeholder pension fund) falling by 17.5%.

The Financial Times highlighted the strength of life offices and demonstrated the differences evident from one office to another. The accepted method of measuring the financial strength of a life company is by looking at its Free Asset Ratio (FAR) – which shows the ratio of assets to liabilities. The higher the FAR, the stronger the life company and the more likely it is to pay out decent bonuses to its policyholders. However, even taking into account the FAR it is still difficult to predict how a with-profits policy will perform because of their ‘opaque’ nature. 

The Name’s Bond

As the Government last week announced that it would create a £50 billion fund to purchase company assets in an attempt to stimulate the economy this provided a much needed fillip for the corporate bond sector. Part of the package included the facility for the government to purchase ‘high-grade’ corporate bonds, thereby offering the potential to prop up a sector of the market that’s been hampered by fears of defaults as the recession deepens.

Bond prices fell sharply over the second half of 2008 as the market continued to worry about the impact of the economic downturn on company’s ability to repay their debt. This has pushed yields to levels not seen since the Great Depression.

The Sunday Times reported that corporate bond funds have seen record inflows during the last three months of the year, as investors look elsewhere for income as the effect of falling interest rates hit returns from traditional sources such as banks and building societies. The article highlighted the performance of some of the leading corporate bond funds including the Invesco Perpetual fund, which is managed by Paul Read and Paul Causer, who are also responsible for the St. James’s Place Corporate Bond funds.

Pension Opportunities Limited

The continuing economic malaise continues to affect the ability of employers to offer final salary pension arrangements for new employees. A snapshot survey of 100 companies conducted by the National Association of Pension Funds (NAPF) shows that a quarter of those schemes that have already closed the doors to new members, expect to close to future contributions from existing staff in the next five years.

The Times reported on Saturday that the NAPF has called on the state to underwrite the Pensions Protection Fund (PPF), set up by the government three years ago to pay pensions if companies collapse and are no longer able to meet their liabilities. Ballooning shortfalls in company schemes against the backdrop of an economic recession and the potential for further corporate collapses could stretch the PPF to breaking point.

Pension schemes rely on the returns from equity markets to meet their long-term liabilities, but as global markets continue to suffer, their ability to match these obligations becomes more and more challenging. In total, the NAPF said that more than 650,000 of the 2.7 million people saving in final salary schemes could be affected. Many more could see cuts to
the value of their pension as employers look at methods of protecting the schemes.

Alternatives include raising the retirement age, capping contributions or taking other methods to cut costs.

New Start For New Star?

Tumbling equity markets have hit asset managers around the globe and last week the battle for control of New Star, the fund management firm created in 2001 by city heavyweight John Duffield, became a little clearer as Henderson Group emerged as favourites to buy its beleaguered rival, according to an article in The SundayTelegraph.

One of the best known financial brands, New Star once sold products to 10% of retail investors in the UK but its previous successes have done nothing to halt the dramatic collapse of the troubled group. Shares closed at 0.3p on Friday after losing 99% of their value during 2008. At their peak in July 2007 the shares were trading at a staggering 485p.

Continued volatility in global markets, the departure of several high-profile fund managers and the burden of £240 million worth of debt has led to the company delisting and looking for new owners. Over the course of the week several suitors including Schroders and Neptune Investment Management were believed to have made bids for the asset manager.

New Star clients are no doubt looking for a rapid resolution to the deal as they seek to end the uncertainty surrounding the future of the group.

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