Telephone 020 8878 8080
market news by nicholas ford
It’s been a busy week. The major events were the run on Northern Rock and the threat of contagion through other UK retail banks on Monday. This was averted with emergency steps taken by the government and the Bank of England. On Tuesday the focus for UK investors moved to the US as equity markets bounced when the Federal Reserve cut rates by 0.5%.
Dealing with both of these points:
The Bank of England is in a tight spot. Charged with maintaining financial stability they have stopped the run on retail banks but in doing so have, for now, bailed out a bank with an aggressive business model which was not perhaps attuned to the interests of savers but to shareholders. Unlike its European and US counterparts, the Bank of England has shown stoicism in the face of recent events, refusing to provide cheap finance to bail out the City and has upheld its ‘moral hazard’ principle. Mervyn King is being grilled today over his actions in recent weeks and whether the Northern Rock crisis could have been averted. Perhaps it would be more appropriate to put the Financial Services Authority in the dock; after all they know about and sanction the activities of the banking sector. Only time will tell but if Mervyn King and the Bank of England do hold their ground, the UK banking sector should emerge stronger and risk should be permanently repriced in the markets. Meanwhile we hope the governor is not made a scape goat for the oversight or incompetence of others.
There was much relief both in the US and globally on Tuesday, when the Federal Reserve cut interest rates in the US by 0.5%. The rally on equity markets appears to overlook the substance of the situation, that liquidity remains very tight indeed and the half point cut in rates was made in a time of considerable stress in the financial markets and was nigh on essential to placate a panicking Wall Street. Falling interest rates usually mean weaker times ahead.
--------------------------------------------------------------------------------------------------------------------
Northern Rock became the big issue on Monday, and there was a sense in the press and the media on Tuesday that as its share price rose the issues pent up within the financial markets fell away. This is of course not really the case, it was merely a relief for the Chancellor. The issue is liquidity and the cost of capital and its still here. We believe there are several pointers which suggest a further correction in equities may surface. In no particular order:
1 – Hugely volatile market: equity markets are rising and falling sharply with large volumes passing through and no apparent direction.
2 - Threat of recession in the US and the UK: mortgage rates are moving up, the cost of capital for businesses has increased, unemployment is rising the US and the UK.
3 - CDO’s or Collateralised Debt Obligation’s, the cause of current turbulence have not disappeared.
4 – City redundancies: In the UK there are whole departments within the larger investment banks which may well be laid off, in particular those dealing with credit. The investment banks look likely to right down some of the debt from deals already agreed but which they are unable to collateralise and sell on.
5 - Fund manager departures: there seem to be a large number moving around at the moment, this is not uncommon in volatile markets. They are a canny bunch and starting a new job now gives them the opportunity to rotate portfolios, any underperformance is excused during the switch over on from their predecessor’s portfolio and they are able to set themselves.
6 - Investors are still wishing to de risk portfolios and will in our opinion be selling as the market rises. The market crash following the dot com boom earlier in the decade removed an enormous amount of speculative capital from financial markets, current invested capital seeks long term returns balanced against risk and so long as risk is present investors will ere on the side of caution.
We believe there may be a shorter, sharper shock shortly. and the answer to the question raised in this articles title is, not much.
NB: The subtitle of this article refers to the mistake made by a BBC news reader on the 10 o'clock news this week and is not of our own invention.