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market news by nicholas ford
Most commentators agree that the US economy is now contracting. Recession is usually defined as two consecutive quarters of declining Gross Domestic Product and therefore negative economic growth. So if not official, we are probably almost there. This is bad news for the global economy which will have difficulty avoiding being dragged along.
In addition, evidence abounds that the problems in the credit markets which first arose in the sub prime lending are spreading throughout the debt markets, to prime lending, corporate lending and securitised debt, i.e. corporate bonds. The cost of insuring bonds against default is rising fast, an indication that default is viewed as more likely.
In addition to this, rumours arose yesterday that one of the largest Wall Street investment banks has severe liquidity issues. By liquidity issues it is meant that whilst a bank may be solvent (i.e. assets outweigh liabilities) there isn’t enough cash flowing within the company to continue operating normally. The banks are trying to refinance structured investment vehicles (SIV’s) which rely on cheap loans to invest in higher yielding longer term assets. Liquidity, or the willingness of banks to lend to each other, has contracted and is now more expensive and refinancing these SIV’s is proving troublesome for some of the investment banks. Coincidentally, today the Federal Reserve, together with the European Central Bank and the Swiss National Bank, once again raised the funds available at favourable rates to the banking sector, this time by a further $200bn.
So far from dissipating, the troubles that arose in the sub prime mortgage markets appear to be spreading across the debt and credit markets. This is inevitably affecting the equity markets since equities or shares are basically one step down the pecking order from bonds when it comes to paying dividends, and the bond holders are repaid first should a company enter bankruptcy.
On top of, and as a result of this the US Dollar is weakening against other major currencies which in turn brings its own problems, a weak currency makes inward investment into the US less attractive. This is particularly relevant with regard to foreign investors buying US government debt.
So all in all, a fairly bleak picture is coming out of the US at the moment. What can the powers that be in the US do about this? Tax cuts and interest rates are the chief weapons to prime an economy, so the question is how much and when and more importantly, how does this affect the UK investor? The US market remains the driver of the global economy and in a broad sense the outlook does not look good at the moment. However in the UK, the vast majority of the debt is with the consumer and the government, corporate debt is actually quite low so many companies listed in London have strong balance sheets, strong cash flow and look well placed for a downturn in economic activity. The UK equity market is trading at fair value and for long term investors any further sell off would be a buying opportunity.