Dec 10 2007
With 2007 drawing to its conclusion, many investors may be wincing at memories of the last few months - and hoping for a brighter future in 2008. Undoubtedly this year will be remembered for the punishment meted out by the subprime markets, with overly-relaxed lending policies coming home to roost for a number of institutions. Notably, Northern Rock will stick in the minds of those tempted to dabble in high-risk lending in the ensuing years. However, perhaps more worrisome was the impact that short liquidity in the credit markets had throughout the wider financial sector, with tremors felt in more corners than expected. With the dollar continuing to flag and investors driving up the gold price as safe-haven buying prompts the rejection of major currencies and their associated assets, how do the early months of 2008 look set to pan out?
In his December 3rd weekly strategy report, David Sharp of JPMorgan Asset Management opens with comment on Citigroup's decision to sell equity units to Abu Dhabi Investment Authority. He claims that the move to create breathing room in preparation for further write-downs in 2008 was notable in that it could market a turning point for the banking industry as a whole. However, he suggests that significant efforts to ease the market instigated by Federal Reserve rate cuts would be required to match the institution's recovery of 1991-92 - and points out a lack of forecasts for major cuts in the coming six months. Barings Global Weekly Report also suggests that the Citigroup decision is testament to a more cautious attitude from banking institutions as 2008 approaches, adding Freddie Mac, Wells Fargo and the Federal Deposit Insurance Corporation to the list of organisations taking action to increase flexibility.
On a positive note for the wider market, Mr Sharp asserts that the current crisis is one of capital liquidity in the banking system - a problem resolvable within the sector rather than elsewhere. However, he also sounds a warning that, at a whole-economy level, corporate profits have dipped sharply, while the public and media increasingly cry "recession". The call from Mr Sharp is for the aggressive Fed rate cuts required by Citigroup and its peers.
Meanwhile, Barings Monthly Asset Allocation Views Percival Stanion states that the upward revisions in recent months of US non-farm payrolls data has reassured investors that the US economy is "not on the point of imploding" - an assertion supported by continued respectable consumer confidence. He suggests that, in consequence, the chances of substantial rate cuts from the Fed are lessened. "Market optimists will probably conclude that the summer months were just a panicked reaction to a little local difficulty in the lower quality US mortgage-backed debt market," Mr Stanion states, adding that such investors will now be looking to a healthy global economy led by Chinese development. However, Barings' head of asset allocation warns that the problems in the sector will heighten in the coming months, with the "full horrors probably not becoming apparent until next year". He urges neutrality on equities as a result, instead favouring oil services.
Invesco Perpetual Monthly Market Roundup Overview observes the similarities in conditions experienced in October compared with September. Concerns persisted about banks' earnings, the Fed cut interest rates and the US dollar continued to struggle against other major currencies - a trend that has continued throughout November. It notes that stock markets as a rule saw off the storm with little damage, finishing ahead domestically and suggesting a positive future that could defy the expectations of pessimists.
On Europe, the Invesco Perpetual Monthly Market Roundup Overview states that equities performed well during October, driven by US reserve rate cuts in both September and predicted cut at the end of October – forecasts which were eventually borne out and may be followed by a further cut this month. Meanwhile, a strong start in UK equities was tempered somewhat by resurgent fears about the embattled financial markets.
Indeed, Barings Global Weekly Review focuses on the likelihood of a further interest rate cut by the reserve to be implemented in December. The commentator reports observations from Federal Reserve chairman Ben Bernanke, who suggests that a cut will result should financial markets distress persist, that inflationary pressures do not increase and that economic data released in recent days does not appear stronger than expected. Tellingly, meanwhile, vice-president of the Federal Reserve Don Kohn has chosen pragmatism and flexibility as watchwords dictating decisions to be undertaken in the approaching days. Perhaps this sentiment suggests the increased openness to reassessment that the widespread problems of recent months have prompted.
In Europe, the future for interest rates looks more mixed. Barings Global Weekly Review identifies a "policy dilemma" for the European Central Bank, based on tight credit market conditions in conflict with robust economic growth. The point is further explored in the Barings World Market Monthly Review which states that all central banks have been forced to resolve inflationary pressures - normally resulting in tighter policy - with "patchy" domestic demand. Meanwhile, continuing limitations on liquidity would also suggest an easing of policy if further credit crunches similar to that resulting from the US subprime "debacle" are to be avoided next year.
Transferring focus to the UK markets, Craig Inches of the SWIP Absolute Return Bond Fund predicts a "gentle" slowing of growth compared to a speedier decline in the US - although forecasting that US problems will stop short of recession. In an effort to invigorate the economy the Bank of England will cut interest rates next year, Mr Inches believes - although his comments were made before the early cut in rates instigated on Thursday. Rate cuts are likely to bring inflationary concerns in their wake - but the SWIP fund manager states that those investing in inflation-linked products such as inflation bonds will be able to enjoy the benefits of such economic change.
Meanwhile, those with property funds are assessing the damage of recent months - although the SWIP property trust, run by Gerry Ferguson and Nick Ireland, states that current falls in yields can be greeted as a welcome return to stability. Mr Ferguson asserts that a market correction in yields is underway. The differential for property yields compared to gilt yields have fallen into negative territory. Challenging market conditions are set to follow - but they are preferable to the uncertainty resulting from the "unsustainable level" achieved by the asset class this year. Meanwhile, he believes that market fundamentals are still sound. "Rents are growing; the occupational market is still very much active. The scenario we have just now is totally unlike what we had in 1992, where the market was driven down by the fact there was a vast amount of overbuild, a large amount of supply and no demand. [...] We should take comfort from that".
As the US economy flags and financial markets continue to reel from overexposure to the subprime sector, many may join Mr Ferguson in welcoming a return to safe territory - and hope that greater flexibility from central banks across the world is enough to avoid the worst of the global economic slowdown.
