Published on January 9, 2009
C LEAR AS A B ELL V IEWS ON THE P AST, P RESENT AND F UTURE Sound Advice James Vinall – Senior Investment Officer 8 th January 2009
Optimism is gathering pace in the first few days of 2009. Last year saw the S&P500 down 38% (1,447 to 903), FTSE100 down 31% (6,416 to 4,434) and the Nikkei 225 down 40% (14,691 to 8,859) and pundits are suggesting 2009 will be better as equities rarely decline over two consecutive years. Many institutions are said to have significant cash waiting to enter equity markets. Analysts are pointing to oversold indicators and exceptional value in certain sectors suggesting there are bargains to be had. As individual and corporate spending has collapsed, governments around the world are picking up the slack with massive stimulus packages and money supply. The accompanying spin is fuelling hope that the worst will soon be behind us. Factor in the Obama effect and equities look set for a positive first quarter in 2009. C LEAR AS A B ELL V IEWS ON THE P AST , P RESENT AND F UTURE Sound Advice EquityBell Securities was set up in October 2008 to provide outstanding investment advice to non-discretionary, active trading clients using direct market access brokers and wealth managers. The credo is absolute returns by giving sound advice in asset classes that are individually appropriate to the risk appetite of each particular client. H OPE S PRINGS E TERNAL
However, that does not mean this buoyancy will last all year. The US Federal Reserve Bank kept rates deliberately low from 2002 to 2006 to encourage consumers to spend on borrowing to keep the asset boom rolling and Central Bankers across the world basked in the warm glow of never ending prosperity. These cheap rates were leveraged by a wacky wheeze dreamt up by AIG et al to insure financial institutions against default on loans and mortgages without needing extra debt provisioning. This increased money supply by 30% over what was previously allowed. Banks could suddenly lend to anyone as they would not carry the can if the borrower failed to service the debt. One quadrillion dollars (a thousand trillion) of financial derivatives also created extra “off balance sheet” cash through leverage and guarantees. Central bankers and regulators sat back while cash was created from thin air without a second thought to global systemic banking risk. Citizens across the world trusted their bankers and leaders that all this debt financed wealth creation was prudent, sustainable and desirable. The current recession comes from a financial crisis which generally last longer than recessions borne from business cycles. This is an income crisis, not a credit crisis as individuals and companies struggle to earn enough to service their debt. Economic recovery cannot begin until individuals have sufficient cash and confidence to resume spending. Central Bank rates are converging towards zero (with the Bank of England cutting rates down to 1.5% today) to encourage debtors to borrow and spend even more which is very unlikely to work in the long term. Savers and pensioners are also not going to increase their spending as they are being punished with low rates because the less prudent borrowed beyond their means. While inflation optimists point to accelerating money supply, if we factor in credit being deleveraged from loan books, real money cannot be called easy. C LEAR AS A B ELL V IEWS ON THE P AST , P RESENT AND F UTURE Sound Advice
We are now fifteen months into the largest debt hangover the world has ever seen. Most market participants have never seen anything like this before and would like to believe that “it’ll be alright in a few months” while following the rosy spin of the politicians and central bankers who do not want us to realise how bad the global debt crisis really is. Barrack Obama is ploughing US$’s into every corner of the economy in a last ditch effort to fight off the recession as the cost of mass unemployment and worthless pensions is vast. The US and UK governments will have to print money in quantitative easing to provide liquidity to banks who have to deleverage loans made using credit guarantees over the past four years. Trust in paper (or fiat) money is waning and gold is emerging as the currency of choice. Following the collapse of the Japanese economy in 1990 from overburdening debt, Japanese banks took rates down to zero, but only those with money met the criteria to borrow and with no economic expansion, demand was virtually non-existent. Just like Japan in the early 1990’s, government initiatives and fiscal programs are coming thick and fast, but will mostly be guarantees and credit. The relief euphoria from the headlines will fade into the reality that governments do not have hard cash to inject unless they print it. The resulting deflation is what Obama, Gordon Brown and Trichet are all trying to avoid. Capital based pensions are also financed out of bonds and equity which have fallen significantly and will reduce the disposable income of retirees, adding to all governments burdens. Previous recessions in the US and the UK have never had individuals, corporations and governments all heavily indebted at the same time. April 2009 is where the “it’ll be alright” hope will collide with the reality of huge debt, increasing unemployment, pension security and failing banks. There will be a dawning realisation that the length of this recession is likely to be longer than a few years coupled with a fiscal power shift to Asia that may never swing back to the West. This time it really is different. C LEAR AS A B ELL V IEWS ON THE P AST , P RESENT AND F UTURE Sound Advice
Every economy in the world has been hit by the recession, but countries that are leveraged to Western consumer (like China) have been hit hardest and fastest. Social and labour unrest is increasing and there have already been strikes and protests in Guangdong (China’s export manufacturing region) as workers have been laid off following the collapse of consumer spending. China now holds US$650 billion of US Treasuries, which is up US$190 billion over the last year, but their recent purchases have slowed considerably. If you add in other known holdings, analysts suggest that China owns $1 of every $10 of America’s entire public debt. The most pressing question is what the Chinese government will do? The number one guiding principle of the Central Committee of the Communist Party of China is to retain power and control over a vast and diverse population. Domestic interest will always come before foreign consideration. Beijing could maintain the status quo by keeping the Yuan low against the US$ to make their goods affordable and keep lending money to the USA. However, the Sino-bashing camp in Washington could be the tipping point for China to sell some of their bonds to finance domestic stimulus. China will need time to adjust to domestic market manufacturing, but will probably be the first global economy to embark on recovery. All of this will become clear over the next three months. Look for signs of Chinese domestic stimulus coupled with heavy selling of US$ Treasuries and a declining US$. C LEAR AS A B ELL V IEWS ON THE P AST , P RESENT AND F UTURE Sound Advice
Equities The FTSE 100 index currently stands at 4,502 having lost 33% since the 29th October 2007 peak of 6,726. This is still 20% above the bottom made this year on 21st November 2008 at 3,734 and a whopping 37% above the low of this decade made on 12th March 2003 at 3,277. The S&P 500 (currently at 909) is also 17% above the low made on 9th October 2002 at 775, but unlike the FTSE, a new decade low was made at 741 on 21st November last year. Barring unforeseen events (like war or natural disasters), we expect a hope driven “bear market” rally in equity indices through to April 2009 as the “powers that be” try to inflate their way out of the recession and declare that growth is back and deflation is dead. Obama takes office on the 20th January 2009, which should provide a fillip to equities. This may turn out to be the swansong for equities with the FTSE 100 regaining 5,100 and the S&P 500 back up to 1,100 (Dow Jones Industrial over 10,000) before resuming the slide around April 2009. C LEAR AS A B ELL V IEWS ON THE P AST , P RESENT AND F UTURE Sound Advice
I t is interesting to look at the chart below and compare the FTSE 100 reaction the current financial crisis with the performance of the Dow Jones from 1929, Nikkei 225 from 1989 and the NASDAQ Composite from 2000. All dropped 40% to 50% from their ultimate peak over the first year, before staging bear market rallies. The final bottom of the markets was generally found at 30% of the ultimate peak after three years. C LEAR AS A B ELL V IEWS ON THE P AST , P RESENT AND F UTURE Sound Advice Data Source: FT Only trade the expected New Year counter trend rally with speculative money and don’t build long term core positions. Look to finesse an exit of other “red ink” positions before April 2009, as you do not want to wait 25 years to be back in the black. Remember the Dow Jones Industrial took 25 years from the 3 rd September 1929 to 24 th November 1954 to make a new high and the Nikkei 225 is still 77% off the December 1989 peak. This suggests that the FTSE (see the purple line on the chart) should reach 5,100 (up 13% from here) in the expected bear market rally, before resuming a long painful slide over the next 18 months to bottom out around 2,000 (down 70% from the 2007 ultimate peak).
Currencies The US$ and GBP are likely to continue to decline as central bank rates are kept low, banks are unable to lend and money is printed. The fundamentals of the EUR are better which should support the currency, especially as the greenback is starting to shed its reserve status. The CHF’s should retain its safe haven status as Switzerland is the world's largest net creditor and also runs one of the world's largest current account surpluses. As investors are generally reducing risk and deleveraging, so current appetite for carry trade borrowing is weak. Switzerland has deeper pockets and greater financial stability than nearly all other Western economies and that perceived security should keep the CHF appreciating. The Swiss National Bank (SNB) has significantly less need to print money, so if the CHF appreciates too much against the EUR, they could facilitate carry trades to hold the currency in line with the EUR. The one concern is that liabilities at leading Swiss financial institutions could be greater than the Central Bank assets and any rescue package (if needed), would cause significant strain. The JPY has already been in this mess for 18 years, so has less pain to endure than the US, UK and Western Europe which should keep the currency higher. C LEAR AS A B ELL V IEWS ON THE P AST , P RESENT AND F UTURE Sound Advice
Fixed Income US$ and GBP bonds are likely to continue to be weak for quite some time. Long term bond holders who are enjoying higher coupons should hold to maturity (if they can). Investors who want to put money into bonds may like to keep durations around 3 to 5 years in high quality paper, to be in a better position at redemption to put the money to better use. As we expect the EUR to appreciate against the US$ and GBP, it may be better for investors to buy 3 to 10 year high quality EUR denominated bonds where the yields are similar to get the expected FX gain. We would also prefer high quality CHF corporate bonds although the yield will be quite low. The general rule for GBP bond investors should be to lock in coupons now, even if the return is low, preferably in a currency that will be better than sterling. Gold Central banks printing money coupled with fraud and mismanagement at leading financial institutions and corporations may cause a flight to safety. Once the equity markets have had their first quarter bear market rally and greed gives way to fear, gold is likely to become the currency of choice and could significantly appreciate. As the share price of Gold producers usually outperforms Gold in a rising market, investors may like to consider buying the equity of companies that do not hedge their gold production beyond 1½ years like the 13 components of the AMEX Gold BUGS index. Oil As conflicts escalate and OPEC cuts production in line with demand destruction, the price of crude oil should rally in the first quarter back to the US$65 to US$80 a barrel range. C LEAR AS A B ELL V IEWS ON THE P AST , P RESENT AND F UTURE Sound Advice
Risk Warning Notice : Equity Bell Securities is a trading name of Equity Bell Limited (registered office: Talbot House, 8 – 9 Talbot Court, London EC3V 0BP. Registered in England and Wales No. 6725781) is an Appointed Representative of London Islamic Investment Bank Limited, which is authorized and regulated by the Financial Services Authority. Whilst every attempt is made to ensure the accuracy of the information provided, no responsibility can be accepted for any inaccuracy. The information provided cannot be relied upon as constituting a recommendation, nor construed as any offer to sell, or any solicitation of any offer to buy investments. No liability is accepted for any loss whether direct or indirect, incidental or consequential, arising out of any of the information being untrue and / or inaccurate, except caused by the wilful default or gross negligence of EquityBell Securities, its employees, or which arises under the Financial Services and Markets Act 2000. Sound Advice Conclusion Despite a hope filled start to 2009, we suspect we have not seen the worse yet and the world is going to get a whole lot more complicated and dangerous through 2009. The only thing we are guaranteed is volatility and everyone needs to look at their asset allocation and make adjustments. James Vinall is the Senior Investment Officer of EquityBell Securities. James has been in the financial industry for 23 years trading equity derivatives in Hong Kong, Tokyo and London as an investment banker, sales at a hedge fund, advising gregarious trading private clients for a tier one wealth manager, raising money for tech start-ups in private equity before returning to advise active trading private clients. If you wish to discuss investment advice from EquityBell Securities please contact James Vinall at [email_address] or on +44 20 3189 2108 Equity Bell Securities Quay House, 2 Admirals Way, Canary Wharf, London E14 9XG Tel: +44 (0) 20 3189 2105 www.equitybell.com C LEAR AS A B ELL V IEWS ON THE P AST , P RESENT AND F UTURE
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