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Quarterly Newsletter - Spring 2009

The G20 Summit

The G20 Meeting in London has come and gone.  After all the fanfare during the build-up when we heard about Gordon Brown’s “global new deal” which entailed a $2 trillion-plus fiscal stimulus to end the recession, the Germans, Spaniards and the French made it clear that they did not share our Prime Minister’s vision. This must have been a bitter pill for Gordon Brown to swallow, particularly as the criticisms were voiced by his European “friends” whilst he was on a whistle-stop tour of three continents in order to drum up support for his plans.  By rejecting his ideas, the Europeans also sent a clear message across the pond to President Obama, who was desperate for other big economies to emulate his $800 billion stimulus plan.

This anti-Brown stance just before the London Summit was a little worrying, since everyone attending was keen to show unanimity when it came to the big issues.  After the G20 Meeting, France’s leading newspaper Le Figaro proclaimed: “It’s a victory for the French-German axis.” In that comment, the paper was targeting the Anglo-Saxon capitalist system.  Monsieur Sarkozy delighted in telling his countrymen that new banking regulations would be more stringent and include the hedge fund industry. M. Sarkozy has always had a thing about hedge funds, but he overlooked the fact that no hedge fund needed bailing out by the taxpayer.

Hedge funds had boasted that they would be able to make money irrespective of whether the market went up or down, and many of them managed to do so.  In this, they were helped by the fact that they could borrow money cheaply to play the stock market, either by going long or by shorting shares.  Additionally, they made full use of derivatives, such as “contracts for difference” and various forms of “swaps”, which meant that they were able to obtain a big position in a company by putting up only a fraction of the money.  Of course, they acquired a questionable reputation when they shorted, among others, bank stocks and helped share prices go down even more quickly.  In fairness to the hedge funds, they were only doing what they were meant to do.  Their real problems emerged when they were forbidden to short stock, particularly as banks by then were withdrawing their lending facilities to the funds and worried hedge fund investors wanted their money back.  What ensued was deleveraging on a massive scale, and these fire sales negatively affected normal shareholders who saw their investments getting hammered.  As a result, many hedge funds have failed altogether, and more will follow that path.

The new banking regulations are to include “tough new principles” on bankers’ pay and bonuses, and this cannot be a bad thing.  For too long has this self-serving culture been allowed to reward risky strategies and short-term profit thinking whilst ignoring long-term benefits.  Indeed, even failure often reaped untold riches in the form of ludicrous salaries, bonuses, severance pay and pension packages. 

 So, what else was the outcome of the G20 Summit?

The G20’s main focus was the global recession and the measures to bring about an economic recovery.  The International Monetary Fund has for years been asking for more funds to, among other things, finance export trade and help countries that are in trouble, and at long last this has been promised with a number of measures that could amount to a boost to the IMF’s coffers of $1.1 trillion.  About a quarter of that will be in the form of “Special Drawing Rights”, another euphemism for quantitative easing which, to you and me, means the IMF is allowed to print more money.

After the G20 Summit, Gordon Brown missed no opportunity to repeat ad nauseam that the total value of the various stimuli amounted to $5 trillion, rather more than the $2 trillion he had hoped for, whilst casually overlooking the fact that these funds represented measures that had already been announced by the member states before the G20 leaders met.  For the UK’s longest continuously serving Chancellor in nearly 200 years, he certainly has a funny way with words and figures.

Tax havens came under attack, being asked for fuller disclosure and threatened with inclusion on a blacklist and subsequent severe sanctions if they fail to co-operate.  Well, we shall see whether this new approach spells the end of banking secrecy across the globe.  We somehow doubt it.

Another item on the agenda concerned trade protectionism. That old chestnut was discussed at length in November of last year at the Doha World Trade Organisation talks, when virtually all present pledged to improve free trade.  It will therefore come as a bit of a surprise that, according to the World Bank, 17 of the G20 members have since then introduced protectionist measures!

The G20 Meeting itself was somewhat overshadowed by the Obama road show.  Barrack Obama’s calm and authoritative performance was worthy of an established and experienced statesman, rather than a relative newcomer, and Mrs. Obama’s style, poise and grace underlined the fact that we now have very different new occupants in the White House.

Was the G20 a great success?  Well, it has been said that we should have had a G2 rather than a G20, for the two nations that really matter right now are America and China.

Given the fact that virtually all the measures announced in this meeting of the G20 leaders have long been anticipated and discussed at length not only by the civil servants of the participating nations but also in the media across the world, one could be forgiven for thinking that this kind of summit amounts to little more than a talking shop, albeit with one very important item on the agenda, namely the photo call.

Normally, the photo opportunity makes for a good spectacle, with the great and good jostling for position and then putting on an earnest and near pious demeanour, all designed to bolster their egos, improve their standing back home and rally electoral support.  If Romeo and Juliet had got married rather than gone to their tragic ends, the Capulet and Montague families would have had less difficulty to agree a pecking order to establish who should stand next to whom for the wedding portrait.

This time, it was different.  The first official photograph went ahead without the presence of Canadian Premier Harper.  Some observers said he was on a bathroom break, but the Canadian version had him being briefed on a draft communiqué.  Two hours later, the leaders lined up again, but this time both the Indonesian PM Yudhoyono and Silvio Berlusconi were missing.  Thankfully for us, we were not told what Signor Berlusconi was up to, and thankfully for the other leaders, no third attempt was made. However, there was a final photo with all the leaders present, this time at Buckingham Palace in the presence of Her Majesty, and this time all went smoothly, apart from Mr. Berlusconi’s personal clownery that managed to ruffle the feathers of even our usually unflappable Queen.

The Markets

After a truly dismal 2008, stock markets the world over started displaying tentative optimism at the prospect of globally coordinated stimulus packages and a new man at the White House.  There even were signs of a return of risk appetite, as evidenced by the 500 point rally in the Dow Jones immediately after Christmas.  However, this proved a false dawn as markets quickly were overtaken by an avalanche of bad economic data.  Gloomy downward revisions to already poor growth forecasts by the IMF were compounded by the World Bank’s prediction of the first period of negative global growth since World War II. By the end of February, all major markets were showing double digit losses for the year to date, with only the domestic Chinese market in Shanghai bucking the trend.

Numbers became almost meaningless as RBS posted the biggest corporate loss in UK history, Toyota announced its first ever quarterly loss and banks everywhere became the subject of government bail-outs or takeovers.  The automotive industry also provided the biggest shock in the US when the once mighty General Motors had to go cap in hand to the new Administration.  GM having to ask for government assistance was a psychological blow for Americans.  Less than forty years ago, GM was the world’s biggest company both in terms of turnover and market capitalisation.  Indeed, it is not so long ago that old adage “If it’s good for General Motors, it must be good for America!” held true.

Sadly, the latest statistics show that the US has already lost over five million jobs so far in this downturn.

Eastern Europe added to the gloom as it became apparent that the problems relating to short term foreign debt obligations and the need to refinance $400bn of loans potentially threatened to spill over into mainstream European banks.  It was suggested that Austria’s economy was in danger of collapse should there be a significant level of debt default from the East.  The situation is reminiscent to that of South East Asia in 1987.

Since these dark days at the end of February, stock markets have rallied significantly, and many indices have posted gains of between 20% and 30% from the low point.  Somebody has quipped that markets “have had a good year in the last six weeks”!

Needless to say, the worry is that this is simply a bear market rally as economic “green shoots” are still scarce and more bad news could easily trigger yet another downturn.

At Lacomp we feel it is far too early to believe that this recent upturn is anything other than a bear market rally, and we would not recommend that people look towards increasing their equity exposure.  Too many negatives are still out there: the global economy is still contracting, and nobody truly understands quantitative easing and therefore is unable to tell whether it will have the desired effects.  A lot of deleveraging still needs to happen, and that will take time. On the other hand, we do not believe that inflation will be a problem for some time to come.  We foresee a fairly lengthy period of low interest rates, debt-financed growth and increased taxation, the latter of which taking us to a very topical subject: the Budget.

The Budget

Like budget statements the world over, the offering from Alistair Darling was the usual mix of economic policy, political posturing and arithmetic sleight of hand.  However long it is argued over whether we should have been in this particular creek in the first place, it was clear from his initial economic overview that the paddle was well and truly missing.

The numbers made for truly sobering reading, not least because the Chancellor had to spell out what was already clear to most observers.  The stock market, having already discounted the bad news, took the Budget in its stride and the FTSE 100 ended the day marginally higher.  Bond markets reacted more markedly as ten year gilt yields rose and sterling weakened but, even here, the bad news was really no news at all.  The Budget had few surprises, and had been so widely leaked and discussed beforehand that the general tone was already set before the Chancellor rose to speak.

Growth for the current year would be down 3.5%, borrowing for the current year would be £175bn rather than the £48bn estimate in the pre-Budget Report and would remain at this level for some years to come.  Borrowing requirements over the next four years were predicted to be £173bn, £140bn, £118bn and £97bn.  The ratio of debt to GDP would thus rise to 79%, almost double the level previously considered prudent.  Inflation would remain low with RPI turning negative at around minus 3% and consumer price inflation falling to 1%, holding out the worrying prospect of deflation. 

The scale of the numbers and their  impact for the future underlines the enormity of the global financial crisis.  The ‘real’ economy was the victim rather than the cause of this particular downturn and it is likely that the effects will be felt for many years following the virtual seizure of the global credit system in 2008.  Globalisation brought with it both economic gains and the propensity to disseminate bad news globally, such that few have escaped the fallout from an initial problem seemingly confined to the US mortgage market. 

Faced with the reality of a burgeoning government debt and declining fiscal revenues, the options for economic announcements on a grand scale were severely curtailed.  The almost daily extension of government support and borrowing as the crisis unwound through the winter months had used up all the headline-grabbing expenditure solutions and the economic measures were largely confined to short-term micro management designed to ease progress back to ‘normality’.  Whilst small in themselves, the measures to improve credit insurance, extend capital allowances and bolster the housing market and car industry will all  oil the wheels of the hoped for recovery.  Inevitably, the Budget comprised small measures and a tacit admission that the problem was so huge as to nullify ‘normal’ economic management.

The sleight of hand came in the form of a fiscal ‘triple whammy’  for those earning over £150,000 coupled with increases on the traditionally inelastic fuel, tobacco and alcohol.  Trumpeted as an abandonment of New Labour and a return to Dennis Healey’s fiscal approach, the reality is that these changes, affecting 1% of earners, will not significantly add to government income.  Expenditure cuts (efficiency savings aside) will inevitably form the major element of the medicine to come, and these cuts will affect everyone.

It is on the subject of future economic recovery that the Chancellor has pinned his hopes, predicting a turnaround at the end of this year and a 1.25% growth figure in 2010.  The projected growth of 3.5% in 2011 seems particularly optimistic and his view, at odds with the consensus, is dependent in no small part on events in the broader global economy.  If China and the US can kick start global trade and if there are no more financial shocks (many fear that there are more ‘shoes to drop’) then perhaps he will confound the pundits as his predecessor did on more than one occasion. However, Brown had a broadly benign global economic backdrop with which to work whereas Darling has to cope with headwinds on a scale not seen for generations.

Rather like buying a wardrobe of clothes for the next two years on the premise that you will lose a stone in weight, there is an undeniable element of hope in the economic forecasts.  It is a very real possibility that further borrowing and further expenditure cuts will be necessary before the economy reverts to trend growth.  

23rd April 2009