Joined: 05 Aug 2006
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Sun Sep 06, 2009 7:57 am Reply with quote
G20, equities and a ‘double dip’
By Neil Hume
Published: FT September 4 2009 20:05 | Last updated: September 4 2009 20:05
As G20 finance ministers met in London on Friday to discuss how and when they will withdraw the expensive medication that has kept the global economy functioning, it is worth pausing for a moment to consider what this means for equities.
There is little to worry about in the short term. It is highly unlikely the G20 members will suddenly end their huge stimulus packages because that would threaten the fragile economic recovery. Indeed, Alistair Darling, the chancellor, warned this week that the world could be dragged into a double-dip recession if governments stopped stimulating their economies. This is why stock market bulls believe the summer rally will continue.
But at some point the G20 and others will need to restore their rapidly deteriorating finances and the fiscal and monetary tightening implied is likely to have serious implications for equities. At best the stock market could be facing years of range bound trading. At worst another lost decade. It is sobering to think that the FTSE 100 was trading at 6,332 10 years ago – 23 per cent above last night’s close.
A report by Morgan Stanley this week, highlighted the poor state of government finances in the European Union following the worst postwar global recession. Citing European Commission projections, the bank forecast budget deficit and gross government debt across the 15-strong group of eurozone countries would reach 7.4 per cent and 82 per cent of GDP respectively in 2010. To put those figures into perspective, the European Stability and Growth Pact limits budget deficits to 3 per cent of GDP and gross debt to 60 per cent of GDP. To correct these imbalances would require a combination of spending cuts, privatisation and tax rises. A tepid economic recovery would not be enough to repair finances, the bank’s strategists said.
Clearly, there will be many stock market losers from higher taxes and spending cuts. For example, lower government spending would hit construction, bus and rail and drug and healthcare companies. Higher taxes would hit retailers and other consumer-facing companies.
Governments will also look to sell their large stakes in banks such as RBS and Lloyds as quickly as possible and this will create a stock overhang. This process has already begun. The Swiss government recently sold its 9 per cent holding in UBS for a $1.1bn profit. On top of that, the stock market will have to contend with a huge supply of government bonds and the prospect of lower trend growth in the future.
But what really concerns Morgan Stanley and others is the combination of fiscal tightening and further deleveraging by consumers and banks. It is this cocktail that will condemn the stock market to years of range bound trading. “Post the rebound rally, we expect some sort of trading range for years to come because of the structural problems of the financial sector, household deleveraging as well as the poor state of government finances,” Morgan Stanley said. “We expect MSCI Europe to be in a broad trading range for years to come, between 600 and 1200 (Latest value 1046).”
Of course, the stock market rally could continue for a while longer given that significant spending cuts are not expected in the next year and the US Federal Reserve is expected to keep rates on hold at least until the second half of 2010. But for some observers, the reluctance to implement exit strategies from policies such as quantitative easing and increase interest rates is just making things worse. In a recent note, Bob Janjuah, RBS’s chief strategist, said the emergency fiscal and monetary support put in place after the collapse of Lehman Brothers had tricked the markets into believing all was well but was just creating another bubble that would make the events of the past two years seem like a walk in the park. “Think of unemployment, inflation and bond yield up in the teens and then ask yourself how you will feel,” he said.
So, enjoy the rally while it lasts because it looks like the hangover will be painful.
Joined: 05 Aug 2006
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Fri Oct 23, 2009 11:50 am Reply with quote
Economic intervention is driving the equity market
Created: 22 October 2009
Written by: Maike Currie
A year on from being priced to go bust, small caps have enjoyed a massive rally with the market up over 70 per cent compared with the All-Share's rise of just over 20 per cent. While the exact inverse of last year, the sector's dramatic surge upwards is nothing unusual, says Victoria Stewart, manager of the Royal London UK Smaller Companies Fund. "Small caps are the high beta part of the market, and as the emerging growth part of the UK market the sector has behaved accordingly," she says.
The big swing factor however has been the return of liquidity. "Last year we saw liquidity dry up month after month, culminating with a strike on liquidity in the fourth quarter when we saw small caps take that final dive," says Ms Stewart. "Now with an environment of near zero interest rates, both bank deposits and gilts are yielding close to nothing, and as a result money is finding its way into the equity markets, and clearly also the property market. It is cash looking for a home."
The economics behind it all
The return of liquidity and financing - be it banks lending again at a price or the reopening of the equity markets - has lead to a deluge of fund raisings this year. "Companies like Yell have come back more than once, and they're not alone, many of the pub companies are tapping both the equity market and the bond market," comments Ms Stewart.
So is there more upside to be had in small caps? Ms Stewart's response is pragmatic, and it lies with the government's fiscal fixing. She says: "There is a big difference between perhaps what economic policy should be and what economic policy actually is. Current policy is to re-float the economy at all costs and in the process of doing so, to keep interest rates as low as possible. The consumer is so indebted that we can't afford to put up interest rates and choke off the consumer at a time when we need to fix the public deficit. So there is a collective will to keep the loose monetary conditions and while we have that the liquidity continues and this supports the equity market."
So regardless of whether the market experiences a short term pull-back or a bit of profit taking in the New Year, Ms Stewart believes economic intervention will continue to push the equity market on and consequently the small cap will follow. "It is very difficult to see an alternative asset class that you will prefer over equities given the stimulus packages and the monetary policies that are in place," she adds.