Archive for July, 2010
As we have already mentioned in passing, there seems to have been little debate as to the consequences of the possible failure of the austerity measures that several countries are now proposing or trying to adopt to deal with their budget deficits. The impact of budget cuts on growth has received a lot of attention; the importance of those cuts, not so much.
There are two items in the news this week that suggest it should.
First is the latest from Greece, where striking lorry drivers are defying the prime minister’s emergency order, signed yesterday, to return to work. This has led to fuel shortages in Athens, and together with other strikes and rioting, a fall in tourist numbers. (There are echoes here of Britain’s haulage strikes over the price of fuel ten years ago: for a few days they were an inconvenience – then high street chemists started to run out of insulin, among other serious problems.)
The second item concerns the funding of Trident. The chancellor is insisting that the cost of renewing Britain’s nuclear deterrent should be met out of the defence ministry’s budget (of which it would account for about half), rather than being provided for separately. The ministry is not best pleased. It looks as though the British cabinet is split – and not even along party lines at that, as the chancellor and defence minister are both Conservatives.
Britain’s coalition is holding up reasonably well for the moment. But over the next few months we will be enacting austerity measures of our own. British people haven’t had a sovereign crisis and IMF intervention to convince them of these measures, and they are likely to prove unpopular. Should the coalition face Greek-style resistance to its plans, together with siren voices from the Labour opposition denying that they are necessary, might it fall apart? Or seek to preserve itself by watering down its commitment to reduce borrowing?
Both of these are risks that seem remote at present, but events at home and abroad suggest that they are real. A broken (rather than merely Brokeback) coalition, or a failure to stave off a debt crisis … What price sterling under those conditions?
As a brief but heavy rain shower over London heralded the true arrival of summer yesterday, our thoughts turned to the fabled Summer Lull.
This period in financial markets is supposed to begin roughly when Wimbledon starts, and finish approximately as the kids go back to school in September. The theory goes that at this time of year, senior market participants are hosted at a series of high profile sporting events before being flown off to their holiday homes and luxury hotels. Their deserted offices are not supposed to witness much in the way of interesting activity during the period. It is a halcyon season for all concerned.
That, at least, is the theory. Over the recent past the summer has proved anything but quiet.
Last year of course the thundering juggernaut of the relief rally saw the FTSE100 gain 15% across July and August. The same months in 2008 were more convincingly dull (July: down 3.8%, August: up 4.2%), but one month later Lehmans went pop and Footsie shed 13%. In June ’07 it was Bear Stearns – remember them? – and although the market reaction was muted at the time that was the signal that the subprime crisis, which had been gathering itself quietly in a specialist corner of the credit markets for a few months, really was going to shake the world.
Why the trip down memory lane? Well, the equity market recovery from the correction we saw over the spring has seen the FTSE100 rise nearly 8% month to date – the steepest monthly gain, funnily enough, since last July.
Will August see a gentle falling back, giving us overall a traditional summer non-event? Or will it be 2009 all over again?
In the latter case, as we are optimistic about the prospects for the world but cautiously so, we would humbly diagnose a case of heatstroke and position for a cooler reappraisal of market valuations once those City offices have filled up again.
How many times have you heard somebody say, “you can’t go wrong with bricks and mortar”? Or: “My property investments are my pension”? Or: “I understand property but I don’t understand stocks and shares”?
Britain’s love affair with residential property as an asset class is well known, long standing and seemingly indissoluble. But could it also, at the moment, be badly advised?
This week saw the publication of the Bank of England’s quarterly data on housing equity withdrawal – as the Bank describes it, “new borrowing secured on dwellings that is not invested in the housing market (e.g. not used for house purchase or home improvements).”
This indicator has been in negative territory for some time, which is to say that for the last couple of years Britain has on average been repaying its mortgages to a greater extent than it has been remortgaging to pay for – well, anything really, from long term care to long haul holidays. Adjusting for inflation, over £45bn has been repaid in today’s money since the series went below zero in Q2 2008 – much smaller than the inflation-adjusted £99bn that was borrowed / “withdrawn” in the two previous years, sure, but hardly small potatoes.
What does it mean?
Well, in the aftermath of the ERM debacle of the early 1990s, house prices began to rise again much before mortgage equity withdrawal (as it was then known) returned to positive territory: mid-96 on the basis of the Nationwide house price index vs. mid-98. Property bulls might take some comfort from this.
But when you consider that mortgage approvals have yet to recover to anything like their pre-recessionary level; that this reflects the continued tightness of credit conditions for mortgage borrowers relative to that time; and that house prices have already showed signs of cooling this year even in the absence of the kind of rise in unemployment that typically catalyses a price fall through increased forced selling – then you might think twice before downloading the brochure for that little one bed place in the new development by the railway station.
Or “economic forecasting”, as it’s also known.
Last week saw the publication of the latest quarterly survey from the IMF, which has made headlines around the world. (Who would have thought that a brief time ago this organisation was being written off as obsolete?) For the world the major news was that the Fund’s growth forecast for 2010 has been revised up, from 4.2% to 4.6%. For Britain, the news was not so good: our growth for this year has been revised down a little (from 1.3% to 1.2%), and for next year by a fair old chunk (2.1% plays the 2.5% the Bretton Woods relic was predicting three months ago).
This seems odd. Yes, Britain’s coalition government recently added some numbers to its commitment to fiscal tightening. Yes, if one inputs lower government spending numbers into a growth forecasting model, said model could well produce a lower aggregate number. But why single Britain out .. ?
As the IMF say in their own report:
the overarching policy challenge is to restore financial market confidence without choking the recovery.
Much of the world is scrambling to do this. Even in Japan, which hasn’t run a budget surplus since 1992 and which hasn’t been demonstrably harmed by its sumo-sized debt burden, they’ve started to consider the possibility of thinking about paying some borrowing back. Opinion is at best divided on the impact of fiscal “austerity” / realism on aggregate demand in economies whose private sectors have returned to positive growth.
So for the IMF to turn all pessimistic on Britain while acknowledging that their previous global forecast for growth was too tight seems a little churlish while most other countries are either trying to tighten spending – or actually doing it – too.
If you want to be really pessimistic about the future, forget about the impact of government austerity. Consider what might happen should austerity measures fail, through being too politically difficult to implement.
The debate doesn’t seem to have moved on that far yet. Predicting that countries with clear deficit reduction targets might choke off a bit of growth, well – that might be contentious, but .. Trying to predict which countries – out of almost all of them – will fail to deliver on deficit reduction and precipitate worries of another sovereign crisis? That, frankly, is a mission for the real IMF.
… To the blog at Vigilant Financial, where you will be able to find weekly updates containing our market thoughts and company news.
This week saw the launch of our new website, and with it the opening of Vigilant’s doors for business.
It is an interesting time to be starting a new business in the finance sector. The road to recovery is running less smooth than was recently thought. With riots in Athens – and latterly nerves in Shanghai – faith in the ability of governments to deliver us from all evil has been shaken. When a state bails out its population, can it defend them from loss – or merely destroy its own solvency?
The markets’ view into the back end of last year was that our governments, by taking on every last contingent liability they could find, had protected us absolutely from any consequences of our borrowed profligacy. Now – as is the way with markets – they are not quite so sure.
One thing we can be sure of is that even the most intractable path becomes navigable with the assistance of a reliable guide. At times like these we believe it will pay to be Vigilant.