The Year In View

As this will be the last comment to be posted for 2010, it seems the appropriate place for some reflections on the year (almost) gone by.

Since this blog began in July, one consistent view has been that while the world economy would continue to recover, it would do so patchily. Equity markets agreed. At present, the S&P 500 has risen by 11.5% year to date; the Nikkei 225 is down 3.1%. In Europe, the stronger countries turned in some of the best equity market performance in the world, with Germany’s DAX up 18.4% and Sweden’s OMX higher by 21.6%. At the other end of the spectrum, Ireland’s ISEQ fell by 4% and the Athens Stock Exchange General Index stands a staggering 33.7% below where it started the year. Our own FTSE 100 index is in the middle, having risen 9.1%.

Despite the recent sell-off, bond markets – which reached crazy levels earlier in the year – have generally turned in a strong performance over 2010 as a whole. Ten year US, German and UK yields have fallen by 40-50 basis points (0.4-0.5%) year to date, implying price gains of around 3-4%. Unsurprisingly, the exceptions were the more distressed European government bond markets, with ten year Irish bond yields 350bp higher and the yield on ten year Greek paper up by almost 600bp.

Commodities have enjoyed a strong year overall, with the S&P GSCI total return index up some 6%. Behind the headline number, the near Brent Crude future has risen 18% year to date, a figure matched by the Bloomberg Base Metal index. Precious metals continued their staggering run into precarious territory, with gold 26% higher and silver up an astonishing 73%. One of the few fallers was a significant one for the index, however: the NYMEX natural gas future is down 26% on the year.

Finally, in the world of currencies, the big loser was the euro, down over 9% on a trade weighted basis year to date. The major gainers were the safe havens of the yen (up 13.4%) and the Swiss franc (up 12.8%), and the Australian dollar got an 8% boost from the commodity boom. Both sterling and the US dollar are broadly flat.

There are a number of observations that could be made on all of this, and even some hints to be drawn about the future. For now, however, we will limit ourselves to noting the disparity of returns between and within asset classes, underlining the portfolio contribution to be made from decision making at this level. And as to the future, may we wish you a merry Christmas, and a happy and prosperous new year.

Euro Paean

About a month ago, as the situation in Ireland continued to deteriorate, an informed commentator observed that the euro faced a battle for survival:

The first year of the Lisbon Treaty has been clearly marked by the crisis of the euro zone. It was not a period of vision, it was a period of survival; it’s not finished yet.

Who was this prescient figure? Some eurosceptic economist, perhaps? A scaremongering journalist?

Actually that quotation – and much besides – comes from a speech given in Brussels by “President of Europe” Herman Van Rompuy on 16 November, twelve days before EU leaders agreed the structure of Ireland’s famous bailout.

The Irish rescue package has been taken by some as evidence that the euro cannot survive. They worry that the single currency is serving too many masters with vastly different economic needs, and that it must collapse (perhaps by means of a German exit). Greece, Ireland … Portugal next? How long can this continue?

Now it is correct to note that the one-size-fits-all interest rate that goes along with single currency membership has caused problems over the years. In 2004-5 a rate of 2% was perfectly appropriate for Germany, for example, where inflation was contained at 1-2% and the economy was emerging but sluggishly from recession. In Ireland, however, where inflation was around a point higher and growth was sprinting along at 5%, such a rate was far too low.

Such imbalances, however, are inevitable in any economy. The US, for instance, comprises fifty states with vastly different growth and deficit positions. The more indebted of them face the prospect of default. For taxpayers at large, bailing out irresponsible borrowers will be no more palatable in America than it has proved on the Continent. Yet who is talking about Illinois abandoning the dollar?

Europe’s leaders have been acutely aware of the risks to their currency throughout the period of turmoil. To interpret their agreement of massive inter-state bailouts and emergency central bank support as a sign of structural weakness is to precisely misread the reality of the situation.

A year ago it was possible to ask, “what would Germany do if asked to bail out Greece? Will the euro survive a sovereign crisis?” Well, we have had two such crises now. The strong states have stood four-square behind the weaker ones, and four-square behind the euro.

Of course, sovereign defaults are terrifying. Market participants are rightly fearful of them, and market prices have moved in response. The euro is some 9% weaker on a trade weighted basis than it was at the start of the year, and the stock markets of Greece, Ireland, Portugal, Italy and Spain have all taken various degrees of battering.

But the French and German markets are up. In fact, the DAX has comfortably outperformed the All Share and the S&P 500.

Above all, the euro has survived – and the events of this year suggest that it is more and not less likely to continue to do so. As another European once observed: that which does not kill us, makes us stronger ..