Monthly Archives: July 2009

26th July Making sense of the rally

At face value, the latest rally in equity markets is a very positive sign. Macroeconomic data has been showing signs of improvement and oil bounced strongly off its 100 day moving average on July 15th. Even Earnings Season has been relatively positive. Barring a couple of nasty surprises some solid companies, such as Apple, gave surprisingly bullish reports.

However I am still not buying it.

Back in May I wrote that the Dow was likely to hit 9,000 by the end of July. It has now achieved this. If you tune into any of the euphoria on most business media channels you would be forgiven for believing that 10,000 is just around the corner. Talk of this being a bear rally has been shoved to the sidelines as a procession of traders and other assorted talking heads have been excitedly announcing the bullish sentiment out there.

However what no-one seems to have picked up on is the lack of volume in the market. To give a rough idea ,volume has been roughly two thirds of what it was from March to early May this year (the first stage of the rally) and one third to half of what was seen during the heavy selling from October 2008 to February 2009.

Unless there is a notable pick up in volume then this rally is inevitably going to run out of steam.

We need to see what happens now towards the end of August, but I still have serious concerns about the strength of the bond market. The various stimuli plans across the World are still wholly reliant on bond sales. So far there have been few signs of serious weakness in demand, but we are only halfway through the year. For me September/October will be the crunch time. If the bond market fails to soak up the need for capital to underpin the financial system, then this will likely be the catalyst for the next collapse in equities.

I know this is still a very pessimistic view, but I just don’t believe the worst is behind us yet. It can’t be….

16th July Disgust at Goldman Sachs’ earnings

I started writing this blog yesterday, but had the foresight to sleep on what I first wrote. It was something of an embarrassing rant…

Anyway, feeling much calmer now, I can’t shake a sense of deep disgust at Goldman Sach’s earnings’ announcement on Tuesday.

In summary Goldman is on course to match, or even better, the record payouts to staff of 2006 and 2007. If earnings keep pace for the rest of the year, then the average salary for Goldman’s 29,400 staff will be $770,000! This is during the worst Global economic crisis in 75 years. If ever a clear indication were needed of how divorced investment banking has become from the true economy, then these earnings provide it.

The investment banks were at the epicentre of the Credit Crisis. Had they not received staggering bailouts during 2008, then they would not exist now. Even so we find ourselves now having to stomach vast payouts to staff, less than 9 months after the collapse of Lehmann, while the rest of the economy suffers dreadfully. How these people can people sleep at night is beyond me.

The flippant answer is on huge piles of money of course, but there is a more serious issue at stake here, namely the structure of international markets.

By their own admission, the bulk of the bank’s earnings of $3.44bn were generated on the fixed income, currency and commodity desks.

There is no surprise that fixed income (bonds) has provided such a substantial contribution to Goldman’s bottom line. One of the fundamental drawbacks of governmental fiscal stimulus measures is that they were always going to reward the very people who created this mess. After all in issuing and distributing all these bonds, who were the middlemen going to be? Naturally the answer is the surviving investment banks.

In an era of record debt issuance, Goldman Sachs and their ilk have been happily accruing fees for the “value” they add in selling the bonds to international investors (for that read the Chinese, Japanese and Arabs). Even earning fractions of percentages has proved to be incredibly lucrative.

The performance of the currency and commodity desks also cause a lot of concern. While economic output has collapsed the only way that Goldman could have generated substantial profits from this activity would have been on speculative trades. This highlights a critical flaw in modern markets. A somewhat forgotten issue during the Credit Crisis was the power wielded by international finance houses in pushing up or driving down prices of currencies and commodities. This issue went away with the collapse of the hedge fund market, but it is sure to return.

The problem occurs in establishing the true value of the underlying asset class. For a trader looking at a screen, driving up the price of rice or driving down the price of coffee has little meaning other than a series of flashing numbers and a nice bonus at the end of the year. However in the real world these price movements have serious social consequences. For the time being we have forgotten about the lurking dangers of inflation, but the recent commodity rally should give us all cause for concern. I fear this is another issue I shall return to in the not too distant future.

While we have a financial sector that pays no heed to this danger then the next financial crisis is going to be so much worse than the current one.

I have written before that the lack of accountability is one of the worst aspects of the response to the Credit Crisis. My position has now hardened. Not only has there been a total lack of accountability, but it looks like terrible failure is going to be richly rewarded. This cannot be good for the long term health of our economy or society.

14th July It’s the dishonesty that bothers me most….

I haven’t really felt like blogging much in the last 10 days, as I haven’t really seen the point. Markets are quiet because it is summer and the only items of interest in the news provide the most warped view of what is happening in our society at the moment.

I thought about writing a response to last week’s Government White Paper on the FSA, but decided not to bother. From what I picked up (and I did read a lot into this) it was yet another white wash. Not only does the Government believe the Tripartite System (between the Treasury, the Bank of England and the FSA) worked, they are even proposing to increase the powers of the FSA. A pretty decent overview of the main themes can be found here.

There was no mention or acknowledgement of any mistakes having been made and, more worryingly, there was absolutely no recognition of the urgent need for a fundamental restructuring of the financial services sector.

In the run-up to the Credit Crisis the regulatory system failed. There can be no argument about this. Not only have we witnessed the collapse of a large group of banks, building societies and other financial institutions but also consumer and corporate debt have been allowed to run out of all control, whilst the collapse of the housing market bubble is likely to cause long term economic hardship. This is not even to consider the long-term future of Sterling or what on Earth is going to be done about the Public Sector deficit.

As far as I am concerned these issues are all inextricably linked. The lack of effective checks and balances to ensure and, where required, enforce accountability were both substantial contributors and amplifiers of the current crisis.

One issue in particular is bound to come back and bite us, if left unresolved — namely the separation of investment and commercial banking. I will write about this another day.

And what about the Opposition? Although the Tories rejected last week’s White Paper and promised to remove the new measures and give greater authority to the Bank of England once in power, they are hardly leading the charge for the creation of a new order. I can understand the electoral rationale behind not committing to too much at this stage, but this is not providing us with the leadership we desperately need.

This country faces huge challenges and the sooner we collectively admit this, the sooner we can work towards overcoming our woes.

3rd July A small step in the right direction

I caught a news item yesterday that there are plans in the UK to ban credit card cheques. This announcement was part of a new wider initiative, which will see the creation of a Consumer Advocate. This new role will be charged with representing large groups of consumers in legal action against disreputable trading practices.

From what I have read this move is widely being interpreted as a means of reigning in some of the more excessive lending practices, which have blighted our economy.

While the Government’s record of appointing various “Czars” has been pretty lamentable, there is a chance that this new post could actually work. Given the severity of the Credit Crisis and how cash-strapped the majority of families are in the UK, I expect there will be the political impetus to allow whoever takes on this role to enact some good.

The key challenges that I can think of, off the top of my head include the bank charges scandal, the introduction of >100% mortgages and rampant use of store cards. If these three areas can be tackled, then I expect a great deal of pressure would be taken off stretched household budgets.

I do hope I am not being unduly optimistic in this view as it really is about time that we started to see some positive, long-term changes coming out of the current mess.

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1st July Time for an honest debate about public finances

I have been watching the debate about the state of Public Finances unfold with a great deal of interest. While Mervyn King’s interjection was particularly amusing, Prime Minister’s Questions have been particularly tempestuous in the last three weeks.

On the one side Gordon Brown has been fighting a dogged rearguard action in defence of Labour’s record of “investment” in public services, whilst refusing to acknowledge the need for cuts. On the other side David Cameron and Nick Clegg have been fighting each other to take shots at this ludicrous claim.

Judging by Brown’s increasing petulance it looks like the message is starting to hit home. And so it should…

Nobody in their right mind is supportive of increasing public expenditure. The argument that this will be the stimulus for economic recovery is, quite simply, nonsense.

In the run-up to the Credit Crisis public spending had already ballooned. At the same time taxation increased massively. In spite of the increased revenue, the Nation’s balance sheet was not looking at all healthy. Of course since then revenues have plummeted and borrowing has exploded, thanks largely to bailing out the City. It is no exaggeration to say that our Country is on the verge of the financial abyss.

While I am still certain of the likelihood of an IMF bailout, the next Government (for that read Tory, with a massive majority) is going to have a great opportunity to rebalance our economy. The rebalancing will have to include redressing the ratio of public versus private sector employment, addressing the shambolic inefficiency that plagues public bodies, addressing the increasing disparity between public and private working practices and, finally, cutting taxes.

Although the process will be extremely painful, not least through substantial cuts in public sector employment, once the worst is over we should be better positioned to take advantage of all that is good about this Country. The stability of our democracy and creativity of the people who live here will be the bedrock of future economic growth. However neither will be able to flourish under the weight of debt currently proposed.

Herein lies the severity of the problem. Before the next election there is simply no way that Brown is going to have the honesty or integrity to stand up and say “OK, we got it wrong”. Public sector employment and the relative silence of the public unions are about the only straws the current Government has to grasp at if they are to stand any chance of re-election. Even hinting at cuts would inevitably result in strikes up and down the Country. The last thing that Labour can afford is to fight an election with a similar backdrop to that of 1979.

Of course in not facing up to this harsh reality the risk is that the damage that has been caused is being amplified by throwing good money after bad. The only question is when the Tories will eventually seize the initiative on this simple truth and start pounding it home.

P.S. One final bit of excitement today; I had a meeting with the new developer of the system. Fingers crossed these might be the guys to get us going again :)

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