3 Month Commentary & Market Review
| 31/10/2008 | Local Currency | Sterling | ||
|---|---|---|---|---|
| Capital returns (equities) | 3m | 6m | 3m | 6m |
| UK Market | -20.6 | -29.6 | -20.6 | -29.6 |
| UK Mid Cap | -29.1 | -37.9 | -29.1 | -37.9 |
| UK Small Cap | -30.0 | -40.3 | -30.0 | -40.3 |
| US | -23.6 | -29.8 | -6.4 | -14.0 |
| Europe ex-UK | -23.9 | -33.3 | -23.2 | -32.7 |
| Japan | -34.1 | -37.2 | -11.2 | -18.2 |
| Pacific Basin | -28.7 | -38.4 | -27.8 | -38.0 |
| IFC Emrg Mkts | -46.4 | -52.3 | -34.3 | -41.6 |
| World | -25.1 | -32.2 | -15.3 | -23.6 |
| 10 year bond yields | Yield % | 3m ch. | 6m ch. | |
|---|---|---|---|---|
| US | 4.0 | +0 | +22 | |
| UK | 4.5 | -28 | -14 | |
| Germany | 3.9 | -47 | -20 | |
| Corporates | Spread | Yield % | Spread Change | |
|---|---|---|---|---|
| US AA Corp | +1.65 | 6.2 | +103 | +118 |
| US BAA Corp | +5.65 | 10.2 | +371 | +408 |
| Currency | 3m | 6m | Current level | |
|---|---|---|---|---|
| $ vs. £ | +22.6 | +22.6 | 1.616 | |
| $ vs. € | +22.5 | +22.7 | 1.273 | |
| € vs. £ (p/€) | +0.1 | -0.1 | 0.788 | |
| Yen vs. $ | +9.9 | +6.3 | 98.350 | |
| Brent oil in US $ | -51.6 | -46.3 | 59.9 | |
Source: Datastream
Equities have been rocked by unprecedented volatility in the past three months, as fears about the health of the banking sector reached a crescendo, at the same time as the prospects for economic growth worsened, owing to the associated credit crunch as well as the peak in oil prices during the summer. The global banking crisis directly hit confidence in the equity and credit markets, in addition to forcing the liquidation of portfolios funded by borrowing (e.g. banks' proprietary positions and many hedge funds). Although there has been some relief on inflation as oil and other commodity prices have retreated from their highs, the positive impact has, despite substantial injections of Government capital into the banking sector, been overwhelmed by the financial sector crisis and the forced selling evident during October. Global equity markets collectively fell 25.1% in local currencies but this loss was reduced in sterling terms to a fall of 15.3%.
The UK market fell 20.6%, with mid-cap stocks and smaller companies lagging, down 29.1% and 30% respectively. The US market fell 23.6% in dollar terms but a relatively moderate 6.4% in sterling terms, as the dollar rose sharply. European markets fell 23.9% in local terms and 23.2% in sterling terms. In the Far East, markets fell 28.7% in local currency and 27.8% in sterling terms. Emerging markets more generally fell particularly sharply, by 46.4% in local currencies and 34.3% in sterling terms. Japan declined 34.1% in yen but currency factors again offset much of the loss, which was 11.2% in sterling terms.
Waning current inflationary pressures and downward pressure in equities led to greater demand for Government bonds' relative short-term nominal capital security. Although increasing government deficits and stimulative monetary policies have raised the spectre of greater inflation in the future, the present has been dominated by concerns about recession in 2009. Yields were steady over the period in the USA, but declined by 0.5% in Europe and by 0.3% in the UK. Credit spreads widened sharply, as economic fears were compounded by forced selling.
The US Federal Reserve [the Fed] resumed cutting rates, reducing them by 1%, to 1%. Many other central banks have also cut rates, including a coordinated move in early October, with further reductions expected. UK rates, which were cut to 4.5%, are expected to fall sharply in coming months. Even the European Central Bank (which raised rates as recently as July) cut in October, suggesting a rapid reversal in its assessment of the relative risks of inflation and recession. Money market interest rates have begun to moderate from their worst crisis levels, indicating that the Central Banks' measures to restore confidence are starting to gain traction.
The oil price has halved since the end of July, the peak of over $140 per barrel having proved unsustainable (and economically, probably the straw that broke the global camel's back). This is likely to feed into lower inflation rates, as well as boosting disposable incomes.
On the currency front, the feature of the late summer was a dramatic rise in the US dollar, although this appeared linked to diminishing confidence in the global economy rather than increased confidence in the US. The dollar rose by over 22% against the Euro and sterling. However, it was down 10% against the yen, which benefited even more than the dollar from the unwinding of borrowings that had been used to fund investment portfolios.
Equity markets have suffered two of their most traumatic months in modern history, hit by fears of a financial sector collapse and poor trends in economic growth and corporate earnings. The fear of a general implosion in the banking sector appears to have passed its worst, as governments worldwide have injected substantial amounts of new capital into the banking sector, addressing both solvency and liquidity concerns. The focus has moved on to the fear of a recession, fuelled by reduced credit and the earlier impact of the shock rises in commodity prices. Economic forecasts now build in virtually zero growth overall in 2009, implying several quarters of declining output (in common parlance, a recession). Although the increased dividend yield and reduced earnings multiple in global equity markets has clearly factored in a pessimistic outlook for earnings and dividends, living through the confirmation of downgrades in corporate earnings will act as a headwind in coming months.
Crucial to any sustainable rally in equity and credit markets will be abatement in the rate of forced liquidation since, by definition, such sellers are driven by necessity not a sense of value. This can be expected to show up in a reduction in day to day volatility and greater discrimination between companies that are economically vulnerable and those that are less so. The decline in oil prices is a powerful beneficial force for consuming countries, since oil price swings have underlain or exacerbated most of the recessions of the past forty years. Although the recent halving in oil prices (to levels last seen in early 2007) has been ignored in the light of shorter term fears during the recent market sell-off, we would expect a combination of lower fuel prices, declining inflation and significantly lower interest rates to improve the investment climate during 2009.
The FTSE 100 fell 1035 points in the three months to the end of October, excluding the benefit of dividends, which particularly affect performance figures during seasonal dividend-paying periods. The 5 main contributors to/detractors from this performance were (in points):
| AstraZeneca | +9.7 | Rio Tinto | -104.1 | |
| Diageo | +7.7 | RBS | -96.9 | |
| GlaxoSmithKline | +4.6 | Xstrata | -79.2 | |
| NG Transco | +3.7 | Anglo American | -77.3 | |
| Smith & Nephew | +1.0 | BHP Billiton | -59.3 | |
| Total | +26.7 | Total | -416.8 |
|---|
Source: Bloomberg