Evercore Pan Asset

Yesterday markets recovered some of the large losses of the previous week, in relief at the EU and UK banking packages, and the changes to the Paulson approach in the USA.

The authorities are now hurling huge sums of money at markets, seeking to meet the shortage of dollars created by dollar losses by banks around the world against dollar liabilities that need repaying. We have had the first round of concerted interest rate reductions, and the offer of guarantees on interbank lending to try to get that moving again. These are all positive signs.

The most contentious part of government moves comes over the decision to make taxpayer capital available for new shares in banks. It is an improvement on the previous approach of nationalising in its entirety any bank that was on the brink of failure. This approach has burdened the US taxpayer with two very large mortgage banks and AIG, and the UK with Northern Rock and parts of Bradford and Bingley. The authorities presumably came to realise that they could not afford to continue with such an approach given the other banks that could be at risk. The new approach, however, still raises issues of how much risk can taxpayers take on, and how much money can governments afford to spend on this type of adventure?

In the UK there is a plan to take a majority stake in RBS and a substantial minority stake in Lloyds/HBOS. Their combined balance sheets amount to £3 trillion, meaning the UK taxpayer is on risk for £30 billion of losses for every one percentage diminution in their assets. At a time when the UK government is already borrowing very large sums for its more normal purposes, and the stock of UK public debt and other liability is already large, this is a worrying development. It was interesting to see that the Barclays share price rose on news that it would seek private capital and cut its dividend, whilst the share prices of the companies seeking public capital fell on an otherwise spectacular day for shares.

In the US the Paulson plan, once heralded as imperative to save the world’s financial system by buying loan packages form the banks, has been developed to include $250 billion of new public capital going in to the main US banks. It will be interesting to see the reactions of existing shareholders to the terms of these capital raisings, as existing shareholders have traditionally made the decisions about when and how to raise new capital.

The big question before us, is this the bottom of the share markets? Will confidence now return? Will banking markets now start to function properly?

It is true that two of our conditions for a bull market have been met. Commodity prices – and in due course the rate of increase in retail prices – are falling. Interest rates are on the way down. Share prices ,especially in Asia, have fallen a long way. The two remaining issues relate to whether banks can now start lending at any sensible level, given the shock they have received, and how deep and long the recession is going to be.

We are less gloomy today that a week ago. Shares are now cheaper, and some progress has been made in bottoming the banking crisis. When we buy shares it will be in the faster growing parts of the world. We are still pessimistic about the UK where the twin deficits in public and private sectors are now very large, and where the economy is too dependent on financial services which are in the eye of the storm. In the west banks will enter a period of caution in making new advances, which will make life difficult for many companies.