Evercore Pan Asset

Markets looked as if they were beginning to form a base, to look through the gloom of the crisis. Some started to anticipate greater financial stability, and eventual economic recovery. The market chatter said that banks were now underpinned by government action. There would be no rerun of the “crisis” of last autumn and no more runs on major banks. Reflationary packages would help, and the magic of lower interest rates would gradually work through. It was after all a normal cycle, even if a rather violent one. Many investment houses remained fully invested throughout.

In recent days old fears have returned to stalk the markets. They have been joined by some new worries. Central to the recent sell off has been the continuing weakness of leading banks. In the US dreadful figures from the nationalised mortgage bank were followed by worse figures from AIG and yet another rescue package for that unhappy insurer. In the UK RBS duly delivered dire figures. The government offered another huge financial injection to them. HSBC announced poor figures coupled with an enormous £12.5 billion rights issue. In Euroland there are growing rumours about large losses in Eastern Europe, producing stress for Austrian banks especially.

Joy at the US, UK and Euroland reflationary packages has been tempered by asking who is going to buy all the government paper needed to pay for them. Hope based on the authorities’ talk of quantitative easing has been met with fears of inflationary consequences if they overdo it. Every possible piece of good news generates a contrary worry. In other words, it has remained a bear market. Pension and charity Trustees looking at the big losses recorded by many funds in 2008 are now realising that it has in many cases got a lot worse in the first two months of 2009. Some are concluding their funds are still running too much risk for the conditions.

The authorities in the US and the UK are so visibly desperate to try everything that it makes building confidence difficult. In both countries government believes it needs to borrow more to tackle a crisis brought on by too much borrowing. In both the state readily pumps huge sums into distressed financial institutions that need to make fundamental changes to their costs and their business model in order to have a viable future. The easier the authorities make it for these businesses to get taxpayer money, the longer they delay making the necessary changes. The more the authorities borrow to put into the banks, the more they undermine confidence in public finances.

The weak banks and insurers need to cut out loss-making business, reduce their investment banking and trading activities drastically, put remuneration onto a sustainable basis and cut their employee numbers. They need to work their way patiently and professionally through the books of past business which is difficult, and only write new business which is a good bet and which they can afford. It’s no way out of a credit explosion to lend more money to people and companies who will not be able to repay it.

Markets are already beginning to discount the large bond sales programmes the authorities will need. Towards the end of last year we warned about the government bond bubble. Since then yields on longer dated UK and US government bonds have risen, as markets have started to reappraise the risks. If the authorities are too imprudent this fall in bond prices will continue, making it more difficult and dearer to raise all the money they need.

Lower interest rates and quantitative easing normally work to end a slump and to initiate recovery. The authorities in the US and UK are making it more difficult, by forgetting the lags between lower rates and positive moves in the economy, and by damaging their own balance sheets to sure up the banks and other financial institutions. I am not advocating more bankruptcies on the Lehmans lines, but do think a period of tough love for the banks would work better, whilst protecting the credit rating of the state. This remains a bad time for the prudent and for savers. Damage limitation is still the best strategy, with the low returns on cash once again being about the best available from the main asset categories over the last month. We have remained cautious for discretionary clients.