Another grim week
March 10th, 2009
The last week has seen another sell off in worldwide equities, as investors have taken fright at the continuing gloom from the real economies. This year investors have become more nervous about the short term prospects of the stronger exporting economies. These have experienced even sharper declines in manufacturing output than the high-borrowing countries as their export efforts hit the high headwinds of collapsing world demand. Meanwhile, the importing and borrowing countries, led by the US and the UK, are taking time to respond to the lower interest rates and monetary activism unleashed belatedly by their authorities.
We remain pessimistic about the UK. The superior growth rates to Euroland achieved in the last decade owed much to the success of the financial sector which is now troubled, to inward migration and to substantial expansion of public spending. Each of these favourable factors is going to be different in the years ahead, as the UK will at some stage have to control its public spending and borrowing, and as it becomes a less attractive place for migrants with fewer new jobs available.
The UK authorities have now announced their asset insurance scheme for Lloyds Bank to complement the RBS scheme. The result will be that the government gains a majority shareholding in Lloyds, meaning that the government will own controlling stakes in a £2 trillion bank, RBS, and a £1 trillion bank, Lloyds. The future of the public finances, and the progress of the currency, will now be strongly linked to the finances of these large banks, which have a combined balance sheet twice UK GDP.
As if on cue, sterling fell back below $1.40 and below 90p for a Euro as the Lloyds package was revealed. On both sides of the Atlantic governments are considering what additional support they can and should offer to the ailing motor industry. Worldwide there is huge overcapacity. Governments and customers are demanding quicker changes to model ranges to make vehicles more fuel efficient and cheaper to run, whilst people are reluctant to borrow to buy a new car when they are faced with uncertainty about their own jobs.
In the EU eyes are turning eastwards. There is a growing realisation that several countries in the former Soviet bloc are in need of financial help. Some wish to join the Euro to try to stabilise their currencies. Others in the West already within the Euro are suffering badly from its current level, which is hitting their ability to export. There will be frantic talks to try to find a remedy for the Eastern countries. The struggling Euro members are likely to be told to deflate more to try to bring their costs down.
We continue to recommend caution to investors. Cash has turned out to be the least worst of the major investment classes so far this year, despite the low returns. Some government bonds are also benefiting from the announcements of quantitative easing, to be carried out by governments buying in their own bonds. Whilst low yields and high prices in US and UK government bonds may have further to run in the short term, in the longer term the need for both governments to raise such large sums from the bond markets could change that position markedly.
