Evercore Pan Asset

Yesterday equity markets took a dive again. Reality came back home, as President Obama intervened to dismiss the boss of GM, and warned the US motor industry that there would be no more easy terms bail outs.

Whilst there is more money in circulation, as the governing authorities create and spend it, it takes time for it to have an impact on industrial output and world trade. The main economic numbers continue to look poor. The US, UK, Spanish and Irish property declines are not yet over. The industrial output of Japan, Germany and China remains weak, given the sharp decline in the demand for imports in the highly indebted countries. The large imbalances in the world economy between savers and borrowers, and between importers and exporters, remain to be corrected.  From time to time these realities will hit market sentiment. There is little sign of any immediate rebound in world demand for vehicles or other manufactured products.

However, there are some signs of corrections taking place. Savings – or private sector debt repayment rates – are picking up in the heavily borrowed countries. The decline in imports to those countries is a necessary part of the adjustment. The high savings and exporting countries are taking action to create more domestic demand, as they need to do. Returns on cash remain very low, as all the principal economies are now close to zero official interest rates, and several are embarking on quantitative easing. Some banks are working their way through the losses and the shortage of capital. In the UK Barclays has passed the Regulator’s new stress test without needing taxpayer money or even guarantees to do so.

We remain cautious, but wishing to buy corporate bonds for yield and Asian equity for recovery on bad days. We continue to avoid the UK, as the high level of public borrowing and the extreme imbalances which need to be corrected make the risks higher than in more balanced economies. We are suspicious of government debt instruments in highly borrowed countries at current low interest rate levels, despite the government buying which could drive yields lower before the bubble bursts. Whilst cash gives very little return, so far this year it has continued to do better than global equity or property, because it does not go down.

For longer term funds we are concerned about the resurgence of inflation in due course. In the UK the CPI rose by 3.2% in the latest annual figure, despite the sharp contraction and the collapse of many commodity prices. This reflects the lower level of sterling and the UK’s import dependence. Inflation should fall more this year, but as the recent sharp rally in commodity prices has reminded us, when there is global recovery there could be some big price increases in the basics. The UK – and the US – authorities will also have an incentive to allow some inflation, as they consider how to repay all that fixed income debt.