Evercore Pan Asset

After the Lord Mayor’s show comes the clean up. Markets gave a good send off to the G20’s show of unity. It allowed the share price rally to continue. Buyers emerged, seeking some better income compared to cash. Investors took comfort in some small green shoots, noticing the rally in Baltic freight rates, in some commodity prices, and the statements from commentators that China and the USA could start to see recovery this year.

Will this be sustained? There is no evidence of a sharp turnaround in world trade or in the major economies yet. The thawing of credit markets is not happening rapidly. The banks in trouble are now in receipt of government support in most places in the world, but that does make them robust and able to create deposits and loans on the scale required.

The Irish budget today is likely to see both spending cuts and tax increases to try to right the large and growing deficit. This bubble economy, inflated by easy credit in the good years, has seen a sharp contraction in its housing and building sectors as the credit was switched off. The government has had to go to the aid of banks that are large in relation to the size of the sponsoring economy. The adoption of the Euro has meant wage cuts have been necessary to try to price Ireland back into world markets as devaluation is not an option for them. Meanwhile they face difficulties in selling to their main export market, the UK, thanks to the devaluation of the pound.

This budget is interesting, as the UK will have a late budget on April 22^nd. The UK like Ireland experienced an over inflated credit bubble, which manifested itself in very high house prices and an overextended banking sector. There are two schools of thought about the budget. Some believe the government needs to do more of the same, spending and borrowing more to try to increase demand. Others argue that course of action will do more damage to the national finances, running the risk of going beyond the market’s willingness to finance the deficit. Doing more in the public sector will mean bigger cutbacks in the private sector, as the private sector has to lend the money to the government or pay extra taxes to sustain the higher levels of public spending.

It is unlikely the government will do much to try to correct the deficit this April, as the electoral timetable dictates otherwise. They will need to come up with some more credible figures than those supplied in the Pre Budget report last autumn. It is unlikely the economy will start to recover well in July this year as forecast, and likely the deficit will be much larger than advertised. Meanwhile Dunfermline has been added to the portfolio of weak banks, which now includes Northern Rock, Bradford and Bingley, RBS, Lloyds and HBOS.

At Evercore Pan-Asset we remain concerned about the high level of financial risk in the UK public sector. We think the UK is in for a period of no growth followed by slower growth. The huge imbalances in the public accounts will need to be tackled at some point. This is likely to mean higher taxes as well as lower spending given the way the government approaches the issue.  We recommend investors to use this period of quantitative easing to sell medium and longer dated fixed income gilts. We also continue to prefer Asian equities to UK ones, and recommend switching out of the UK. We still like corporate bonds for their higher income and some recovery prospects as credit markets improve. We favour Asian equity for the recovery and would buy more on any setback.