Evercore Pan Asset

It’s been a good few days for markets and for our portfolios. Suddenly there’s sunshine. As we suggested last time, the Chinese authorities seem to be shifting from retrenchment to thinking about how to encourage growth again once inflation is back down. Meanwhile Chinese factories remain busy and their products stay competitive. Chinese shares still look cheap despite the rally. In the US the third quarter GDP figures came in at an annualised 2.5% growth rate, better than some feared. We have been expecting a good end to the year in the US, as the investment tax breaks for companies acts as an incentive to pull forward corporate spending. The US market is moving to the top of the trading range we think applies. Brazil is making progress with its counter inflation strategy, with an economy that shows promise. Its market still looks good value.

European shares have rallied as well. German exporters and manufacturers shares look cheap, and Germany remains a strong performer within the Euro zone. The ostensible trigger for the European rally, the deal hammered out on 26th October by the Euro area leaders, was more hope than solution. The leaders offered three components to sort out the debt and banking crisis.

The first was the decision to ask the banks and other private sector investors to take a 50% cut in the money they will receive back from their holdings in Greek state bonds. The aim is to have a voluntary agreement, to avoid triggering a formal default. There has been no mention so far that the public sector holders will accept a cut. We await confirmation that all main private sector holders have signed up, so we can calculate how much debt is written off. If around €100 billion is removed from the accounts, that does help by lowering the interest burden for a bit. There remains the need for determined Greek action cut spending and increase tax revenue, which is difficult politically, and difficult against a background of falling output.

The second was the requirement that EU banks raise an additional 106 billion of capital, so they can absorb losses more easily. This was at the low end of market estimates of what was needed. The governments have in mind that the banks should do it by raising more capital on the private markets. If they are unable to do so they need to seek the money from their own home government. People anticipate nationalisation of some banks in Greece, where the Greek bond losses will be largest. It is also possible some banks will get their loan to capital ratios into line by reducing lending rather than by raising new capital.

The third was the decision to increase the size of the European Financial Stabilisation fund from the previously agreed €440 billion to €1 trillion. The Fund is a Luxembourg company. So far it has raised just €13 billion in borrowings, and lent €9.5 bn to Portugal and Ireland. It has permission to borrow up to €440 bn directly. Its borrowings are guaranteed by all Euro member states governments in a specified proportion. Each state has to guarantee 165% of its share of the 440 billion, so that the AAA rated member states always guarantee 100% of the money raised. This enables the company to borrow at AAA rates.

There is as yet no agreement on how to increase the fund to 1 trillion. They are looking at using some of its money to guarantee tranches of state debt, thus gearing the effect of the loans and guarantees. They are also considering setting up parallel funds, inviting in sovereign wealth funds and governments with large reserves to contribute.

We do not think these measures solve the Euro crisis. Too many countries still have too much debt and large deficits. The southern states remain uncompetitive within the Euro. These measures buy a little time, but we see Europe as a slow growth area at best, with substantial risks of further shocks in the banks and debts of the sovereigns.