Market Watch - Leeds Financial

Market Watch

 

Listening to our revered politicians, one could almost be led to believe that the country’s finances are not out of control and we have many billions of pounds available to spend on health, crime, immigration and education.  This year the Government is expected to spend £704 billion and it will have a shortfall of £163 billion. However due to the repayment of existing debt, they are set to borrow £220 billion.  Whilst the Government argues that it is the cost of bailing out the banking system that has led to this situation, this is not completely true. Tax revenue has also been very badly affected due to falling tax revenues.  The Treasury had originally thought that this year’s tax revenues would have been around £650 billion, but due to the recession they are now likely to receive only £541 billion.  Whilst the level received is expected to pick up slowly over the next few years, it is going to be quite some time before the revenue from taxes reaches pre-bubble highs and this requires strong economic growth. According to the latest Ernst & Young Item Club forecast, they predict weak 1% growth this year, leading to 2.7% next year and 3.4% in 2012. This is close to Treasury forecasts that have been widely dismissed as unrealistically optimistic. Strong economy growth has, of course, been already factored in to the Government’s forecasts and it is these growth forecasts, which I have questioned consistently. I believe that the economy is likely to drift back into recession in the much-feared double-dip, because the underlying issues that created the credit crunch have not been fully addressed, either at home or globally.  In an unusually blunt report, the European Central Bank last week made it clear that it feared governments are not doing enough to put the global economy back on a sustainable growth path, despite huge amounts of rhetoric.  It believes that the distortion in the global economy that provided the backdrop to the financial crisis looks set to widen again and upset the worldwide recovery.  The report highlighted last September’s Pittsburgh Summit in which G20 leaders pledged to promote better balanced current accounts and it noted that, if anything, the situation has got worse since then.  Whilst all three main political Parties have suggested they have come clean with the electorate over public finances, according to the Financial Times, in its own calculations, all three of the Parties have a £30 billion hole in their manifestos which will have to be plugged with huge tax rises or spending cuts after the election.  The scale of the budget gap amounts to a quarter of the spending on the National Health Service, half the cost of basic State pension provision. It is also the equivalent of a tax increases for the average household of £1,100 a year.  Ultimately, the nation has to decide whether or not it wants to support a public sector, which is too large for the current tax base, and that it is argued is too large for the size of the economy.  The cost of social protection and personal social services will account for a third of all Government spending this year, or around £229 billion.  Health spending at £122 billion is the second most significant spend by the Government and adding these two together, it accounts for nearly half of all Government spending.  If Parties are therefore to protect both these areas, the level of budgetary cuts elsewhere will be eye watering. In a rare moment of admission on policy error, Gordon Brown in the week acknowledged that he was not tough enough in reigning in the City and that light touch regulation in hindsight was a mistake.  I have stressed before, I believe a lot of the failure arises from the regulatory regime, where the tri-partite system set up by Mr Brown, when he took power away from the Bank of England and handed it to the FSA created an unworkable system, as no one organisation had an overall picture of the structure. At the height of the property bubble I quoted property tycoon Gerald Ronson who, stated that the property market had got out of control and that he had never experienced anything as disjointed it in all his years as one of Britain’s shrewdest property investors.  Speaking at his company’s annual lunch the Chief Executive of Heron International said Britain was becoming a two-tier country and that he feared that the consequential effects of significant unemployment would be social unrest. Ed Balls’ younger brother, Andrew, who is head of European Investments at Fund Manager Pimco, warned in the week that sterling could come under significant pressure if the UK fails to tackle its budget deficit after the general election.  His comments come a few weeks after the Managing Director of one of the world’s largest bond investors, Bill Gross, warned that UK Government Bonds were “resting on a bed of nitro-glycerine”.  Mr Balls stated that he is cautious on the UK owing to the end of quantitative easing and added that Pimco are underweight in gilts.  “There are better alternatives, including German funds,” he said.

The general election is starting to unnerve consumers and during the week Britain’s estate agents reported a surge in the number of properties for sale as sellers look to complete deals before next month’s general election.  In its monthly analysis of the housing market, the Royal Institute of Chartered Surveyors said political uncertainty had resulted in selling activity-reaching levels not seen since the introduction of Home Information Packs in the spring of 2007.  It also noted that with demand from buyers stabilising, its members were reporting fewer price increases.  Instructions from sellers in March outstripped enquiries from would-be buyers for the third month in a row.  Reflecting the low level of completed sales since the start of the year, RICS said that the average number of sales per surveyor had dropped from 18 in the previous three months to 17, but predicted that the housing market would pick up.  Personally, I believe that once the inevitable public spending cuts bite, probably in the second half of the year, the housing market is likely to start falling again. The number of mortgages taken out by homebuyers rose by 12 per cent in February following weak January numbers the Council of Mortgage Lenders reported in the week.  A total of 35,000 loans worth £5 billion were advanced over the month, compared with 32,000 in the previous month.  The number of loans was up 49 per cent on February’s 2009 figure and the value is up by 67 per cent.  Remortgaging activity increased for the first time in five months, but continues to remain weak, with just 24,000 loans advanced during the month.  This was a 2 per cent increase on January’s figure, but 35 per cent down on last February’s number.  According to the Nationwide, consumer confidence plunged last month at its sharpest rate since the beginning of the recession, amid growing election worry.  Nationwide’s Index of Consumer Sentiment fell to 72 from 81 in February, removing all the gains seen since December.  At the last election in 2005, consumer confidence also subsided but at a much more reduced rate.  On a positive note, the British Retail Consortium said activity in the high street last month was up 6.6 per cent on March 2009, the sharpest rate of increase in four years.  The timing of Easter, however, looks to have played a significant part in this rise.  On a like-for-like basis, which strips out the impact of retailers increasing their floor space, sales in March were up 4.4 per cent on a year ago, compared to a fall of 1.2 per cent in March 2009, when Easter was later and the economy was in the doldrums. In another positive move, Britain’s trade deficit with the rest of the world shrank to its smallest in almost four years in February, boosting hopes of economic recovery taking hold.  The Office of National Statistics said that the February deficit on goods traded narrowed to £6.17 billion after it widened to it’s biggest in more than a year in January, when it reached £7.87.  Analysts had been expecting a deficit of £7.3 billion.  More encouraging was the fact that exports outpaced imports, with the seasonally adjusted figures showing volumes of exports up 6.3 per cent, whilst the volume of imports was 1.4 per cent lower.  This trend was not anticipated and if it can be continued on an ongoing basis this will have a very positive effect in rebalancing our economy and our fortunes. Without such a trend living standards will undoubtedly suffer going forward.

 

The Royal Bank of Scotland and Germany's IKB were the two biggest losers in the alleged fraud committed by Goldman Sachs, according to the U.S. Securities and Exchange Commission. The alleged fraud concerned the marketing of synthetic collateralised debt obligations backed by sub-prime mortgages in 2007. RBS paid Goldman $841 million on or about August 7, 2008, to unwind a guarantee it inherited when it acquired part of ABN Amro. Many European politicians are frustrated with Goldman’s after revelations that it perfectly legally helped Greece hide the true extent of its debts just before it joined the euro. These new allegations, concerning activity that may have directly hurt the pockets of two of the region's biggest and most powerful governments, could scarcely have come at a worse time for the company. The possibility that if proved guilty Goldman Sachs may be frozen out of many of its business activities through a combination of client abandonment and government self imposed embargoes should not be ignored. Reputation equity is fickle and can be lost in a blink of an eye, having been accumulated over decades of hard work. This is why PR firms play such an important role for the titans of the financial world. Goldman Sachs has often been accused of being a US government department due to its close links to various US administrations and this has brought with it a movement both within Wall Street and Main Street for retribution. Rolling Stone magazine described Goldman Sachs as “a great vampire squid wrapped around the face of humanity”. The firm is widely viewed as being far too powerful for anyone’s good and at the height of the financial crisis, treasury secretary Henry Paulson, a former Goldman boss, spoke to chief executive Lloyd Blankfein some 24 times in a single week. If treasury secretary Henry Paulson had not rescued AIG then Goldman Sachs would have folded. The bank is expected to earmark about $5bn (£3bn) for staff pay and bonuses this week, fuelling the controversy over bankers' rewards in the teeth of the financial crisis. Chief executive Lloyd Blankfein is expected to unveil revenues of $11bn for the first quarter of this year on Tuesday, up from $9.4bn in the same period of 2009. About 47% of that will go into a "compensation pool" for bosses and employees. Amid widespread popular anger against the banks, Goldman last year shrank its bonus pool to 36% of revenues rather than the usual 50%. Despite reining in, however, it still paid out a total of $16.2bn. Blankfein was awarded a $9m bonus in shares in 2009, down from the $68m he received in cash, shares and options in 2007. Goldman made record profits of $13.4bn last year, after net revenues more than doubled to $45.2bn. This came after the demise of several rivals and despite the bank coming close to disaster. At the height of the crisis it took $10bn of US government money, which it has since repaid. Blankfein told the Times in November that his staff were doing "God's work" and such outrageous arrogance attracts few friends anywhere.

 

Under an agreement reached last Sunday Greece had hoped that it had solved its short term borrowing issues, although the three-year deal only effectively gave it eight months cash. But the deal's deliberate opaqueness, combined with uncertainly over how long it would take for the money to be paid out, saw lending rates soar later in the week, with the difference in yields between Greek and benchmark German 10-year bunds increasing to about 4.15% on Friday. The country has to refinance €16bn of maturing debt by the end of May, and markets are increasingly only prepared to lend at rates that would be ruinous to the country. Led by Germany and France Euro zone nations will provide an estimated €30bn and the IMF will assist with up to €15bn. The prospect of Greece turning to the International Monetary Fund for support has been met with howls of protest in Greece. On Friday just a day after the socialist government formally requested more details on the EU-IMF aid deal, in a move seen as being one step away from enacting the emergency fund, Greeks were up in arms about further IMF involvement, due to concerns that its intervention would inevitably lead to tougher cost-cutting measures, as it attempts to avert bankruptcy. In global eyes the IMF has a reputation as a mercenary slayer of fiscally delinquent nations that have lived beyond there means for too long. The week had got off to a good start for Greece when the country's debt agency sold €780m of 26-week bills with a yield of 4.55pc. Investors bid for 7.67 times the amount the indebted country was aiming to sell of the bills. In addition, it sold €780m of one-year bills, yielding 4.85pc, with investors putting in bids for 6.54 times the amount of debt on offer. At the end of the week the situation had worsened significantly, as news emerged that four German professors were preparing a court challenge to the EU-IMF rescue for Greece at Germany's constitutional court as soon as the mechanism is activated, claiming that it violates the 'no-bail-out' clause of the EU Treaties. The Greek rescue is dynamite in Germany, especially in the Ruhr where jobs are in short supply and funding for schools is under threat. Newspaper articles have called for Greece to raise the retirement age to German levels of 67 (in Greece it is 55) and sell off its islands before asking for money and the backlash could see Chancellor Angela Merkel's Christian Democrats lose control of North Rhine-Westphalia in elections on May 9, shifting the balance of power in the Bundesrat.

 

Argentina a frequent sovereign debt defaulter has offered to repay the last group of creditors owed money from when it defaulted on nearly $100bn (£65bn) of loans almost a decade ago. During the week Argentina announced details of a debt swap offer that it is making to holders of nearly $20bn in bonds that have not been paid since the country defaulted in 2001. Creditors will have to take a 66.3% "haircut" on their investment but currency movements mean that the offer is worth around 51 cents in the dollar. The government had persuaded most of its creditors to accept a deal back in 2005 but holders of the remaining $20bn were holding out for a better deal. Adding in the interest over the period, those holding out are owed nearer $30bn.Getting a deal done is very important for Argentina as it has effectively been frozen out of the world debt markets for the past nine years. In the past, creditors have resorted to the courts in order to attempt to seize everything from naval vessels to diplomatic residences.

 

US Consumers grew gloomier in the middle of April despite a better-looking job market, according to a report released Friday. The University of Michigan/Reuters consumer sentiment index's preliminary reading for April fell to 69.5, from a final March reading of 73.6. The index was the lowest since November 2009.Economists had expected the mid-April index to rise to 75.0. Home construction climbed for a third straight month in March, and permits for future groundbreakings rose strongly in a sign builders are confident government tax relief will lift sales. Housing starts increased 1.6% to a seasonally adjusted 626,000 annual rate compared to the prior month, the Commerce Department said Friday. Construction rose in the South but fell in the three other regions of the U.S. Economists expected starts to rise 6.1% to a level of 610,000. February groundbreakings, originally seen down 5.9%, were revised to an increase of 1.1%. January starts jumped 6.3%. According to Realty Trac repossessions rose by 35pc in the first quarter of 2010, against the same period last year, as banks took charge of 257,944 houses and flats, the highest in any three-month period since January 2005. The numbers show that the rate of foreclosure, the process that begins after a mortgage defaults and leads to repossession rose by 16pc in the first quarter, with 1 in every 138 US homes receiving such a notice. The situation is concentrated in a handful of states led by California, Florida and Arizona with ten states accounting for more than 70pc of foreclosure filings in the first quarter. Official data showed US retail sales in March rose 1.6% versus a forecast of a 1.2% increase. Separate data showed US inflation met expectation, coming in at a 0.1% rise in consumer prices for March. The inflation number boosted expectations that the US Federal Reserve will keep interest rates low for some time to come. The panel of economists responsible for officially deciding the length of recessions said Monday that it's "premature" to say when the recent downturn ended. The National Bureau of Economic Research said the panel met Thursday in the hopes of determining when the economy, which slipped into recession in December 2007, hit bottom. The committee said that many economic indicators are "quite preliminary" at this time and could be revised in the months ahead. The committee bases its decisions on "actual indicators" and not forecasts about economic growth, the job market and other measures." Although most indicators have turned up, the committee decided that the determination of the trough date ... would be premature," the group said in a brief statement. The U.S. government is increasing debt at a slower pace than last year according to Treasury Department figures released on Monday. In the first six months of the fiscal year, the U.S. government borrowed $717 billion, which included a $65.4 billion deficit in March. This means the deficit for fiscal 2010, which started in October, is down 8% from $781.4 billion in the same period last year.  Despite better numbers so far this year, the Treasury Department is still forecasting that the deficit will hit $1.56 trillion this year, up from the record $1.4 trillion losses posted last year. The US trade gap grew wider than expected in February, as greater domestic demand lifted imports of computers and other consumer products, official figures showed on Tuesday. The trade deficit grew by 7.4 per cent to $39.7bn after falling in January, according to the commerce department. Wall Street analysts had predicted that the gap would grow to $38.5bn. The US trade deficit has widened by nearly 50 per cent compared with a year ago, whilst trade volumes have picked up considerably as global demand has returned. In February, imports outstripped exports, rising 1.64 per cent to $179.8bn. Meanwhile, the US deficit with China, its biggest and most politically sensitive trade partner, fell to $16.5bn. This was the lowest level in nearly a year and comes as the two countries have been debating China’s exchange rate policy that the US is hoping will become more market based.

 

The Chinese economy expanded at an accelerated rate of 11.9 per cent in the first quarter, raising worries about overheating. This was the fastest rate in nearly three years and higher than economists had expected, putting more pressure on Beijing to consider more tightening measures, including allowing the exchange rate to increase. The numbers were announced a day after the government revealed that housing prices increased by 11.7 per cent over the last 12 months, the fastest rate since the figures were first published five years ago and prompting new concerns about a potential bubble in the property market. In the week authorities announced new measures to curb speculative buying by raising the minimum down payment for purchases of second homes from 40% to 50%. But despite rising fears of overheating, consumer price inflation dipped to 2.4 per cent last month, from 2.7 per cent in February. However, factory-gate inflation continued to accelerate, increasing from 5.4 per cent to 5.9 per cent in March. Lending by Chinese banks fell sharply in the first three months of the year as the government efforts to clamp down on new loans proved successful. Banks lent 2.6 trillion Yuan ($381bn; £247bn) between January and March, a 43% drop on the 4.6tn Yuan they lent a year earlier, the central bank said in the week. It has set a limit for lending for the whole of 2010 of 7.5tn Yuan, against the 9.6tn Yuan lent last year. China confirmed last week that its reserves have hit new high of $2.447 trillion (£1.59 trillion) at the end of March a 25pc increase on the same period last year and a rise from $2.399 trillion at the end of December. This gives them the world's largest level of reserves, which have risen sharply over recent years on the back of the countries large trade surplus. About $900bn of its reserves are held in US Treasury debt, although the country has turned less keen on them over recent months, indicating a willingness to diversify its investments and to reduce its reliance on the dollar.

 

One of the most visible threats to a double-dip recession is the ever-increasing price of oil and during the week the Organisation for Economic Co-operation and Development said it believed that oil markets were “overheated”. However, the International Energy Agency revised up its forecast for global oil demand this year, believing it will hit a record high and demand would reach an average 86.6 million barrels a day, up from 84.93 million in 2009.  The previous record high was 86.5 million a day in 2007, before the onset of the global financial crisis.  It is well documented that the Western economies are seeing a period of declining oil usage due to the economic slowdown in the west, whilst demand in Emerging markets, particularly China, continues to grow strongly. During the week the US military warned that surplus oil production capacity could disappear within two years and there could be serious shortages by 2015, with a significant economic and political impact.  This scenario was painted in a joint operating environment report from the US Joint Forces Command and whilst the US military says its views cannot be taken as US Government policy, it admits they are meant to provide the joint forces with “an intellectual foundation upon which we will construct the concept to guide out future force developments”. If this military view is correct, then the Iraqi invasion could turn out to have been a very astute move by the US!  This is the latest in a number of warnings that the world may be hitting peak oil, the moment when demand exceeds supply. Such an event would almost certainly catapult oil prices beyond the $147 a barrel figure reached in 2008, when oil prices last hit their peak. Crude for June delivery, the most active contract lost $2.08 to close at $84.67 a barrel in New York. Crude for May delivery, the front-month contract, settled $2.27 lower at $83.24 a barrel. The May contract lost 2%, while the June contract declined 1.2% in the week.

 

On Friday Gold futures for June delivery fell $23.40, or 2 percent, to $1,136.90 an ounce in New York. It was the biggest drop since Feb. 4 and the metal lost 2.2 percent in the week. A major worry was Paulson & Co., which is connected to the SEC lawsuit against Goldman Sachs but hasn't been charged. The hedge fund giant is one of the world's biggest investors in gold. If Paulson investors try to redeem from the firm's hedge funds, the firm might be forced to unwind some of its gold positions, pressuring gold prices and contributing to weakness in other commodities markets.

 

This week’s economic numbers will be highly significant in light of the imminent election and probably of greatest importance will be Friday’s GDP figures for the first quarter.  Whilst January’s bad weather had a depressing effect on exports and construction activity, stronger Government spending and industrial output should be enough to offset the negative effects. This period also saw an increase in VAT hit retail sales very badly in January.  Economist are predicting that the economy will have grown by between 0.3 per cent and 0.4 per cent in the first quarter and if this turns out to be the case, as I anticipate, then GDP will have posted its first annual growth since the third quarter of 2008, very useful for the Government in light of the election.  This would mean that GDP during the recession fell 5.2 per cent below the peak recorded in the first quarter of 2008. Wednesday’s unemployment numbers are expected to make better reading, although, like last month, this will largely be due to the fact that the number of people leaving the jobs market is on the increase rather than an increase in the employment number.  Thursday’s retail sales numbers are expected to be stronger, being helped by the earlier Easter.  Due to rising energy prices, inflation on Tuesday is expected to see CPI inflation pick up from February’s 3 per cent.  Public sector borrowing numbers on Thursday are likely to confirm that the overall budget deficit for 2009/10 was £166.5 billion, as forecast in the budget. A figure which would have been unimaginable few years ago when the Government was shouting about it's cast iron five golden rules, all of which have been swept away.

 

Whilst earnings are expected to draw the greatest market attention in the US, economic data this week will also be a factor, with leading indictors for March due for release on Monday, and data on existing and new home sales coming later in the week. Weekly jobless claims are likely to draw more than their usual attention, with analysts waiting to see whether recent rises were the result of data being disrupted by the Easter holiday. The FTSE 100 Index fell 81.05, or 1.4% on Friday to close at 5,743.96 its biggest decline since February. The Index fell 0.6 percent in the week, breaking six straight weeks of gains.

 

We have now had the first week of the US’ first quarter results season and on the whole figures have impressed investors, beating already high expectations.  Investors have taken these numbers to heart, continuing to push both our own and US markets up to year highs.  Investors are, however, I believe continuing to dismiss the ongoing Greek difficulties, where there remain question marks over the recently agreed bailout.  Constitutionally, the German bailout is being question in Court by four leading economic Professors who believe that not only is such action illegal under the German Constitution, but that ultimately the loan does not solve the Greek problem and is merely postponing the inevitable default that will occur.  They argue that the single currency is fundamentally flawed and that individual country tectonic plates are now tearing wide open the central flaws and this will ultimately lead to a significantly modified euro - if not it's demise.   In a very high profile report Morgan Stanley in the week suggested that rather than Greece or the weaker currencies leave the euro and establish a secondary currency region that Germany itself take the lead and withdraw, as ultimately its economic interests are very different to the other members of the euro zone. A number of Germans believe that these weaker members will only hinder further German prosperity and possibly even dragging Germany down with them.  The threat of default from Greece remains significant and during the week the EU warned Portugal that it might need to take additional steps to cut its budget deficit if economic conditions worsen.  The country’s current austerity programme aims to cut Portugal’s public deficit very slightly to 8.3 per cent in 2010 and the Government is aiming to return to below the European Unions Treaty threshold of 3 per cent by 2013.  Only two weeks ago, after a new budget was past, credit ratings agency Fitch downgraded Portugal’s credit rating from AA to AA- over concerns about its high debt levels.

 

The market’s current euphoria, I continue to believe, is misplaced and strongly rallying markets are acting as a magnet for trend followers who are getting sucked in and are fuelling further rises. This requires a trouble free recovery, as ratings get ever more stretched.  The greatest danger with stock markets is poor timing more than poor underlying investments and as history repeatedly warns   the time to buy is not when markets are rallying strongly.  The time to buy is when bargains are around and this is when sentiment is on the floor and the future looks very uncertain. A very old market adage is buy on cannon and sell on trumpet. This philosophy helped established some of the financial dynasts that we still know today.  Due to the global financial systems still being in intensive care and the fact that the global imbalances that started the credit crunch have increased, I believe that terrible markets will be with us again and probably in the not too distant future. My worry is that it may be much sooner than is on the time horizon of many investors who’s current blind optimism is inappropriate. I believe cautiousness should be the driving factor presently as you never know when a Goldman Sachs enquiry or another unexpected event may erupt. With so many potential issues to be addressed another volcanic economic eruption seems a certainty, irrespective of how our politicians would like us to see the immediate future – travel plans permitting!