Market Watch from www.legalandfinancial100.co.uk

As I thought, the UK election provided no clear winner and the prospect of either a minority government or hung parliament being successfully able to implement what are expected to be some harsh austerity measures look very slim.  This leads me to assume that, come the autumn, we will have another general election.  Markets, however, as the Europeans have found in the past few months, operate at a much faster speed than politicians and should the rating agencies decide that the UK is being too slow in addressing its weak financial position then the UK could lose its AAA rated credit status, making it much more expensive for the country to borrow on international markets  and whilst I do not expect bond markets to close to a UK government, as they have in Greece, there is a growing worry that such action may be about to occur in Portugal and, to a lesser extent, in Spain and in Italy.  If this were to occur it would be very bad news.  As we have seen during the course of the week, contagion from Greece is spreading and my concern remains that if investors start to panic then there is a likelihood that their imaginations will run away with them, further exacerbating the situation. 

 

The DOW fell by 10 per cent on Thursday night, before bouncing back to closing on 3.5% down, and numerous other markets moved at similar speed downwards. This shows just how nervous global investors remain generally. At 2:30 on Thursday the Dow, was down about 200 points and quickly dropped another 200 points in the next 15 minutes. At around 2:45, trades in a number of stocks listed on the New York Stock Exchange were slowed for about a minute due to excessive volatility. During this short time however these stocks were trading normally on electronic markets like the NASDAQ. It appears to have started when P&G on the NYSE fell 10% at around 2:45 p.m. at which point the stock hit what's known as a "circuit breaker." What then appears to have happened is that the circuit breaker mechanism that are designed to cool things had the opposite effect as it happened just as investors were growing increasingly worried about Greece. Around the same time other stocks began to trade at strange prices and then nearly every stock on the market began to see a sharp sell off and liquidity dried up. The Dow Jones industrial average, which had been down about 400 points just before 2:45 p.m., plunged nearly 1,000 points in a matter of minutes as panic struck the trading computers. Accenture fell from $40.13 at 2:45 pm to 1 cent before quickly rising back to $39.57. NASDAQ has said it will cancel all trades that were executed between 2 p.m. and 3 p.m., in which the stock price traded more than 60% off of the stock's price at 2:40 p.m. Whoever takes the reigns of government, they must immediately confirm their plans to address our budget deficit, because if they don’t then the matter could well be taken out of their hands and that is the last thing that a UK economy with a weak government needs.

The credit rating agencies will be pivotal to our short term and their actions over the past few weeks have seen them pile significant pressure on the weaker European nations.  Although S&P says that U.K. government debt will rise to 77 percent of GDP this year and may approach 100 percent by 2014 together with the fact that it cut its outlook on the investment grade from stable in May 2009 on concern that public debt may rise to a level incompatible with a AAA it and Moody’s said on Friday that the U.K.’s top AAA credit rating isn’t at risk from an election result that failed to produce a clear winner. “The complexion of the new government is not, in itself, a rating factor for us,” S&P said  “Instead, our focus  is on whether the government’s fiscal consolidation plan to be  unveiled in due course is likely or not, in our view, to put the U.K. Government debt burden on a secure downward trajectory over the medium term.” It did however confirm its negative outlook on the rating, indicating it is more inclined to lower the grade than raise it. A decision on the rating will be made by the end of the year following an assessment of the government’s medium-term fiscal plans, the statement said. Moody’s confirmed its stable outlook. “Moody’s stance assumes that the incoming economic team can muster convincing parliamentary support for a fiscal adjustment that is no looser nor slower than was outlined by all three political parties during their respective pre-election campaigns,” In an ever increasingly nervous and trigger happy global bond markets, I believe that markets are already and will continue to price in lower ratings and Bill Gross comments on Spanish debt eloquently makes this point clear to all.  After all both Enron and many investment banks that failed so recently  ailed investment banks did so with the highest of credit ratings! When we talk about bond markets we are in effect talking about those with credit that are prepared to lend to those in need.  Bond markets forced former US President Bill Clinton to balance the US budget deficit in the 1990s following a huge sell off in US Treasuries.  At that time James Carville, one of his top advisors, famously said “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as 400 baseball hitter.  But now I would like to come back as the bond market.  You can intimidate everybody”.  Credit agencies have come under significant criticism for their involvement in the US subprime market and there are clearly conflicts of interest which would appear to have seen the rating agencies put monetary gain ahead of due diligence.  In the week former US Treasury Secretary, Henry Paulson, said they were “a dangerous crutch” that too many investors and banks depended on before the global financial crisis.  Legislation being debated in Congress to overhaul US financial regulation would require greater disclosure about how much money rating firms receive from Wall Street, forcing regulators to reduce their reliance on credit rating companies and make it easier for investors to sue the firms, but a complete overall of the system looks unlikely. During the week Bill Gross of Pimco slammed the rating agencies, blasting their “timidity and lack of commonsense”.  His comments followed Standard & Poor’s downgrade of Spain which was moved down from AA+ to AA, with the threat of a further downgrade if Spain’s government did not act soon to stabilise its finances.  “Oooh so tough and believe it or not Moody’s and Fitch still have them as AAAs” he said.  “Here’s a country with 20 per cent unemployment, a recent current account deficit of 10 per cent that has defaulted 13 times in the past two centuries, whose bonds are already trading at Baa levels whose fate is increasingly dependent on the kindness of the EU and IMF to bail them out.  Some AAA!”. Talking about the agencies he added “They have brazenly sold their reputations for unbiased judgement to the very companies they were standing in judgement upon.  Don’t bury them however, like vampires in the dead of night, they will outlast us all”. 

 

In assessment of the crisis gripping Greece and the Euro zone, Moody’s in the week warned that banks in the UK and Ireland, as well as Portugal, Spain and Italy all faced challenges if their countries suffered the same fate as Greece in being downgraded by the credit rating agencies.  Whilst Portugal is at the forefront of investor concern about the level of its debt, the UK was in greatest danger of sovereign contagion from exposure to Greek banks Moody’s thought.  The UK’s fiscal deficit is not too far short of Greece’s, 13.6 per cent of GDP, and bigger than that of Portugal and Spain, both of whom have just seen their credit rating downgraded.  The risks for the UK finances are significant and our politicians will be clearly aware of this and it is hoped that Westminster points scoring does not detract from the much more important bigger picture.  The election run up has been a triumph of duming down, whilst elevating minority matters.   This has been coupled with political brow beating over unavoidable economic truths and, as we know from our history, economics always ultimately win. During the week Chief Executive of clothing retailer Next, Simon Wolfson, who is also a Tory Party donor, warned that unless the incoming government took urgent action to tackle the hole in the UK’s public finances, the country could face the same economic woes as struggling members of the Euro zone within three years. 

 

The European Commission warned ahead of the UK general election that whoever wins the general election they must make sorting out the public finances its top priority.  The Commission Spring economic forecast put the UK’s deficit for the calendar year at 11.5 per cent of GDP, the highest of all the 27 nations and worse than the Treasury’s own forecasts.  The country’s budget shortfall was the third largest in Europe last year, but will overtake both Greece and Ireland this year, according to its forecasts.  Europe’s measures to tackle its public finance problems are predicted to cut its deficit to 9.3 per cent of GDP this year.  In financial terms the Commission’s forecasts are for a worse deficit than predicted by Alistair Darling in his March budget.  In 2010/11 the Commission put the deficit at 11.5 per cent of GDP compared with Alistair Darling’s forecast of 11.1 per cent, the ratio of public sector net borrowings, the gap between tax and spending to GDP.  The EU did, however, double its forecast for British growth this year to 1.2 per cent from 0.6 per cent in line with the March budget forecast of 1 per cent to 1.5 per cent.  But, in 2001, it warns that growth will only pick up to 2.1 per cent, slightly below a Treasury forecast of 3 per cent to 3.5 per cent.

 

According to the Markit/CIPS services survey of purchasing managers, the uncertainty of the general election, coupled with the volcanic ash cloud, held back growth in Britain’s service sector last month, with its headline activity reading recording 55.3 in April, down slightly from 56.5 in March.  Whilst it was still in positive territory, it was short of the 57 forecast by investors.  Britain’s manufacturing sector expanded at its fastest pace for more than 15 years in April according to a UK manufacturing survey from Purchasing Managers Institute, the PMI and Markit.  Their survey showed a headline reading of 58 in April, whilst March’s reading was revised up to 57.3.  The new order element of the survey was also very encouraging. 

 According to the British Retail Consortium, food inflation rose to 2 per cent after dropping to 1.2 per cent in March, which was the lowest level in the history of the index.  The BRC said rising commodity prices, such as oil and cocoa had particularly put pressure on food prices.  Non-food prices also saw a significant rise from 1.3 per cent in March to 2 per cent last month, marking their highest level since the survey began in 2006.  Bank of England numbers, showed mortgage lending slowed sharply in March compared to the previous month in a sign that the housing recovery is running out of steam.  Net lending secured on dwellings rose by just £300 million in March compared to February, a steep decline compared to the £1.8 billion rise in February.  The number of house purchase approvals increased slightly to 48,901 in March from a nine month low of 46,882 in February.  On Friday the Halifax said that House prices unexpectedly fell in April as the number of unsold properties rose to its highest level in a year. The average cost of a home in Britain fell by 0.1 per cent to £168,202, according to them Analysts had predicted a rise of 0.5 per cent, for an annual increase of 7.1 per cent but they were 6.6 per cent higher than they were a year ago. Halifax also said that prices were likely to remain flat throughout the remainder of the year my view is that they will return to falling. The price of goods leaving British factory gates rose by a greater-than-forecast 5.7 per cent in the year to April, adding to concerns about price pressures and the fear that UK rates may increase before the year end. This was as the numbers hit their highest annual rate for 18 months. The 5.7 per cent rise for the year to April followed a rise of 5 per cent in the year to March, representing the highest annual rate since October 2008 when the index rose by 6.7 per cent. Figures from the Insolvency Service in the week showed that the number of people in England and Wales entering into insolvency rose to a new high in the first three months of the year. In 2009, 134,142 individuals entered into insolvency and in the first quarter of this year a total of 35,682 people became insolvent equal to 566 people a day. Individual insolvencies were up 17.9% on the same quarter last year, and as expected. the number of bankruptcies rose by 7% over the quarter but fell by 10.7% year-on-year to 18,256, while the number of individual voluntary arrangements increased by 20.1% over the year to 11,782. On the corporate front total company liquidations fell by 4% compared with the previous quarter to 4,196.

 

European markets were rattled on Thursday after the European bank held European interest rates at 1 per cent and ECB President, Jean-Claude Trichet, said that the prospect of a default within the Euro zone “is for me out of the question”.  Trichet said that the European Central Bank did not discuss the option of purchasing Euro zone government bonds in the secondary market, which many in the market had been anticipating, or what is otherwise known as quantitative easing.  Whilst this would have been a huge step for the European Central Bank, an increasing number of commentators believe that this is the only option available to it, if it is to restore any calm to increasingly jiggery bond markets as contagion is spreading rapidly. Italy which is one of the troubled European countries confirmed in the week that it is cutting its economic growth forecast for this year, citing slower recovery in exports than it had originally thought.  Gross Domestic Product will rise 1 per cent in 2010 and 1.5 per cent in 2011, down respectively from 1.1 per cent and 2 per cent predicted in January.  The government raised its debt forecast to 118.4 per cent of GDP this and 118.7 per cent next year, from a previously predicted 116.9 per cent and 116.5 per cent respectively.  This month the European Commission forecast Italian debt of 118.2 per cent of GDP this year and 118.9 per cent in 2011.  On Friday the European Union dropped new regulations that could have led to the closure of Drax and other heavily polluting coal-fired power stations within six years. The decision follows a vote on the industrial emissions directive in the European parliament's committee on environment, public health and food safety in Brussels.  It has to be endorsed by the parliament in July but is unlikely to be rejected. The sector had been facing tougher emissions targets and has been given an extra three years' grace period to 2019 after Britain argued it faced an "energy crunch" before large-scale wind farms and nuclear stations came on stream closer to 2020.

 

During the week more fuel was added to market worries over Greece when Lazard confirmed that it had been hired to advise the Greek Government. The bank has been prominent in advising emerging market nations, such as Argentina, with debt restructuring. Even though the ECB and the European Commission have denied that a restructuring is being considered, bond market analysts have suggested that investors holding Greek debt will suffer a “haircut” — a managed default under which they will get less than full repayment. Spain’s economy emerged from an almost two-year recession in the first quarter, trailing the euro area by six months. GDP grew 0.1 percent in the first three months of 2010; the Madrid- based Bank of Spain estimated in its monthly report. GDP contracted 1.3 percent from a year earlier.  Standard & Poor’s cut Spain’s credit rating on April 28, saying the government was underestimating its fiscal problems and overestimating growth prospects. The government is basing its budget plan on an assumption that the economy will grow 1.8 percent next year, accelerating to 3.1 percent in 2013. At 11.2 percent of GDP, Spain’s budget shortfall was the third- biggest in the euro area last year and the European Commission projects the gap will be larger than Greece’s in 2010. The National Statistics Institute publishes its first estimate of first-quarter GDP on May 12.

 

U.S. regulators closed four banks holding less than $740 million in total assets as this year’s failures climbed to 68. Lenders in Arizona, California, Minnesota and Florida were closed by regulators and the Federal Deposit Insurance Corp. The failures cost the FDIC’s deposit insurance fund $213.7 million. FDIC Chairman Sheila Bair has said she expects failures to slow but still exceed last year’s total of 140. Pending home sales rose 5.3% in March after climbing 8.3% in February and economists had expected sales to increase 5%. Factory orders were 1.3% higher in April after rising 1.3% in March, the Commerce Department said. Economists thought orders would fall 0.2%. The U.S. economy in April added jobs at the fastest pace in four years, but the unemployment rate unexpectedly rose, indicating the labour market may still need a long period to heal. In its closely-watched employment report on Friday, the Labour Department said nonfarm payrolls rose by a higher than expected 290,000 last months the largest gain since March 2006. That followed an upwardly revised 230,000 increase in March were expecting payrolls to rise by 180,000. The March figure was originally reported as a 162,000 increase. Taking into account revisions to prior months, the U.S. economy added an average of 143,000 jobs a month in the first four months of the year, which may fuel optimism about the job market's recovery. The unemployment rate increased to 9.9% last month. Economists were expecting it to remain at March's 9.7% level. The U.S. economy has lost nearly 8.5 million jobs over the past two years, more than half of today's total unemployed.

 

Royal Dutch Shell Chief Executive Officer Peter Voser said on Friday that he sees global demand for energy doubling by 2050, amid a curbing of traditional fossil resources. His views mirror mine and that is why in the coming weakness exposure should be sought to this area. Crude-oil futures settled lower Friday, losing 13% in a week as Investors worried that Europe's debt problems will derail the global recovery. Crude for June delivery the most active contract lost $2, or 2.6%, to close at $75.11 in New York the lowest level since mid-February.

 

Gold closed at $1,208.50 on Friday, dipping slightly at the end as investors cashed in some gains after the previous session’s five-month high, but with underlying safe-haven demand still firmly underpinning prices. For UK investors Gold hit a record high in sterling as the prospect of a hung parliament pushed the pound lower against the dollar. On Friday it had risen to a high of $1,210.35 an ounce, the metal hit an all-time high of $1,226.10 an ounce in December’s 

 

Having delayed its first meeting, the Bank of England meets on Monday and UK interest rates are expected to remain a hold at 0.5 per cent.  All eyes, however, will be on Wednesday’s inflationary report, where it is expected that the Bank of England will report that inflation is likely to be a little higher in the shorter term than it had earlier thought.  On the same day employment numbers are expected to show over 2.5 million people, or 8 per cent of the workforce, unemployed.  A wider measure, which includes part-time workers who would like a full time job and economically inactive people who would like some work, is likely to be over 5.5 million.  On Tuesday the British Retail Consortium is likely to say that retail sales growth fell sharply in April.  This will be partly due to the timing of Easter, although the underlying fundamentals appear to be deteriorating.  Also on Tuesday, official industrial production figures should point to a slow recovery, with output rising by around 0.3 per cent in the past 12 months. Thursday’s trade figures are likely to show a deficit in March of £6.5 billion, only slightly better than previous numbers.  What is worrying is that sterling’s sharp decline has not closed this gap more fully.  On Wednesday the National Institute of Economic and Social Research gives its estimate of GDP growth.  The numbers are expected to say that GDP grew by around 0.5 per cent in the three months to April, compared to the previous three months.

 

The last time there was a hung Parliament, Britain was sinking in debt and the global economy was in trouble not unlike now. Harold Wilson's Lab-Lib pact started on March 4 and fell apart for a second election on October 10, when Wilson got in with a majority of three. The elections were between two disappearing acts Lord Lucan's and that of John Stonehouse, the former government minister who pitched up in Australia after faking his own death. Two years later Britain was being bailed out by the IMF.

 

The last week has been one of major significance and the fact that the Greece situation has not been contained is increasing the likelihood of a collapse in the current Euro zone structure, which I believe ultimately, will happen.  The political leadership vacuum from Germany ultimately dragged the Greece situation out over six months of contradictory and half-hearted proclamations of European solidarity.  My fear remains that this very same scenario may be played out in the UK over the next six months and this will almost certainly lead to difficult times, irrespective of the scope of the cuts which will now be unveiled.  These cuts were, of course, masqueraded as efficiency gains during the election campaign.  A coalition government would create distractions from repairing the public finances and a fragile alliance is unlikely to hold.  As soon as one side sees its chance, a fresh election will be triggered. We are in an era of accelerating change, moving toward a future that will be profoundly different from the past thirteen years. Every crisis creates opportunity as the indiscriminate selling of shares occurs as Investors look to raise cash (often to pay back borrowings) and this throws up valuation anomalies which I will be utilizing for my clients, but not yet as the Euro deal over the weekend does not solve the issues it only creates liquidity whilst solvency is the issues. My concern is that the change of mood in the investment world moves into the real world where companies make and sell products and services. If it does my forecasted double dip will be firmly with us and this time the public purses will be bare.  The debt problems that caused the most serious financial meltdown of the post-war era have not actually been solved.

Leeds Financial

Leeds Solicitors