Financial Update from www.Legalandfinancial100.co.uk

The US economy is increasingly showing signs of a sharp slowdown and this was most notable in the week when numbers for new home and existing home sales fell dramatically short of expectation.  I believe that the US housing market, which has rescued the US economy from seven of its last eight recessions, could well be the catalyst this time for pulling it back into the much feared double-dip, with grave consequences for the rest of the global economy.

 

In Europe, the underlying stresses in the system are continuing to exert pressure and in the week it was left to S&P, the credit rating agency to exert more pressure on them as it downgraded its credit rating for Ireland.  Its view on Ireland has worsened because it has increased its estimates for the cost of bailing out the Irish banks and in particular Anglo-Irish Bank.  S&P increased its estimate for recapitalising the banking system to as much as €50 billion from a previously estimated level of €35 billion. They now see the total cost of supporting the banking sector at €90 billion or 58 per cent of GDP and Irish Government debt to GDP ratio rising to 113 per cent of GDP in 2012.  The Irish Government was quick to denounce the analysis, but the fundamental situation remains that whilst the Government has undertaken harsh austerity measures, voluntarily and probably harsher than the IMF would have required, Ireland’s debt is growing far too fast because the fiscal deficit is too big.  The IMF predicts fiscal deficits of 11.1 per cent of GDP in 2011 and 8.6 per cent in 2012.  Unless this deficit is cut hard and fast, the country, investors fear, is heading for a Greek crisis.  Before the credit crisis, Ireland’s debt was only a quarter of GDP, but the collapse of the property market and subsequent bailout of the banks has radically altered this and, according to the International Monetary Fund, Ireland’s debt to GDP ratio will rise to 94.7 per cent of GDP in 2011 and will continue to rise slowly, until hitting 97.7 per cent of GDP in 2014.  The S&P’s projection that it will hit 113 per cent of GDP in 2012 is therefore a real concern.  These concerns were reflected in higher borrowing costs for Ireland, who is now paying around 5.5 per cent to borrow for ten years.  There is an irony in this in that Greece, who pushed its crisis to its limits, is able to borrow from the EU at 5 per cent and from the International Monetary Fund at significantly lower rates, within the terms of its €110 billion bailout.  The ludicrous situation is that for its contribution to the Greek bailout, Ireland is having to borrow the money at high, if not a penal rate, in order to lend it to Greece within the emergency package at significantly lower levels.  Moody’s in the week also added to the situation be saying that European government budget cuts in the aftermath of the credit crisis will weigh on economic growth and increased the risk of countries having their credit ratings cut.  Ireland’s rating is now the lowest since 1995, although it remains slightly better than Italy and three notches above Portugal.  It also remains seven notches higher than Greece’s ‘junk’ rating. At 113 per cent of Gross Domestic Product in 2012, Ireland’s debt will be 1.5 times the medium for the average of Euro zone sovereign nations and significantly above the similarly rated countries of Belgium and Spain, who will have debt to GDP ratios of 98 per cent and 65 per cent respectively.

 

In the UK the Monetary Policy Committee’s new member, Martin Weale in an interview in the Times said he was concerned that the Bank of England’s growth forecast of 2.8 per cent in 2011 and 3.2 per cent in 2012 could prove to be too optimistic and there was a “significant” risk of a slide back into recession.  I agree with his views.  With annual sales of nearly £14 billion and a spread of businesses across the whole economy, the Co-operative Group is often regarded as a bell weather company.  During the week Peter Marks, the Chief Executive, said he believes that the UK economy will not pick up until the end of 2011 at the earliest and believes that there are significant challenges ahead. The British Chambers of Commerce in its latest economic forecast believes that rated should be on put hold at 0.5 per cent until the second quarter of 2011 and the bank of England should consider pumping more money in to the UK economy to ensure a stable recovery. In its latest reports it forecasts GDP growth of 1.7 per cent in 2010, 2.2 per cent in 2011 and 1.8 per cent in 2012. Although higher than its predictions of 1.3 per cent in June, it warned the pace of recovery would slow sharply as the coalition government's tough deficit- reduction measures kick in. The BCC also forecasts unemployment will increase over the next 18 months, from 2.46million to 2.65million in the first half of 2012.

 

On a positive front, according to the CBI Distributive Trade Survey released in the week, high street sales were at their highest level since April 2007 last month, due to hot weather and heavy discounting.  The retail survey’s sales balance rose to +35 in August from +33 in July, with retailers expecting demand to remain strong in September.  In another positive sign, the CBI quarterly Business Optimism Balance surged to +22 in August from -5 in May. There was further evidence of the contracting nature of credit in the week when lending to British business, outside the financial sector, fell again in July, whilst the number of new loans to buy homes also declined.  The British Banker’s Association said that lending to private, non-financial companies, which form the bedrock of UK industry, fell by £2.4 billion in July a bigger drop than seen in June and larger than seen on average in each of the previous six months.  Mortgage approvals for new home purchases slipped to 33,698 in July from 34,575 in June, and was lower than the monthly average in every month bar February since house prices hit their trough in April 2009 and began reversing their losses.  The number of loans to buy homes in July was also below the average for the previous six months at 35,175.  Overall, net mortgage lending rose £2 billion slightly lower than in June and below the previous six months average of £2.3 billion.  Consumer credit in the month was also flat, with repayments on credit cards of £6.2 billion, outstripping new spending of £5.9 billion.  However, the effect of interest charges on unpaid balances led to a rise in overall credit card lending of £300 million. UK house prices rose modestly in July although the rate at which the housing market is recovering is slowing, official data show. According to the UK Land Registry, house prices in July rose by an average of 0.4 per cent, the fastest monthly rise since January 2010, but the year on year growth rate fell to 6.7 per cent from a peak of 8.7 per cent in May of this year. The UK economy expanded by an upwardly revised 1.2 per cent in the second quarter as the service and construction sectors gathered momentum.  Data on Friday from the National Statistics Office showed a 0.7 per cent quarter on quarter expansion in services sector activity and an 8.5 per cent increase in construction, the strongest since 1982, were key factors boosting output.  From the same period a year ago, the ONS estimates that the economy grew by 1.7 per cent in the April to June period, compared with the previously released estimate of 1.6 per cent.  These are impressive numbers, although we are more concerned about the growth rate going forward and this is likely to weaken significantly due to the challenges ahead.  The June budget detailed a combined £113 billion of spending cuts and tax increases by 2015, which will weigh very heavily on private demand going forward.  The data also showed a slowing contribution to growth from the public sector, with Government spending increasing 0.2 per cent (or 0.3 per cent) on the quarter, compared with a 1.5 per cent gain in the first quarter.

 

Deputy Prime Minister Nick Clegg has defended the coalition government's Budget after a report by the Institute of Fiscal Studies said that the Budget hit poorest families the hardest, The IFS calls the Budget "regressive" and challenged the government's claim that the Budget was "progressive". Its analysis suggests that low-income families with children are set to lose the most - about 5% of net income - due to benefit cuts announced in the Budget. Bank of England Deputy Governor Charles Bean said at the weekend that more monetary stimulus may be required to sustain the recovery as the aftermath of the recession continues to hamper the economy. In a speech that overturned the orthodoxy that has determined policy for the last 20 years, Bank of England deputy governor Charles Bean said interest-rate increases caused widespread "collateral damage" and that direct intervention to curb "exuberant" bank lending would prove to be more effective. “The deleveraging process is incomplete, the recovery remains fragile and a considerable margin of spare capacity is yet to be worked off,” he added and said that “Further policy action may yet be necessary to keep the recovery on track,” and that is code for more QE I believe. Whilst the financial crisis appears to have strengthened the case for adopting “leaning-against-the-wind” strategies during economic booms, a “sufficiently aggressive” policy to restrain asset prices may lead to too-great collateral damage, he suggested. He also said central banks should not raise inflation targets to increase the flexibility of interest-rate settings as this would increase volatility in consumer prices. However, I believe in due course these inflation targets will be comprehensively changed.

 

Ahead of the summit at Jackson Hole, where global central bankers met to discuss the macroeconomic challenges facing the world and how to address concerns about a sluggish recovery, James Bullard, president of the St. Louis Federal Reserve told CNBC on Friday that”I don’t think there’s any question the economy is softer than what we expected as recently as 90 days ago, and we’re all concerned about that.” Earlier in the week, the Congressional Budget Office had said that its $814bn stimulus programme boosted the US economy by as much as 4.5 per cent in the second quarter of this year and kept the unemployment rate below 10 per cent. In early August, the Fed reversed expected strategy in a move that stopped it shrinking its balance sheet.  New, US home sales fell by 32.4 per cent in July year-on-year to a new record and adjusted low annual rate of 276,000. Median house prices also fell, declining by 4.8 per cent to $204,000 in July. New home sales fell 12.4 per cent between June and July, missing projections that they would be flat during the month, or even slightly higher. The 27pc collapse in existing homes sales, nearly twice as much as analysts had expected, to an annual rate of 3.83 million in July (Economists had expected existing home sales to fall by 14.3% to an annual rate of 4.6 million) leaves little doubt that America's property market is contracting fast and cannot stand on its own without the homebuyer tax credits that recently expired.  The tax credits offered certain buyers up to $8,000 to sign a contract by April 30. Deals originally needed to close by June 30, but lawmakers pushed that deadline to Sept. 30. The overhang of unsold homes has jumped from 8.9 months' supply to 12.5, higher than at any point during the Great Recession. Over 20pc of mortgage holders are already in negative equity and home default notices hit 325,000 in July. In another worrying sign for the US economy, the number of people falling behind on their mortgages for the first time is on the rise. The increase in short-term delinquencies is possibly indicating that a new round of foreclosures is on the horizon, even as the overall situation looks to be improving. Around 3.5% of borrowers were 30 days late in their loan payments in the second quarter, up from 3.31% at the end of last year, according to new data from the Mortgage Bankers Association. The change is a reverse from the steady decline in short-term delinquencies during 2009 and rising unemployment is being blamed. Economists are predicting the U.S. economy will shed 120,000 jobs in August, another increase. The nation's overall delinquency rate dropped to 9.85% in the second quarter, down from 10.06% of all loans outstanding three months and the percentage of seriously delinquent loans  ones 90+ days late or already repossessed by lenders dropped to 9.11% from 9.54% in the first quarter. The Richmond Fed's manufacturing index in the week plunged in August with shipments dropping to 7 from 40 two months earlier, and the backlog of orders dropping to -1 from 22..Orders for durable goods rose by 0.3 per cent to $193bn from June to July, missing Meanwhile, US demand for long-lasting goods such as machinery, computers and electronics was surprisingly weak last month. This suggests that business investment, which helped to return the country to growth, could have slowed and become a drag on the economy. Expectations were for a 3 per cent increase. The disappointment was compounded by the fact that “core” orders, which exclude volatile bookings for transportation equipment, fell by 3.8 per cent, reflecting more widespread and underlying fragility. The U.S. economy grew more sluggish than initially estimated in the second quarter and corporate profits nearly dried up, confirming that the recovery is losing steam. Gross domestic product, the value of all goods and services produced, rose at an annualised seasonally adjusted rate of 1.6% in April to June, the Commerce Department said on Friday. In its first report of the economy's benchmark indicator a month ago, the growth rate was estimated to have slowed to 2.4% after a 3.7% expansion in the first quarter. The revised estimate for the second quarter was above expectations for a 1.3% gain among economists.  Separately, the Reuters/University of Michigan index of consumer sentiment for August was unchanged from a preliminary reading earlier this month and edged up to 68.9 from 67.8 in July. The figure bounced off the eight-month low hit in July but just missed economists' forecasts. Also on Friday Intel issued a revenue warning, saying that its third-quarter sales will fall below the company's previous expectations, due to a cooling computer market.

 

At the annual meeting of central bankers in Jackson Hole, Federal Reserve Chairman Ben S. Bernanke said the central bank has the tools to prevent the U.S. economy from slipping back into a recession, whilst stopping short of indicating an immediate need for more stimulus and presented a scenario for continued expansion as households rebuild their savings, banks increase lending and companies become more willing to hire. He stated that “Should further action prove necessary, policy options are available.” and provided his most detailed analysis yet of three tools: further purchases of securities, a change in the Fed’s policy statement and a reduction of the interest rate it pays on banks’ excess reserves. The Federal Open Market Committee “has not agreed on specific criteria or triggers for further action, but I can make two general observations,” Bernanke said. “First, the FOMC will strongly resist deviations from price stability in the downward direction.” and “Second, regardless of the risks of deflation, the FOMC will do all that it can to ensure continuation of the economic recovery,” he added.

 

A call for an early election in Italy drew closer in the week as Gianfranco Fini, speaker of the lower house and former ally of Silvio Berlusconi, prime minister, gave only conditional support to a legislative agenda that will form the basis of a vote of confidence in the government. Mr Fini and his break away faction said it agreed with 95 per cent of the document approved by Mr Berlusconi and his senior party officials, but declared negotiation was needed over some legislation, particularly judicial matters. The decisive vote is expected on September 6, when a draft for the reform of trials will be presented in the justice commission of the lower chamber. The law would limit the length of trials to a total of six-and-a-half years, after which the proceedings would be annulled. This would eliminate three ongoing corruption proceedings against Mr Berlusconi and was passed by the Senate in January. In the lower house, the ruling coalition will not reach its needed majority threshold of 320 MPs without the vote of Mr Fini’s supporters. Mr Fini has said in the past that he does not support the law. Italy has held two general elections in the past four years and it would be a poor signal of the country’s return to political instability if yet another election were held now

 

The extreme heat wave which caused a severe drought and wildfires in Russia has left officials and consumers are now busy calculating its cost and trying to work out its consequences. The Russian deputy economy minister Andrei Klepach said in the week that the drought would take up to 0.8% off this year's economic growth "or maybe even more than that.” The 0.8% is smaller than the 1.0-1.5% range some experts have come up with recently. The Russian government decided to ban grain export from 15 August and this has seen global prices shoot up. Mr Klepach thinks that the August inflation rate will be about 0.5% "at best". While for 2010, it will definitely exceed the earlier forecast of 6-7%, it will be lower than the previous year's level of 8.8%, he suggests.

 

Germany's government has approved a draft law imposing a levy on banks to cover the costs of any future financial crisis and hopes the bill will gain parliamentary approval before being passed into law in the New Year. The levy is expected to raise about 1bn Euros a year. The UK and France have already committed to introducing bank levies, but so far, there has been no agreement on a global tax and the leaders of Europe's three biggest economies have stated that taxpayers should not be expected to foot the bill for any future financial crises. The business climate in Germany’s industry and trade sectors has reached a three-year high following the latest rise in optimism about their current business situation, according to figures released by German research institute Ifo. The latest Ifo Business Climate survey shows that the mood among industry and trade firms improved slightly in August to reach a level not seen since pre-recession period in June 2007. However, their business expectations for the coming half year are slightly less optimistic than in July. An index of executive and consumer sentiment in the 16 euro nations rose to 101.8 from a revised 101.1 in July, the European Commission announced, it's highest since March 2008 and better than forecast at 101.6, after surging exports helped the economy expand at the fastest pace in four years in the second quarter.

 

Postponing cuts in public and private sector debts would be “very dangerous” and risks a Japanese-style “lost decade”, Jean-Claude Trichet, European Central Bank president, warned on Friday at Jackson Hole. He stated that dealing with economic imbalances was not simply a duty to be completed after an economic recovery but “an important precondition for sustaining a durable recovery”, a view a totally endorse. He also added that there is a very clear example of the consequences of choosing to live with excess debt and this is Japan in the 1990s. The speech focused on rising ECB concerns that high levels of Government; household or corporate debt could stifle the global recovery. In recent months, Mr Trichet has argued for tightening fiscal policies rather than providing more stimulus and his comments are the opposite of the actions being encouraged by US policymakers and economists. Mr Trichet argues that In Japan, banks contributed to economic weakness by rolling over the debts of inefficient firms with both operating in a zombie state for a decade. He summed this up by saying, “As long as it is unclear when the adjustment will occur and who will bear what fraction of the costs of adjustment, firms and households may delay their investment and consumption decisions, slowing down the economic recovery.” The U.S. has a “realistic possibility” of falling into a Japanese-style economic slump, says David Wyss, chief economist at Standard & Poor’s. U.S. consumer prices, excluding food and energy, increased less than 1 percent for a fourth month in July. Japan’s so-called core inflation rate has remained mostly negative since September 1998.

 

Bank of Japan Governor Masaaki Shirakawa returned a day early from the U.S., where he was attending the Jackson Hole meeting, in order to attend an emergency central bank meeting. After the meeting the Bank of Japan added 10 trillion yen ($118 billion) in liquidity injections in an attempt to pull down the yen which has hit a 15-year high threatened economic growth. The Bank of Japan boosted the facility to a total of 30 trillion, the bank said in a statement after an emergency meeting in Tokyo.  Japan’s Nikkei 225 stock index plunged below the 9,000-point level on Thursday as traders responded to a fresh surge in the yen and increasingly confusing rhetoric from the Prime Minister and central bank. This is as Japan's core consumer prices index fell for the 17th month in a row in July, underlining the country's severe problems with deflation. The index, which excludes fresh food, fell 1.1% from July last year, slightly bigger than the 1% drop in June. Deflation is adding to economic worries in Japan, where the strong yen is making exports more expensive. On Friday, Finance Minister Yoshihiko Noda told reporters that the yen's strength was having "various impacts" on the economy and that the situation was "serious". On a positive note the unemployment rate improved to 5.2 percent from 5.3 percent in June, marking the first decline since January.

 

After a week of more relatively little economic news flow, next week there are a number of releases which will show the direction of UK house prices and consumer credit.  The Nationwide Building Society’s House Price Index on Tuesday is expected to confirm the slowing trend in the housing market, with prices expected to have fallen by 0.3 per cent in August, a slightly smaller decline than July’s 0.5 per cent.  This will show that house prices are rising at an annual level of 4.9 per cent, down from 6.6 per cent last month.  Also on Tuesday, the GFK Consumer Confidence Survey and figures for net consumer credit are expected to show a fragile situation, with a fall of £100 million in net credit lent to individuals in the month.  On Wednesday, Thursday and Friday, the Purchasing Manufacturers Indices for Manufacturing, Construction and Services are consecutively released.  These are expected to show expansion in August, although these will be seasonally adjusted figures. Rates are expected to remain on hold on Thursday. In the US on Tuesday, The Conference Board releases its Consumer Confidence index for August. The forecast is that the index will have moved down to 50 in August from 50.4 in July.  The Chicago PMI, a regional reading on manufacturing activity, is expected to have fallen to 57.5 in August from 62.3 in July. Also on the same day The Case-Shiller 20-city home price index is expected to have risen 3.5% in June after rising 4.6% in May. The Institute for Supply Management's index of manufacturing is due on Wednesday and is forecast to have eased to 53 in August from 55.5 in July. Any number above 50 indicates growth in the sector. The government is also expected to report that construction spending fell 0.7% in July, after slipping 0.1% in June. On Thursday, the government is expected to report that pending home sales were unchanged in July after dropping 2.6% in June and Factory orders are forecast to have risen 0.3% in July after falling 1.2% in June. The most important day is Friday with the Government's widely anticipated monthly jobs report. It is forecast to show the U.S. economy lost 118,000 jobs in August after falling by 131,000 in July. The unemployment rate is expected to tick up to 9.6% from 9.5%. The ISM services index is also due and is expected to have slipped to 53.2 in August from 54.3 in July.

 

The European Central Bank is expected this week to extend emergency support for Euro zone banks until early next year as it tries to gauges how the 16-country region might withstand a big US or global slowdown. Jean-Claude Trichet, president, is expected on Thursday to announce that at least until the start of 2011 banks’ demands for weekly, monthly and three month liquidity will continue to be met in full. Thus its policy of unlimited liquidity provision, which the ECB sees as its equivalent of “quantitative easing”, which was launched after the collapse of Lehman Brothers in late 2008, will be extended into a third year. Rates are also expected to remain on hold.

 

On Friday After reaching an intraday high of US$1,242/oz, gold retreated to US$1,238/oz after starting the week at just below US$1,230/oz. Oil for October delivery added $1.81, or 2.5%, to $75.17 a barrel on the New York Mercantile Exchange. On the week, oil gained 1.8% and comes after two weeks of losses. In the coming weeks I expect prices to further weaken in light of a stuttering global economy, although I believe a floor of $68 will prevail. A dip to this level will ore sent a good long term buying opportunity as ultimately we will be looking at least $100 a barrel within the medium term.

 

Continuing deflation in Japan, coupled with a rapidly cooling US economy, means that global growth forecasts look excessive and I do not believe that this has been fully calibrated into investor expectations, although the Dow index closed on Thursday night below the psychologically important 10,000 level.  There are signs of slowing global economic growth starting to pull back the more economically sensitive parts of the market, like the mining stocks and whilst we have seen a pick up in the short term of corporate activity, investors should not be lulled into the belief that this will underpin a market where the world’s largest economy looks increasingly poorly and the unthinkable of it re-entering recession is coming an increasing reality for many. Leading equity strategist at SocGen and perm bear Albert Edwards, in the week issued a note suggesting that there was too much hope amongst investors with excessive valuations in the US.  He believes that this will come to an end in the coming months as, increasingly, economic data points to a double-dip recession in the US.  He warns: 'Equity investors are in for a rude shock. The global economy is sliding back into recession and they are still not even aware that these events will trigger another leg down in valuations, the third major bear market since the equity valuation bubble burst.' He also highlights the fact that bond markets in Europe and the US are predicting a very sharp economic slowdown, if not depression in the US and equity markets have not yet been as realistic

 

Leeds Solicitors and Leeds Financial