Monday, 31 October 2011

Mike Lenhoff: Market tactics 31 October 2011

Can equity markets retain their gains?  

Not only is this a busy week for economic data but, with much of it for the US and coming from market sensitive ISM surveys and Non-farm payrolls, it is one that will focus attention on how the US economy is stacking up for the final quarter of the year.

Although the FOMC and the ECB also meet this week no new policy initiatives are likely and nor is any change in the overall messages. However, the Fed has been expecting a better second half to this year than first half, something to which last week’s third quarter GDP data has already given support. A good start to the final quarter of the year with this week’s numbers could add a bit more conviction to the view that the economy is regaining momentum and that the risk of a US recession is diminishing.

Elsewhere, the call by the Presidents of the European Council and European Commission for a ‘renewed collective spirit of common responsibility and purpose’ at the G20 meeting later this week is likely to chime with David Cameron, who intends to set out his own thoughts on how best to push for a more balanced world economy.  More >

Thursday, 27 October 2011

Mike Lenhoff: Market tactics 27 October 2011

Better to travel than arrive but hopefully there’s more travelling.

While the detail of what was agreed early this morning by eurozone leaders has yet to be worked out, the markets’ initial response is correct. Eurozone leaders have demonstrated a sense of unity and determination in delivering on what is needed to tackle the issue of debt sustainability and to help stabilize the financial system. Hopefully the spread in the chart, denoting stress in funding markets, will narrow and the CDS premium, denoting counterparty/default risk for banks, will fall, though the action might come in fits and starts.   

Agreement has been reached on the following:

·    A private sector ‘voluntary’ haircut of 50 percent on Greek bonds so as to reduce Greece’s debt burden to 120 percent of GDP by 2020. The agreement has the backing of the Institute for International Finance, which represents the international banking community. With this, the intention is also to put in place by the end of this year a second financial package for Greece totalling 130 billion euros (as against the 109 billion euros agreed back in July).  

·     A requirement by the European Banking Authority for banks in the EU to hold core Tier 1 capital (‘of the highest quality’) of at least 9 percent of risk assets with a time line for implementation by June of next year.

·    A boost, through leveraging, of the European Financial Stability Facility by offering insurance or first loss guarantees – something that has been discussed for a while – and/or by introducing a Special Purpose Investment Vehicle (SPIV) aimed at attracting both private and public investors (e.g., in the developing world in the case of the latter). The indicated leverage is up to 1 trillion euros.     

Importantly, the new President of the ECB, Mario Draghi, indicated yesterday that the Securities Market Programme would continue to provide any necessary support for government bond markets (e.g., Spain and Italy).

Financial markets should welcome the entire effort. Peripheral bond markets can be expected to firm up a little and German bunds along with other defensive assets can be expected to lose ground a little. Counterparty risk for eurozone banks should ease thus helping to alleviate the stress in funding markets and as for equity markets they should do more of what they’re doing this morning – rally!

Agreed at last is a programme to be taken forward though caution still applies. There are likely to be plenty of glitches along the way in nailing down the detail of it all but the good news is that a broad outline for a workable agenda has been put in place where none existed before and this is progress. Disclaimer >   

Wednesday, 26 October 2011

What has quantitative easing actually achieved?

Earlier this month we enjoyed having the opportunity to talk to clients of our Leeds office. The event was highly interactive with plenty of questions - perhaps underlining that, as per the old Chinese curse, we may live in interesting times!

One of the most common questions was: what has quantitative easing actually achieved? Some potential answers are discussed below - illustrated using the Federal Reserve's own economic database (sentimentally named FRED).

Increasing bank lending

Quantitative easing provoked advocates and antagonists to proclaim it a monetary policy - by buying assets from banks, money is injected into the financial system, spurring inflation and maybe growth. After the event, however, there has been little evidence to support this function. The cash received through their sales of securities have simply been held on bank balance sheets as what are known as "excess reserves".

This should be a blow to policymakers. Banks make money by receiving short term deposits and making long term loans (discussed previously). Regulators require banks to hold some of their assets as reserves to make sure they can repay everyone who might reasonably withdraw their deposits. Because they earn little interest on reserves, banks ought to hold the lowest reserves they can. Their decision to hold more reserves than they are obliged to reflects a reluctance to take on credit risk. The graph below shows that the household mortgage sector has been shrinking since 2006 (the red line, using the right hand scale, shows the rate at which the mortgage sector grows each year). Meanwhile excess reserves have grown spectacularly.

Lowering borrowing rates

This was the principle reason for QE1 in the states, which aimed to drive down mortgage rates. It was also the aim of its later variation, operation twist.

Whether through QE, more conventional monetary policy (like stating that interest rates will remain on hold for an extended period), or more general risk aversion, lower borrowing rates have become available as the graph below demonstrates.

Past Performance is not a guide to future performance

Have these policies worked? Consumer credit is recovering but remains way below its pre-credit crunch peak. Real estate loans, however, continue to decline despite the attractive rates available.

Economic uncertainty restricts demand for loans while the prevalence of negative equity means many homeowners simply don't have the security to refinance.

A positive wealth effect

The fabled "Greenspan put" is a phrase used to describe how former Chairman Greenspan would use monetary policy to bolster the stockmarket when the economic outlook looked bleak. An increase in the S&P 500, the policymakers reason, increases the nation's confidence and their wealth, encouraging them to go shopping. Initial market reactions to the first two tranches of quantitative easing were positive. The reaction to Operation Twist was less so (as we discussed in bitter and twisted).

Weakening the currency

While the UK authorities have been quite outspoken about the benefits a weaker pound will confer upon the economy, in the US a weak dollar is seen as a sign of weakness (and a cause of higher gasoline prices). So policymakers continue to espouse a strong dollar while their actions systematically undermine it.

Past Performance is not a guide to future performance

That unspoken policy, at least, appears linked to the bouts of QE the Fed has enacted. The blue line in the graph above shows the Fed's QE purchases (treasuries and mortgage backed securities) coincide with weak periods for the dollar relative to its trading partners (the red line on the right hand scale).

As we shall comment in future posts, the benefits of any lasting depreciation would be significant - although they accrue more slowly than some of the other hoped-for benefits of QE.


Monday, 24 October 2011

Perspective iPad app - out now

The new issue of Perspective is now available to download at the app store.

The app features an extended interview with Fraser Nelson, editor of The Spectator, plus previously unseen photographs of Westminster Abbey taken when Sir Stephen Lamport talked to Brewin Dolphin about his role in the Royal Wedding this year. You'll also find video, galleries and an article about Geoff Thomas and his work for Leukaemia and Lymphoma Research.

Planning your inheritance

Simon Blowey, one of our financial planners, sheds some light on the gloomy subject of inheritance tax in our new issue of Perspective magazine.

It’s quite typical to begin a financial article with the worn-out quotation attributed to Benjamin Franklin that nothing in life is certain apart from death and taxes. However, as well as being a little trite and over used, the sentiment is actually incorrect, in spite of continued use by financial panjandrums. Leaving the metaphysical debate to one side, many taxes are entirely voluntary, albeit with some planning required on the part of the individual to negate them, and there is probably no greater example of this than inheritance tax (IHT).

While many accept that the taxation requirements for income and capital gains are in principle correct, views on IHT are far more divided. The argument against it generally follows a well-trodden route: as tax has already been paid once upon earnings and gains, the levy of death duties is iniquitous, particularly when adding in all of the other taxes suffered during a lifetime and the raw emotion involved with dealing with a loved one’s estate.

Others have presented a counter argument supporting IHT. It redistributes wealth and raises taxes for the Exchequer. Some prefer that the nation receive their wealth rather than their heirs! One thing is certain. Since the origins of the estate duty, individuals seeking to reduce the effects of IHT have taken action to reduce or completely eradicate the levy on their estates. Indeed, one only needs to look in an obituaries column to see how much of a taxable estate the deceased has left, with the implication that they had either been a pauper or – more likely – successful in shielding their assets from IHT. Read the full article >

Thursday, 20 October 2011

Rob Burgeman on the FT Money Show

Rob Burgeman: Pre-stressed Concrete

A series of polls in Germany has highlighted the difficulties that European leaders face in steering the Eurozone rescue package through the stormy waters of public opinion.  According to a poll in Stern magazine, 80% of Germans oppose making a personal financial contribution to help Greece, while, in a separate poll for Frankfurter Allgemeine, 75% say that they do not trust the Euro. Perhaps this can be explained by Germany’s experience following the reunification of the country two decades ago and the huge costs in trying to rebuild the East German communist economy. After all, they are still paying the “temporary” tax to cover this.

Key Eurozone figures held an impromptu meeting yesterday in Frankfurt and further meetings are expected this weekend, although expectations of any definitive action are fading fast. The forthcoming G20 summit in Cannes is a more likely venue to produce more concrete proposals.  Splits are evident. Nicolas Sarkozy – with one eye increasingly on the forthcoming presidential election following the French socialist’s decision to unite behind François Hollande – is keen to cement his reputation as a man of action.  Angela Merkel, for the reasons outlined above, is keener to slow the speed of radical reform to a pace that can be delivered to an increasingly sceptical electorate. 

A report in the FT overnight that the European Union’s estimate of the amount of capital required by the banking sector might be as little as €80 billion further heightens the sense that, rather than tackling the issue head on, the problem of bank recapitalisations may be mired in the backrooms of Brussels. I, for one, would not be very happy being inside an office built of the materials used to construct these “concrete” proposals

Tuesday, 18 October 2011

The eurozone crisis: what should policymakers do next?

'Bonjour. Mon nom est Nicolas et mon système bancaire doit être recapitalisé.'
These are the words which may be spoken by President Sarkozy in early November when weeks of talks with Chancellor Merkel of Germany conclude. Their anticipation has provided a fillip to the market because admitting you have a problem is the first step towards recovery.

A confession that banks need to recapitalise will only work though, if it is made in conjunction with a second confession; that Greece will not repay its outstanding debts. Markets expect to hear that from the French premier too and indeed recent comments from the Luxembourg’s prime minister and Eurogroup president, Jean-Claude Juncker suggest a realistic haircut – towards the more severe end of the 50-70 per cent target range investors have been speculating about.

That such a crisis has been allowed to develop is a travesty that has already inflicted serious damage upon Europe and its trading partners. In large part this comes down to the failure of both the debtor, Greece, and the creditors, the European banks, to take that crucial first step.
Greece was strong-armed into rehabilitation by accepting loans from the troika and imposing austerity measures. Absurdly, however, none of this will help while its debt to GDP ratio remains anywhere near 150 per cent.

Full article: Money Observer


Sino-American protectionism: more politics than policy

Everybody knows the Chinese manipulate their currency (the renminbi).  Last year nearly half of America's trade deficit was with China. So why is nobody doing anything about it?

It looks like the politicians are trying...

Last week the Senate passed the Currency Exchange Rate Oversight Reform Act of 2011 - an act which would pressurise the White House and the Ways & Means committee (the group that writes tax legislation for consideration by the House of Representatives) to evoke tariffs against China. The House of Representatives now have the opportunity to vote the bill through and have it sent to the President for veto or enactment.

Surely this is a done deal. The issue has strong bipartisan support in both houses of Congress. So much so, in fact, that the House passed a similar bill a year ago which the Senate could have run with.

...but appearances can be deceptive!

They didn't though. Because this issue is arousing more politicking than policymaking. For those congressmen (and women) representing constituencies that have lost jobs to China, supporting the bill demonstrates their commitment to countervailing tariffs (retaliatory taxes on imports) - even if they assume it will not become law.

Neither the White House, nor the Republican leadership want this bill to pass.  The use of cheap Chinese labour has become endemic to the US economy. An acceleration of revaluation would cause cost increases for consumers and businesses across the Union. Many firms either rely on cheap imports or have actively shifted their own production to China.  Whilst the latter might stand tall as a reason to legislate, it provokes significant business lobbying to prevent a trade war between the two countries.

Business as usual

At the moment, behind closed doors, policymakers can admit that legislation would not be helpful. Afterall the adjustment is taking place: the renminbi continues to appreciate at around 5% per annum against the dollar; Chinese wages are rising faster than US pay; and rising fuel costs create incentives to manufacture at home rather than abroad. These themes should play out in the US's favour over the coming years.

The concern would be that as China's economy has lost steam this year, the People's Bank of China may want to switch from their current tightening policy (higher reserve ratio requirements, higher interest rates, a higher exchange rate), to a loosening policy.

If a more hawkish (tightening) stance meant the renminbi's climb slowed, stopped or reversed, then it will become increasingly difficult for congress to remain all talk and no tariffs.


Monday, 17 October 2011

A Chinese currency manipulation primer

Chinese currency manipulation has returned to the business pages and I thought that, before discussing it, a primer on how Chinese currency manipulation actually works would be useful.

China operates without a freely exchangeable currency. Therefore, companies buying goods and services from China must pay in dollars or some other tradable currency.  The Chinese exporter’s bank, having received dollars, must then surrender them to the People’s Bank of China (PBoC) – China’s central bank.

The PBoC receives dollars and converts them into renminbi. Since devaluing the renminbi in 1993, the Chinese have exported about $100 billion more per year than they import (on average). Ordinarily that would mean that selling dollars and buying remninbi, pushes the Chinese currency higher.

But the number of renminbi that the PBoC offers for dollars is determined by their exchange rate policy – not market forces. This means they accumulate excess dollars, which are squirreled away in the State Administration of Foreign Exchange fund (SAFE), while supplying new renminbi that enter circulation in China’s economy.

This has a few implications:
  • First, the PBoC’s release of more renminbi, if left unchecked, means too many renminbi chasing too few goods, causing prices to rise (inflation).
  • Second, because the exchange rate doesn’t appreciate, Chinese goods remain cheap compared to US goods. Conversely, expressed in the deliberately weakened renminbi, any imports are artificially expensive – adding further to inflationary pressure.
  • Third, it leaves the SAFE with a vast sum of dollars to invest – $3.2 trillion as at the end of July. Historically this has been invested in the US treasury market.
Inflation is a big issue for the Chinese as their population spend a high share of their income on food, shelter and energy (non-discretionary items).  The central bank therefore has to find ways to prevent the excess renminbi pushing up prices. Typically the PBoC uses four tools to achieve this, often simultaneously:

1. Raising policy interest rates

Raising interest rates in China discourages borrowers from taking out loans. Unlike developed markets, in China the PBoC mandate two interest rates (one for lending and one for borrowing). Other than that this is basically old-school conventional monetary policy.

2. Changing market interest rates

This is done through what is known as open market operations (OMO). Economists describe OMO as sterilising the new renminbi flowing into the Chinese economy.
If the authorities want to lower interest rates they buy government securities, this pushes the yield they pay down.  If they want to raise interest rates they sell securities allowing the yield to drift higher. The securities’ yield will determine the rate which savers receive. The rate which borrowers pay is basically 3% higher.

If the return achieved on SAFE’s investments (mostly US treasuries) is higher than the interest paid on the securities they sell (Chinese renminbi bills), the monetary authorities realise a profit – in financial jargon this is a carry trade.  As you can see from the chart below, since US interest rates were cut in 2008, China now loses money on these sterilising activities.

3. Raising the bank reserve requirement ratio.  

This restricts the number of loans a bank can advance relative to the deposits they hold.  By raising the bank reserve ratio they restrict credit growth and therefore inflation. 

4. Allowing the exchange rate to appreciate.

Finally the PBoC can restrict inflation by allowing the exchange rate to appreciate. This final tool is the one which is raising protectionist hackles. US policymakers want renminbi appreciation to accelerate.

China is now seeing growth decelerate and so, as Mike has commented, the focus of policy may shift away from fighting inflation and towards protecting jobs (Time for China to weigh in with policy easing). We hope this will be through cuts to interest rate and the reserve ratio requirement, rather than any deceleration of the renminbi’s ascent.


Friday, 14 October 2011

Mike Lenhoff: Market tactics 14 October 2011

Time for China to weigh in with policy easing.

While the eurozone is now getting on with it, the developing world is moving with speed and, in contrast to the developed world, has plenty of scope to stimulate economic activity through the tried and tested means of cutting interest rates - both sizably and aggressively if need be - and through fiscal policy. This week saw something of both and more. More >

Thursday, 13 October 2011

Guy Foster: bank recapitalisation and more stating the obvious

Following on from the theme established by my colleague Rob (in stating the obvious):

The FT reports this morning that French banks are against the idea of a bank recapitalisation programme.  This news follows on from a reasonably sustained campaign by Josef Ackerman, Chief Executive of Deutsche Bank and Chairman of the Institute of International Finance (a global association of banks), expressing similar sentiments.

A recapitalisation would require existing investors to provide new funds or see their share of the banks’ ownership and their entitlement to its profits reduced.  It would also see management’s share of the company (whether through options or outright share holdings) diluted.

In other news, a statement by the International Institute of Turkeys advised that the festive period is a good time to experiment with vegetarianism while the Glass Dwellings Residents Association have mounted strong opposition to a stone throwing championships proposed to regenerate the area.

Rob Burgeman: Slovakia hits headlines

Say what you like about the eurozone crisis, but it certainly does wonders for our knowledge of the peripheral nations of Europe and their domestic political situations.  Slovakia, it must said, has not made many headlines since its peaceful divorce from the Czech Republic in 1993.  It joined the European Union in 2004, adopted the Euro in 2009 and has, with all due respect to the good burghers of Bratislava, not made much of a noise since.  That changed this week when the Slovak parliament refused to ratify the expansion of the European Financial Stability Facility (EFSF) to facilitate a resolution to the Greek debt crisis.

This is as much to do with the internal politics of a Slovak coalition in trouble as it is an economic issue and led directly to the fall of the government.  In all likelihood, a second vote will be held shortly and the logjam will be cleared.  However, with elections looming in larger states, the words of Richard Sulik, the leader of the Freedom and Solidarity Party in Slovakia, will be looked on with alarm by incumbent governments.  “I’d rather be a pariah in Brussels than have to feel ashamed before my children, who would be deeper in debt should I back raising the volume of funding in the EFSF bail-out mechanism” echoes sentiments that will be seized on by increasingly belligerent marginal parties across the Eurozone and will make the task of finding some kind of political consensus that can be approved by 27 different nations more challenging. 
Politicians seem to have woken up to the seriousness of the situation, but it remains to be seen if they can forge the kind of decisive action that is required to resolve the situation.

Monday, 10 October 2011

Mike Lenhoff's Market Tactics - 10 October 2011

News moves markets and it’s time for good news

Equity markets have been starved of positive news flow. So the push by eurozone leaders, led by Mrs Merkel and Mr Sarkozy, along with the involvement of eurozone finance ministers, the European Commission (EC) and the European Banking Association (EBA), to engage in what appears to be a new constructive phase to deal with the eurozone sovereign debt crisis, is a very welcome development.

However, will they dare to be so bold? The chart suggests that the markets are turning hopeful. The goodies they need to deliver include a more ably resourced crisis mechanism in the form of the EFSF, the programme of bank re-capitalizations discussed last week by the EC and EBA, a solution for Greece (widely expected to include debt restructuring) and a scheme for economic governance that builds on or endorses such a framework set out already by the EC for the broader EU. More >

Friday, 7 October 2011

Considering the future of Apple

This week saw the death of Steve Jobs, a great inventor, business man and visionary.

Did he change the world as Apple suggests? Probably. Was he driven to change the way we do things in every day life? Definitely. From the level of response to news of his death, for example Barack Obama and all CEOs of the major IT companies globally, it is easy to see why Apple, and indeed personal computing will never be the same.

The much anticipated official handover of the company to Tim Cook in August was met with general accord by the markets. It ended any remaining uncertainty over the company’s leadership and allowed the new CEO time to establish himself. He effectively completed the move this week by hosting the unveiling of the new iPhone 4S. The presentation was well received in terms of style, the product less so.

The phone’s new features are more ‘catch up’ than totally revolutionary and the phone’s design is very similar to the iPhone 4. This raises the question over Apple’s future without Mr Jobs. Is the company capable of achieving success with another revolutionary product or is it the next Nokia, a company once dominant now selling millions of low end phones and losing market share hand over fist? Time will tell whether Apple can survive the death of its genius and favourite father.

Equity Analyst, technology sector

Thursday, 6 October 2011

QE2 is launched while Europe prepares its ports for the storm

Markets express the collective views of the many but sometimes they are subject to the whims of the few. In previewing what was sure to be a fascinating week my colleague Mike Lenhoff noted some of our hopes and fears.

"It is doubtful...that the [European] finance ministers will be galvanised into action; that is not quite the behaviour we have come to expect from them"

Maybe not! But their public recognition that the continent's banks need more capital, like the alcoholic's admission of his sickness, is a huge step towards a recovery and one we were pleasantly surprised by.

"It will be astonishing if, against a backdrop where the risk to financial stability in the Eurozone has been steadily worsening...the ECB chooses not to reverse its recent hikes in interest rates."

Well they didn't. They didn't even hint at a rate cut for November but cuts were discussed and extra liquidity was provided (always the ECB's primary concern).

"Equally, there is a good chance that Thursday’s meeting of the BoE’s Monetary Policy Committee will go Adam Posen’s way and endorse a further round of quantitative easing of at least 50 billion pounds."

And in the end it was £75bn - sending gilts soaring and the pound plummeting. Broadly this is shaping up to be a good week for policymakers - two steps forward and only one back. Following through with an audacious recapitalisation program and plan for Greece's orderly default would show our cynicism to be misplaced.

Wednesday, 5 October 2011

Stating the obvious...

It was extremely pleasing to read in the news this morning that European Union finance ministers have agreed that additional measures are urgently needed to shore up the region’s banks.  Elsewhere, results were published on the sylvan nature of the toilet habits of bears while representatives of the Vatican were spotted leaving a large hat retailer.  

Yes, the penny seems to have finally dropped that some action may be required to resolve the situation in Europe.

The problem, of course, is trying to find some agreement between 27 disparate states – each with their own self interests and electorates to appease – while operating in a legal framework that was not constructed to deal with this kind of situation.  This, unfortunately, all takes time - precisely the resource which is most lacking at present.  As my colleague Guy Foster pointed out here, a potential solution does exist, but action is required. Time and the tide wait for no man, it seems.


Monday, 3 October 2011

Mike Lenhoff's Market Tactics - 3 October 2011

BoE and ECB should ease! What’s to hold them back?


Eurozone finance ministers meet today in Luxembourg to discuss Greece and how they might respond to the international pressure to accelerate their efforts in putting in place a credible and larger mechanism (than the enhanced EFSF) for dealing with bailouts, bank recapitalisations and support operations in sovereign debt markets. It is doubtful though that the finance ministers will be galvanised into action; that is not quite the behaviour one has come to expect from them.

Although not in the giant league by assets, it may still be of interest to see what comes of today’s meeting with Dexia and the French and Belgian finance ministers as a guide or lead on what might be expected elsewhere. The three are meeting to see how the balance sheet of the Franco-Belgium financial services group, and big holder of Greek debt, might be strengthened. More >