Wednesday, September 30, 2009

A new quarter awaits

The markets recent adrenalin rush got another boost - this time from a wave of M&A activity. The swallowing up of the small by the large is a very logical way of dealing with surplus capacity and weakened competition. Indeed corporates that are managing to grow profits and sales in stagnant markets - primarily pharmas, retailers, and telco's - are about to embark on another , entirely logical, round of consolidation. These are areas I'm happy to be in and we should see rotation into them.

As for the rest of the market I'm still a doubting Thomas. The performance of banks, autos and the construction sector has been literally awesome. But the share price recoveries have been based on government stimulus . This is the equivalent to building a house on sand rather than rock. What happens when QE is scaled back or withdrawn altogether? Flood the markets with money and prices will rise - for a while. The recent massive flow of funds out of zero yielding money market accounts into bonds and equities is entirely sensible while government subsidies are generating an economic recovery but what then?

Todays IMF report claiming that out of $2,800 billion of system-wide 'crisis' losses only $1,300 billion has so far been recognized shows that global bank capital must still take a further $1,500 billion hit over the next year and a half. There's lot of loan portfolios out there that are going to have to be adjusted down particularly in Germany,Spain and the UK. Expect lots of capital raising ($310 billion in Euroland and a further $110 billion in the UK alone) by financial institutions but don't expect analysts to re-learn the word 'dilution'.

The outline of a new slower growth, higher tax investment environment can be glimpsed . As we've seen at the UK's governing Labour Party Conference this week , and to a lesser extent at the G-20 meeting in Pittsburgh over the weekend, there is a recognition that to withdraw subsidies now would lead to a second, and possibly more severe downturn. What is equally clear is that at some stage bond markets are going to force governments into slowing down their largesse if not dropping it entirely. What happens when electorates in the EU and elsewhere wake up to the fact that the solution to this crisis lies in long term reductions in services,retirement at 70,and higher taxes to pay for QE. In baser terms that's called a reduction in living standards - what politician anywhere is going to tell you that?.

People in the real world are facing this new environment logically. For the first time since records began consumer credit is being repaid more quickly than it's being issued. In both the UK and the US savings rates are on track to reach the 8-10% level as consumers adjust to heightened job insecurity and the need to have a much larger cash deposit when taking out scarce mortgages or car loans. Not long ago the UK savings rate was negative! With the consumer firmly in reverse gear for the next two or three years the long expected inventory restocking may prove to be feeble and short lived. Pricing pressure is going to be around for a while yet. A dollar saved is a dollar less consumed so economies at the macro as well as the micro level are likely to be sluggish through 2010.

Finally, just a thought about politics. This market is simply not pricing in any geopolitical risk. It seems as though there's a belief that the Obama honeymoon will make everyhting ok after the Bush wilderness years. Yet, the more one looks at it North Korea and Iran seem as intractible as ever. Russia seems a little more supportive after the dropping of the Polish/Czech missile shield but remains at best non-commital.And now we wait for the outcome for the Irish vote on the Lisbon Treaty.

Against this backdrop what is the safe haven currency? When it's clear that there is no 'V' shaped recovery but rather a gentle upward drifting stagnation where will be the best place to hold your savings ? The Yen, greenback, euro, sterling or swissie?

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