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Banks are not out of the woods yet in fragile equity markets


Headlines over the past couple of months have been somewhat dominated by cakes and football. In September, the BBC lost The Great British Bake Off to Channel 4 (but without Mary, Mel and Sue, what’s left?), then, following an “error of judgement”, Sam Allardyce was sacked as England football manager after just one match (at least it was a victory).

For investors, there has been other news which ought to be of at least as much interest as cakes and football.

Certainly the Bank of England’s August policy response to Brexit, which included the resumption of quantitative easing and halving the base rate to 0.25 per cent, has already created headwinds for many UK companies, particularly those still operating or maintaining legacy defined benefit pension schemes.

Many such schemes were in deficit before August. Some substantially so. PwC estimates the effect of the reduction in interest rates has increased the aggregate deficit of all such funds by a staggering £100bn to £710bn in August, though this figure has since fallen to £630bn.

It has a real impact on those companies affected: their balance sheets are impaired and they have to divert significant funds, which could be used more profitably to develop their businesses, simply to keep those pensions afloat.

For some, the consequences go further. Consider Carclo plc, a mid-sized UK plastics company with global operations and annual sales in excess of £100m, which was forced in September to pass its dividend citing its ballooning pension deficit as a root cause.

You think monetary policy is some esoteric concept of no interest to anyone other than bankers and economists? Think again.

Banks also remain newsworthy. In the dark days of the New Year, when equity markets were collapsing, investors questioned the financial stability of European banks. Did they still pose a substantial systemic risk despite all the regulatory sticking plaster liberally applied since the global financial crisis?

The eye of the storm centred on Italy but Deutsche Bank also fell under an unwanted spotlight, such that the German finance minister had to refute publicly the idea that the national flag-carrying bank was going bust.

But while the prominence of the banking crisis story might have receded over the summer, the core of the problem has not. As I write, the travails of European banks (and Deutsche Bank, in particular) are once again uncomfortably in the headlines. The sector is far from being out of the woods yet.

Elsewhere in markets…

The US Federal Reserve and Bank of Japan’s respective September policy meetings went with the form book. The Fed kept interest rates flat, though three members of the committee voted in favour of an immediate rise. Market expectation is still that the Fed will most likely go for a single quarter percentage point rise before the end of the year.

Superficially the Bank of Japan also did little but there is a subtly nuanced shift in policy towards “managing the yield curve on the 10-year bond” – trying to steer policy towards pushing the 10-year bond yield to a positive rate of return instead of negative, as is currently the case.

Meanwhile, oil has fluctuated between $42 and $51 per barrel since the beginning of July. A price of $50 is economically sensitive for many producers, being roughly the point at which they break even generating cash from operations.

US producers have been reintroducing mothballed capacity as the price has recovered from its trough of $28 in January and surplus inventories remain stubbornly high. However, at the time of writing, the Opec cartel of producing nations, which controls around a third of global output, has in principle agreed a production cap to try and reduce those stocks and thus allow the price to recover further. The next Opec meeting is later this month, when we will see if that deal is ratified.

Inflation has been a hot topic over recent years, with low interest rates and QE yet to stoke any meaningful rise across the developed world. However, expect a more stable oil price to lead to an uptick around the world in the months ahead.

In the UK, this will be compounded by the material fall in sterling that took place post-EU referendum, and more recently during October. Marmitegate – the public spat between Unilever and Tesco on which foots the bill for the higher costs – is but a first taste of this. Consumers will face the brunt of the impact.

John Chatfeild-Roberts is head of strategy for the Jupiter Independent Funds Team



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