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Spins of omission

One aspect of this market that has remained remarkably consistent has been the level of corporate activity. This is despite the growing belief that private equity deals may be more difficult to put together due to the state of the credit market. The move on Sainsbury by Delta Two, not strictly a private equity group although sharing many of the characteristics, will involve a fair amount of borrowing. These operators may see market value that the more nervous among us believe is no longer present.

Interestingly, I heard an unfavourable comparison drawn between the Qatari-backed investment fund and private equity houses last week. With all the criticism being aired about the lack of transparency of these players in the financial world, it appears that finding out anything about Delta Two is exceptionally difficult. But the fact remains that it is both able and willing to table a bid for one of Britain’s best known companies.

Perhaps this is why shares were able to bounce back so convincingly last week after a rocky couple of trading sessions kicked off by remarks from Federal Reserve chairman Ben Bernanke. The state of the credit market continues to concern the head of America’s central bank. Speaking shortly after Bear Stearns announced that one of its hedge funds had been wiped out by the sub-prime debacle, it was little wonder investors took fright.

It was what this leading economist omitted from his statement to the US Congress that is the real worry. Back in May, when drawing attention to the deteriorating state of the sub-prime market, he stated that “significant spill-overs from the sub-prime market to the financial system” were not likely. No such words of reassurance in last week’s testimony.

What he did say was that the situation was getting significantly worse. We already knew that, thanks to the earlier announcement by Bear Stearns. The collapse of the hedge fund investing in collateralised debt obligations linked to the sub-prime market tells us that the reach of this particular financial disaster is very hard to gauge. CDOs may indeed deliver collateral damage.

Still, with the global economy in seemingly robust form and lots of cash looking for a home, equity markets appear capable of shrugging off the ripples that the deteriorating housing market in the US has been throwing out. The continuing high level of merger and acquisition activity supports the contention of those who consider this particular bull market has not yet run out of steam.

Arguably, there is still some mispricing of assets, particularly of the riskier variety. Small and mid-cap stocks continue to look expensive compared with the market leaders while the risk premium associated with emerging markets has all but evaporated. These are the areas that look vulnerable if it turns out we are underestimating the real consequences of upheaval in the credit market.

What is less easy to judge is whether any case is emerging for returning to the bond market. One of the immediate effects of Bernanke’s comments was a flight to quality, demonstrated in some fairly vigorous buying of US treasuries. The 10-year yield dropped below 5 per cent for the first time in more than a month, despite the Fed chairman reiterating his concern that inflationary pressures remain, which suggests interest rates are not coming down any time soon.

As with other seemingly riskier assets, there does not seem sufficient upside in bonds to jump on board. If, indeed, inflation has returned as an issue – and all the signs from China suggest we can no longer rely on this manufacturing colossus to keep the lid on pricing power – the case for bonds looks weak. High quality big companies with undemanding share valuations still seem the safest option – for the time being.

Brian Tora ( is principal of The Tora Partnership


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