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Utterly unprecedented

Finding adequate words to describe the oscillations in financial markets and economies over the last year is a challenging task indeed. “Utterly unprecedented” almost suffices. The causes of the current crisis (note the use of the present tense here) are well documented. 

However, those two words also neatly summarise the responses of the authorities; the present day economic situation, the resultant global economic imbalances and the record setting reactions of asset markets, both down and then the more recent bounce back up. 

No historical comparison provides the perfect analogy to where we are today. Three periods of financial history do bear consideration though. There are similarities to elements of the Great Depression, the mid 1970s and the two lost decades of recent Japanese financial history. 

Which path our economies ultimately follow is still unclear; a fresh uncharted course is quite possible. What we do know is that the consequences of the recent past will be felt by many future generations. Whilst naturally it is tempting to focus on the negative, there will be an equal, if not greater, number of positive developments and investment opportunities.  All in all, as already noted: utterly unprecedented!

However, future investment opportunities may be very different from those experienced in the last few decades. Time horizons and geographic focus need to be extended. The days of leverage-driven, laissez-faire capitalism in the West are likely to be consigned to the history books. Regulators will do what they were always supposed to – regulate. That is no bad thing.

Historically, too many poorly managed; inefficient consumers of scarce resources were kept afloat by 40 years of American bailouts and two decades of cheap money.  For now the official liquidity tap remains in full flow; when totalled, the aggregate of global monetary and fiscal stimulus combined with recent pure ‘bailouts’ amount to incomprehensible amounts of money. These policies have to end at some stage. At that point we will find out if sustainable economic growth results.

Regardless of what happens, some economies are at a tipping-point. Many leaders of emerging markets now realise that their export-driven growth models are flawed.  Development of domestic growth is now the priority. In the West, deflationary factors remain today but we are very alive to the fact that many trillions of dollars have been pumped into the economic system.  Inflation is lurking in the background and at some stage is likely to re-appear.

After one of their strongest ever runs in the third quarter, it was only to be expected that equity markets would pause for breath in October before buying began again, albeit nervously. We still believe that markets will find a justification for remaining in a bull market phase; that is until such time as the sugar rush of optimism and government stimulus comes to an end. Further quantitative easing should underpin investor confidence and ease short term jitters such as those caused by the Dubai debt problems.

 

From where we sit today, we are not utterly convinced the world has yet turned the corner. While much of the economic data has improved, buoyed by restocking and government intervention, we are concerned as to how long the recovery will last.

So far the US government has managed to keep people spending with initiatives such as the successful “cash for clunkers” programme. But government spending at such high levels, plus the bank bail-outs and quantitative easing, is unsustainable over the long term. Underlying economies will need to recover to justify current market levels.  Several central banks have already begun to “tighten the spigot” in order to wean economies off their stimulus packages; others will surely follow.

Moreover, the “carry trade” trend of borrowing in currencies such as the US dollar with low interest rates to invest in assets with higher yields cannot last forever. When it does unwind, commodity prices are likely to fall and the US dollar will probably strengthen. The latter would be an added boost for UK companies with dollar earnings. In such a tricky and unprecedented environment, therefore, a flexible lower risk approach towards investing appeals. 

Finding adequate words to describe the oscillations in financial markets and economies over the last year is a challenging task indeed. “Utterly unprecedented” almost suffices. The causes of the current crisis (note the use of the present tense here) are well documented. 

However, those two words also neatly summarise the responses of the authorities; the present day economic situation, the resultant global economic imbalances and the record setting reactions of asset markets, both down and then the more recent bounce back up. 

No historical comparison provides the perfect analogy to where we are today. Three periods of financial history do bear consideration though. There are similarities to elements of the Great Depression, the mid 1970s and the two lost decades of recent Japanese financial history. 

Which path our economies ultimately follow is still unclear; a fresh uncharted course is quite possible. What we do know is that the consequences of the recent past will be felt by many future generations. Whilst naturally it is tempting to focus on the negative, there will be an equal, if not greater, number of positive developments and investment opportunities.  All in all, as already noted: utterly unprecedented!

However, future investment opportunities may be very different from those experienced in the last few decades. Time horizons and geographic focus need to be extended. The days of leverage-driven, laissez-faire capitalism in the West are likely to be consigned to the history books. Regulators will do what they were always supposed to – regulate. That is no bad thing.

Historically, too many poorly managed; inefficient consumers of scarce resources were kept afloat by 40 years of American bailouts and two decades of cheap money.  For now the official liquidity tap remains in full flow; when totalled, the aggregate of global monetary and fiscal stimulus combined with recent pure ‘bailouts’ amount to incomprehensible amounts of money. These policies have to end at some stage. At that point we will find out if sustainable economic growth results.

Regardless of what happens, some economies are at a tipping-point. Many leaders of emerging markets now realise that their export-driven growth models are flawed.  Development of domestic growth is now the priority. In the West, deflationary factors remain today but we are very alive to the fact that many trillions of dollars have been pumped into the economic system.  Inflation is lurking in the background and at some stage is likely to re-appear.

After one of their strongest ever runs in the third quarter, it was only to be expected that equity markets would pause for breath in October before buying began again, albeit nervously. We still believe that markets will find a justification for remaining in a bull market phase; that is until such time as the sugar rush of optimism and government stimulus comes to an end. Further quantitative easing should underpin investor confidence and ease short term jitters such as those caused by the Dubai debt problems.

 

From where we sit today, we are not utterly convinced the world has yet turned the corner. While much of the economic data has improved, buoyed by restocking and government intervention, we are concerned as to how long the recovery will last.

So far the US government has managed to keep people spending with initiatives such as the successful “cash for clunkers” programme. But government spending at such high levels, plus the bank bail-outs and quantitative easing, is unsustainable over the long term. Underlying economies will need to recover to justify current market levels.  Several central banks have already begun to “tighten the spigot” in order to wean economies off their stimulus packages; others will surely follow.

Moreover, the “carry trade” trend of borrowing in currencies such as the US dollar with low interest rates to invest in assets with higher yields cannot last forever. When it does unwind, commodity prices are likely to fall and the US dollar will probably strengthen. The latter would be an added boost for UK companies with dollar earnings. In such a tricky and unprecedented environment, therefore, a flexible lower risk approach towards investing appeals. 

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