The Illusion of Recovery - Presenation to the JCC (IOM)

Licensed by the Isle of Man Financial Supervision Commission

Stockbrokers & Investment Managers

Junior Chamber of Commerce

Hilton Hotel

Tuesday 9th November 2010


Today’s Speakers

Stuart Cowan Chartered FCSI Investment Director

“Welcome & Introduction”

Peter Robertson BA (Hons)Chartered FCSI

Senior Investment Manager“The Illusion of Recovery”


http://www.ramseycrookall.com/cowan.html

http://www.ramseycrookall.com/robertson.html


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Ramsey Crookall and Co Limited is licensed by the Isle of Man Financial Supervision Commission.



“The illusion of

recovery”



“are we there yet..........”




The average length of time a country

spends in a deflationary deleveraging

phase is SEVEN years.........................

(McKinsey)


Today’s Presentation

• Introduction

• Remembering the credit crisis

• How the authorities responded

• Three years on – where we are now

• Quantitative easing

• What QE did to economic growth

• The economic outlook

• The market outlook

• Conclusion



Remembering the Credit Crisis – ‘its all about debt’

•Origins in USA - post dot com, Sept 11 2001. ‘Greenspan Put’

•Post Sept 11 recovery driven by cheap debt, easy credit, consumption

•US Mortgage Market - securitised

•New products

•Growth in sub-prime

•Single Euro interest rate led to disproportionate growth in Eurozone

•Recovery in Emerging Markets post 1998 led to increased trade



US


http://stocktickle.com/wp-content/uploads/2010/08/US-total-debt.png


2007 – bubble bursts

•Credit bubble popped in 2007 – Sub Prime Crisis in US

•Mortgage backed securities = global contagion

•Banks refused to lend

•Stock markets collapsed, banks failed eg Lehman, Bear Stearns



How the Authorities responded

• Interest rates cut to record low levels

• Temporary fiscal stimulus – eg VAT cut to 15% in UK

• Central bank intervention – ‘Quantitative easing’ & supporting ‘toxic assets’

• Government spending to stimulate the economy

• Bank bail outs by Governments

• Changes in accounting regulations, eg FASB ‘mark to market’



Three years on – where are we now?

29.10.2007 29.10.2010 Change %

3 month LIBOR 6.26% 0.695% -5.565

UK Base rate 5.75% 0.5% -5.25

US Fed Funds Tgt 4.5% 0.25% -4.25

10 year Gilt Yield 4.84% 3.01 -1.83

FTSE 100 Index 6,706 5,675 -15.3%

S&P 500 ($) 1,540.9 1,183.26 -23%

Gold ($) 791.8 1,359.4 +71%

Bond yields are suggesting low growth. Equities are discounting a ‘V’ shaped recovery. Gold is a hedge against inflation!! How can this be?



‘Quantitative Easing’

•Central bank intervention – aim to stimulate economic growth

•Create money, lend to banks, invest in government and corporate bonds

•QE since 2009: • US Federal Reserve: $1.7trn PLUS $600bn to Jun 2011• UK Bank of England: £200bn• ECB: €750bn emergency measure (loan guarantees)

•The impact so far?• Original aims? • On growth, consumer spending? • On assets and economic data?• On inflation?



What QE did to Economic Growth

US GDP

•Has recovered from 2009 low

•Q3 2010: +2%

•QE: $1.2 - $1.5trn

•But: • Consumer spending 70% GDP• Unemployment high, housing weak• Business investment constrained by

tight credit, and ‘offshoring’• Gov’t stimulus temporary impact• Total consumer debt $11.7trn




United Kingdom GDP

•Q3 GDP: 0.8%

•QE spend so far: £200bn

•Construction has been strong

•Weak sterling helping exporters

•But: • Austerity measures from 2011• Credit remains tight• Total personal debt £1.45trn




EuroZone GDP

•Huge divergences between countries

•The €750bn ‘comfort blanket’

•Penal austerity measures across Eurozone

•Greece problems have not gone away

•Strong Euro will hurt exporters



The economic outlook

•Interest Rates

•Components of GDP

•Credit/debt markets

•Inflation

•Potential headwinds



The economic outlook - Interest Rates

•US: 0.25% UK: 0.5% interest rates at historically low levels

Eurozone: 1%

•Further QE suggests they will remain at current levels

•Expect them to rise sharply once the recovery gains traction

•Must keep an eye on inflation

•Market rates (bond yields) will provide guidance



The economic outlook – credit/debt markets

•Governments are carrying massive debts

•Expect the US Government to continue spending, UK and Eurozone embracing austerity

•Who will buy the US debt?- Largest holders of US Treasuries: China $868.4bn (Nov 2010) US Federal Reserve $842.0bn

Japan $836.6bn

•Banks remain reluctant to lend (Basel III, balance sheet rebuilding)

•UK mortgage lending sluggish – lending multiples much stricter than pre-credit crisis



The economic outlook - Inflation

•UK inflation remains ABOVE Bank of England’s target

•Possible food price inflation from 2011

•Oil price just hit a 2 year high ($87)

•Little wage inflation at this time – job preservation more important

US UK Eurozone

CPI (m/m) 0.1% 0.0% 0.2%

CPI (y/y) 1.1% 3.1% 1.8%

Core CPI (y/y) 0.8% 2.7% 1.0%



The economic outlook – Potential Headwinds

•Sovereign Debt crisis – GREECE, IRELAND!

•Collapsing US dollar – potential inflationary consequences

•30 year US Treasury bond – watch the yield

•Further issues in US securitized mortgages market – watch BAC

•Austerity measures, higher taxes, eg UK VAT 20% from Jan 2011

•Is the recovery an illusion? Has the credit bubble only part deflated?



Consensus Forecasts

2010 GDP 2010 CPI 2011 GDP 2011 CPI

USA 2.7 1.6 2.4 1.4

Japan 3.0 -0.9 1.3 -0.3

Eurozone 1.6 1.5 1.4 1.6

UK 1.5 3.1 2.1 2.6

G7 2.2 1.3 1.8 1.4

Asia ex Japan 8.5 3.9 7.4 3.7

Source: Consensus Economics: 13.09.2010



The market outlook

•Bonds

•Equities

•Commodities

•Currency



The market outlook - Bonds

•Bonds are fundamentally expensive (2yr Gilt yields 0.7%; 5yr Gilt 1.5%)

•Yields have been ‘juiced’ by QE over last 18 months

•Everything depends on outlook for inflation – yields to rise as economy recovers

•Only Central Banks (or avid deflationists) will buy bonds at these levels!

Bond Price 3rd Apr 2009

GRY Apr 2009

Price 2nd Nov 2010

GRY Oct 2010

Tesco 5% 24.02.2014 £100.00 5.0% £109.07 2.12%

Vodafone 4.625% 09.09.2014 £101.20 4.37% £108.05 2.40%

Nat’l Grid 6.125% 13.04.2014 £101.50 5.89% £111.52 2.58%



The market outlook - Equities

•Equities are cheap compared to bonds!

•Dividend yields are attractive (FTSE All Share 3.5%)

•Equity markets have been discounting a ‘V’ shaped economic recovery

•They remain susceptible to bad news, especially Europe & US!

•Note the rise of the Far East Asian and Emerging Markets

• Creditor nations• Strong Exports• Increasingly affluent and aspirational consumers



FTSE 100 Index



The market outlook: Commodities

•Commodities have benefited from

• A weak USD• Rapid growth in the emerging markets• Instruments such as exchange traded funds

•Gold and precious metals are now a hedge against economic mis-management

•Global demographics support agriculture commodities



Goldman Sachs Commodities Index Reuters CRB Commodities Index


http://www.mrci.com/client/w-crb.pdf


Gold



The market outlook: Currency

•USD being ‘debased’ by Federal Reserve• To keep US exports attractive

• Eurozone issues have not gone away. Only looks expensive due to • Fed action on US dollar• Austerity measures in Europe

• Japan currency market intervention unlikely to succeed

• Sterling has benefited from Govt savings review – ‘tackling the deficit’



US Dollar: Trade Weighted index

Long term trend –down!



Conclusion

•Strong recovery in asset prices since 2009

•Helped by the actions of Central Banks

•But economic recovery in the West remains fragile

•Government have taken over the role of borrower from consumers

•Double dip still possible. Consumers retrenching, unemployment remains high

•Equity markets discounting good news (susceptible to disappointments)

•It ‘feels’ illusory! Where would we be without Quantitative easing?



Disclaimer

Where Ramsey Crookall has expressed views and opinions, these may change. Where markets and securities are mentioned in this document they do not necessarily represent a specific portfolio holding and do not constitute a recommendation to purchase or sell. This does not constitute an offer or solicitation by anyone in any jurisdiction in which such an offer is not authorised or to any person to whom it is unlawful to make such an offer or solicitation. The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

Ramsey Crookall and Co Limited is licensed by the Isle of Man Financial Supervision Commission.



Questions

Stuart Cowan Chartered FCSIDirector

Peter Robertson BA (Hons) Chartered FCSISenior Investment Manager


The Illusion of Recovery - Presenation to the JCC (IOM)

Economy & Finance

Transcript of The Illusion of Recovery - Presenation to the JCC (IOM)