Market Bulletin – Pressure Point

On the tenth anniversary of the global financial crisis, the greatest risks appeared to be geopolitical rather than financial.

Wednesday marked ten years since the beginning of the global financial crisis, and its consequences continue to be felt on markets and in politics to this day. Indeed, the crisis was so momentous that commentators tend to divide recent economic history into the ‘pre-crisis’ and ‘post-crisis’ eras.

Yet the world’s focus on Wednesday morning was, perhaps understandably, elsewhere. North Korea responded to US-led sanctions by promising “thousands-fold” revenge on the country. Speaking to press on Tuesday, Donald Trump had warned that the US would meet North Korea’s nuclear threats with “fire and fury, the like of which the world has never seen”. North Korea responded by saying it would conduct a missile test close to Guam, a US territory (and military base) in the western Pacific.

Such inflammatory rhetoric is par for the course among North Korean leaders. It is much less common among US presidents. The fact that Trump’s words closely resembled those of Harry Truman in 1945 was hardly comforting. After the US had dropped an atomic bomb on Hiroshima, and before it dropped a still more potent one on Nagasaki, Truman told the camera: “They [the Japanese] may expect a rain of rack and ruin from the air, the likes of which has never been seen on this earth.”

Pundits and investors alike are increasingly at ease with the former real estate magnate’s negotiating strategy in other areas of politics. But ‘bidding high’ in talk about nuclear weapons is a little different, especially now that North Korea claims to have finally completed building a fully-functioning intercontinental ballistic missile. Jeffrey Lewis, director of the East Asia Nonproliferation Program in Monterey, California, is clearly convinced. “That’s done. We’re there. North Korea can put a nuclear weapon on New York City,” he said last week. Other experts were more guarded.

Markets suffered as a result. Japan’s Topix and South Korea’s Kospi indices took significant hits, while the S&P 500 ended the five-day period down 1.34%. Purchases of ‘safe-haven’ assets such as gold, Bunds and Swiss francs rose. Perhaps most significantly, the VIX (which measures volatility on the S&P 500) jumped more than 50% to reach its highest level this year.

US losses might have been greater were it not for earnings season. Three sectors dominated: energy, which has been buoyed by a higher oil price; finance, which benefits from rising interest rates (and, in the US at least, from much-improved balance sheets); and technology, which accounts for 23% of the S&P 500. These three sectors alone accounted for 70% of earnings growth in the latest quarterly round among S&P 500 companies. While reduced consumer spending has provided a headwind for some of the major brands, such as those owned by Procter & Gamble, a weakening dollar has buoyed corporate profits more broadly.

In fact, the S&P 500 has posted dozens of record closes this year. It is this kind of success – together with the historically low yields on both sovereign and corporate bonds – that has led some analysts to worry whether markets are in a bubble and another financial crisis might be in the offing. Yet there are good reasons to think not. It was a crash in the US housing market that triggered the last financial crisis and, as a report published last week by Capital Economics pointed out, US house prices today are not stretched; the ratio of mortgage lending to disposable income is far, far healthier than in 2007; banks have tightened their lending criteria; and there are far fewer houses coming onto the market. The so-called NINJA (no income, no job or assets) mortgage loans so common in 2007 are no longer freely available. Moreover, on Friday Nationwide released figures which showed that its buy-to-let UK mortgage lending fell by half in the second quarter – last year’s Stamp Duty increase, this year’s tax relief cut, and falling rents were all reckoned to have played a part.

Nevertheless, the crisis offers plenty of salutary lessons to today’s investor. Charlie Geller was one of the few investors to see the crisis coming. In The Big Short, the Oscar-winning film based on the book about the crisis, Geller’s character explained: “Our investment strategy was simple. People hate to think about bad things happening so they always underestimate their likelihood.” It is a warning worth heeding in all markets – there is no substitute for looking closely at a company’s balance sheet, and understanding where the risks lie.

However, just because people aren’t borrowing too much to buy houses any more doesn’t mean that they’ve learnt how to save properly. Alistair Darling, UK chancellor when the crisis was at its peak, used the crisis anniversary to warn that rising consumer debt should “raise alarm bells” over the UK’s economic outlook.

A report released last week by the Social Market Foundation would suggest that he is right to be worried. It showed that 14.4 million working-age adults in the UK are not saving at all, while 26.5 million do not hold adequate asset balances in either ‘rainy day’ or pension savings. Moreover, too many of those who do save fail to allocate their money wisely – 6.8 million hold more money in cash than needed to cover emergency costs. Yet money left in instant access cash accounts over the past five years would have lost 4% in value due to inflation, the report found. Had that money been invested evenly across the FTSE 100, however, it would have gained 47% over the same period.

Figures released by Visa last week showed UK consumer spending falling in July for the third consecutive month – the longest contraction in more than four years. Meanwhile, estimates showed the UK economy slowing again, as a weak pound failed to boost exports. Manufacturing output was flat in June and the trade deficit widened to £4.6 billion – the biggest this year. On the other hand, a survey by Markit showed that UK employers are hiring staff via recruitment agencies at the fastest rate in two years. The biannual Boardroom Bellwether, published last week, showed that two thirds of FTSE 350 companies believed political risk in the UK was rising, against just 40% last December.

Corporate earnings announcements in the UK last week offered similarly varied signals. G4S, a security services firm, and Rupert Murdoch’s News Corp both saw their stock prices sink on poor results. Meanwhile, Worldpay, a UK payments processing company, revealed that it will be bought by the American company Vantiv, creating the largest payments processor in the world.

Stocks in the UK, as in much of the world, suffered in part due to tensions over North Korea, but corporate factors were also significant, pushing the FTSE 100 down 2.69% to a three-month low, as financial, energy and mining stocks slipped; the Eurofirst 300 ended down 2.78% and the Nikkei 225 fell 1.12%.

Continental European stocks were afflicted by mixed corporate earnings and concerns over the outlook for debt. Figures last week showed that Italian banks’ holdings of domestic sovereign debt fell by the largest amount on record in June, and central banks continue to increase bond purchases to plug the gap. The ECB is expected to make a tightening announcement in the coming weeks, but in many ways the market has yet to be let off life support. Ten years after it began, the global financial crisis continues to loom large over the world economy.

 

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