Another day, another drop in the markets

Bets in the City / Simon Denham / 02 December 2008 / Leave a comment

Daily View - 2nd December 2008

Just when you thought it was safe to go back into the water the Dow drops 680 points in a session.

The more you watch the various twists and turns of our great leaders the more you begin to believe that they really have as much clue as myself as to how to put a stop to the turmoil. The underlying reality is that the falls of the last year have been caused by too much money supply operating for far too long. I used to comment on this ad nauseam. Money has been too easy to get and to spend. In the UK money supply has been running at over 10 pc for years with growth of around 2pc (here or there) and inflation of around 2pc (here or there) as well. All this money had to go somewhere and in the main it went into assets (houses being the main one). In the UK this was not helped by a government that continued to add stimulus packages even though the economy was trundling along quite nicely anyway, meaning that even in the best of times there was still a PSBR instead of a surplus.

The result is that the elastic band eventually snapped back and the banks have suddenly had to operate in a world of shrinking liquidity and, not surprisingly, have decided that they want to start restricting their exposure by cutting back on lending. So, in response, over the horizon rides the Lone Ranger in the guise of the Fed, the BOE, the EBC, Bank of China etc to save the world economy. Their reaction has been, and continues to be, 'print more money' keep the ride going for one more round and something might turn up. A redundant man applying for one more credit card on the basis that a job 'is sure to turn up soon'. The alcoholic's 'one more drink'.

Unfortunately this time the spending impulse is unlikely to have much impact in the short to medium term as the down turn has not really been allowed to run its course yet. So high had we flown that the Sun really has burnt our wings away. We might believe that the worst is over... and it might, you never know... but unfortunately this will not stop the continued destruction of loss making companies. The huge injections of liquidity will keep the edifice lurching on a bit longer but the more we try to prop it up the bigger will be the eventual fall. It will be many, many months before growth starts to be positive. If a business is only surviving on overdrafts and borrowings now, what chance in 12 months or 18? Gordon Brown's accusation that the Tories were the 'do nothing party' should become the Conservatives slogan. We have tried the pump-prime method, now what is needed is harsh reality. Get the country's (and individuals') finances back in order. This will take many years and will be unpopular (politicians hate this bit... What Yes Minister used to call "a courageous decision") but that does not mean that it is wrong.

Markets today are, surprise, surprise being called well down on yesterday's close at around the 3990 level and the optimism that we might have been about to get clear of the woods is draining away. The falls yesterday were pretty much across the board with every sector of the index struggling and on the open at least it is difficult to pick a winner to get your teeth into. Tesco may well add to the gloom with its worst period of growth for.... well, ever. But do not be too dismissive, it will still be growth for the biggest beast on the high street. A few years ago Tesco were said to take one in eight of every pound spent, if they are holding steady, and can continue to do so, then there is some hope for good news.

Yesterday was in truth grim across the board, virtually every asset class fell not just a bit but precipitously. Gold slumped 45 bucks as the dollar surged higher. Oil dropped over five dollars as five days of effort failed to get us above 54.75 and OPEC failed to announce any production cuts.

The pound had one of its worst days on record falling 520 pips against the greenback in one session. This is worse than any of the recent drops and you must hark back to the ERM crisis before getting and equivalent open/close move. Spreads on longer term UK Gilt insurance are getting more and more expensive and the yield curve is now 3.5pc from 6mth (1pc) to 15yr (4.5pc). Even though we all believe that rates are going to 2pc (this week maybe), and below, 4year UK government bonds are trading at 3pc. Once the issuance begins in earnest next year this curve may get much worse and will make corporate borrowing even harsher. Over in the States interest rates might be at 1pc but Investment grade US corporate bonds with a 3.65 year maturity are trading with a yield of 7.9pc!! Remember this is investment grade, above BBB.

Junk bonds are trading with yields of, on average, ...wait for it... almost 24pc on 3 year duration debt.

This is not big bad Banks lending at unfair rates, this is corporate debt in the open market. So when you read of how nasty the banks are being to small businesses (effectively Junk status borrowers) remember how much issuers are having to pay investors to buy their debt elsewhere.

The Tradefair Spread Betting Team