Market Bulletin (18/09/2018)
Ten years ago last Saturday, a 158-year-old US bank filed for bankruptcy. The demise of Lehman Brothers was neither the cause nor the lowest point of the global financial crisis; but may have been its most visible and shocking moment. Lehman held $691 billion in assets; its bankruptcy filing was (by more than $300 billion) the largest in US history.
Lehman’s demise also offered a reminder that politics still mattered on markets. Hank Paulson, US Secretary of the Treasury at the time, faced pressure from the financial sector to step in and help the troubled lender, and pressure from elsewhere to let it suffer the perhaps just effects of its poor decisions. Paulson chose the latter: “I’m being called Mr. Bailout. I can’t do it.”
The S&P 500 dropped from 1,255 points on 15 September 2008 to below 900 on 6 October, a fall of more than 28%; then, in March 2009, it hit an intraday low of 666. But the trading week following the collapse of Lehman was particularly ugly. Our opening paragraph on 22 September 2008 captured the general mood: “Tumultuous, febrile, cataclysmic, completely insane – that was how the media summed up what will probably be one of the most extraordinary weeks in the history of the world’s financial markets.”
For too many investors, the crisis was wasted, as they quickly made their way for the exit and ensured that paper losses became all too real. Yet not everyone sold up. On 15 September, the day of the Lehman bankruptcy, Nick Purves of RWC Partners, who still manages the St. James’s Place Equity Income fund, commented: “One thing is certain; when we are through the current problems, a powerful rally will ensue… Crisis creates opportunity because, when the market is ruled by fear, investors’ decisions are driven by emotions, not fundamentals and this enables me to pick up good assets at low prices. It happened in 1998 and 2002 – I believe we have the same opportunity today.”
How right he was. Last Friday, the S&P 500 closed at 2,907 points, 2.3 times higher than its close on 15 September 2008, and more than 4.3 times higher than its mid-crisis intra-day low in March 2009. The FTSE 100 ended last week up at 7,304 points, more than double its mid-crisis low of 3,530 in March 2009. Purves took the opportunity to buy stocks when the market crashed.
“We have been surprised by the extent and the duration of the rally, which has been driven by a continuation of the ultra-aggressive actions of the world’s central banks,” said Purves. “Stock markets have enjoyed a long ‘Goldilocks’ period of healthy profit growth and low interest rates. The most spectacular returns in the portfolio over the period have come from consumer cyclicals such as Next, and from financials, which were priced for financial distress.”
In retrospect, the US appears to have responded more decisively to the crisis than Europe, as the dominance of its major banks relative to European peers attests. It has also enjoyed a far stronger recovery, as evidenced by the deluge of positive data. Last week, unemployment benefits came in at their lowest level since 1973, as employers added 201,000 jobs in August; and private sector wage growth struck is at its highest level since 2009. The latter adds weight to the expectation of two Fed rate rises later this year, as do strong GDP and stock market growth figures: the S&P 500 is up almost 8% for the year, while many emerging markets are in bear territory and the FTSE 100 is down a few points.
Yet America’s allies should not assume that good news at home means an easier time for relations abroad. Last week, China’s trade surplus with the US hit a record high, spiking above £30 billion a month and making another round of US tariffs more likely, despite reports of Beijing showing greater flexibility in talks. Another US concern has been inflation; although on Thursday came news that it rose more slowly than expected in August, pushing down the dollar. Should inflation tick up more sharply, the Federal Reserve is likely to feel still more pressure to act.
Finally, the spectre of midterm elections is shifting into the foreground, offering the possibility of the Democrats winning the House or the Senate (or both). An analysis by Bank of America Merrill Lynch (released last week) shows that market outcomes are more positive if the House and Senate remain Republican.
Beijing is evidently concerned by developments in Washington, perhaps especially in light of economic indicators in China. Last week came news that investment in factories, rail and other infrastructure projects in China has grown at its slowest pace (year to date) in more than 25 years. As a net oil importer, it may also be suffering the ill effects of a rising oil price, which hit $80 last week on news of Hurricane Florence striking North Carolina in the US.
Indicators across Europe offered little reason for cheer, as industrial production fell and eurozone GDP slipped to 2.1% (annualised), having reached above 3% just a few months ago. The latest comments and reports from the European Central Bank, which left rates unchanged last week, suggest it will keep rates on hold through 2019 and only raise them in 2020. Greek bank shares dropped to a two-year low, but European shares more broadly ended the week up.
Signals in the UK were mixed, as long-awaited pay growth increased to its equal-highest pace since 2008. The Bank of England voted unanimously to leave interest rates on hold, however, on disappointing growth and business optimism trends. Deutsche Bank also stepped up plans to move hundreds of billions of assets out of London to Frankfurt.
Market attention is now focused on whether Theresa May can survive and cut a withdrawal deal with the EU. She was helped last week when the influential European Research Group, a pro-Brexit parliamentary group headed by Jacob Rees-Mogg, failed to deliver its own plan for Brexit, reportedly due to internal disagreements. A YouGov poll published last week showed an ever-larger proportion of Brexit voters regretting their choice, while Mark Carney said the Chequers deal would deliver a £16 billion boost to the economy (since a supposedly costlier outcome is currently priced in to markets); both developments should help the prime minister win support for her middle-of-the-road Brexit. However, a new challenge emerged over the weekend as Emily Thornberry, shadow foreign secretary, warned that Labour MPs planned to vote against the Chequers deal.
At a personal level, however, focus in the UK is increasingly turning to the forthcoming Budget, and to what may yet be targeted by the chancellor to pay for his NHS funding pledge. Among the areas on the menu for cuts is tax relief on pension contributions. In this light, it was perhaps significant that David Willetts, an influential former government minister, said last week that it would be unfair to ask working people to fund pensioner benefits, especially now the median pensioner income is greater than the median working-age income. Concerned that the forthcoming increase in the minimum contribution for automatic enrolment (to 5%) will encourage opt-outs, Willetts proposed incentivising automatic enrolment by using National Insurance contributions from pensioners’ income. Such an imposition should only affect wealthier pensioners, he said, but any such move would have significant implications for retirement planning.
RWC Partners is a fund manager for St. James’s Place.
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