15th May 2009

And then at last the parachute opened!

In sterile City offices, country downgrades are achieved by tapping into a keyboard; in the real world they can result in the chucking of a brick. It is very easy to blandly talk about downgrading in the ratings of national economies without appreciating the implications for, not just those nations, but their populations as well. Downgrading is in fact far from just being a technicality but something which can directly impact on the cost of funding for that nation. Such extra costs will mean fewer funds available for investment and expenditure, thus often resulting in cut backs and a reduction in facilities - and consequently employment. Tensions rise as economies weaken.

Over the past few months quite a number of countries have lost their treasured “Triple A” rating status including Spain, Ireland, Greece and Portugal, and this has directly impacted in their cost of funding. For others the issue will be worse - certain nations like Argentina, Pakistan, the Seychelles and Sri Lanka’s ratings have fallen to junk status. Not so much affecting the cost of funding but actually any funding at any price! This, then, is when domestic pressures boil over and even the international funders like the IMF get the blame (as often deflected criticism is provided by weak and unpopular local politicians), and the first bricks and petrol bombs get thrown. I fear a whiff of tear gas before the Summer is out.

Last week I got the distinct impression that I could at last feel the comforting tug of a parachute opening. After several months of seeming to be freefalling, the global economy started to show some more distinct if not necessarily more reliable, signs of slowing its rate of its previously precipitous descent.  The wholly unreliable, and in fact often misleading, monthly housing data is starting to give contradictory signs – which in real speak means that none of them know really what is happening. Some up, some down – well it’s better than all going down. These erroneous monthly figures always claim to be based on actual transactions – the question is then, who did the other one?

With barely any transactions being carried out except by forced sellers, and few buyers with constricted mortgage facilities available, there are barely enough deals being done to really have any proper price formation and thus provide reliable data. The likelihood therefore is that house prices will continue to fall, but at a gentler rate than before. This still looks like a ten year peak to peak cycle to me – so there is still a long way to go yet.

Another parachute indicator was the CIPS/Markit purchasing managers’ survey which came out last week. Although the headlines from certain newspapers waxed enthusiastically as the figures rose from some dismal depths, it is however worth pointing out that the figure was still negative (i.e. below the 50 mark) which still indicates a contracting measure of confidence. Some mentioned that this was a real “green shoot” but I am not sure how something that is still shrinking, albeit more slowly, can really be classed as a shoot of any particular colour? No, more like a weed that is still wilting but just not quite as much as before.

However, let me be more positive – there have been two areas where we have seen some encouraging signs - stock replacement and consumer expenditure. Both of these are quite logical as stock levels will necessitate a certain level of re-ordering but probably only at a low level.  As for consumer spending, again it is quite usual to see a small bounce from a lower level and especially with a little Spring sunshine.  Add to this last week’s German capital goods orders rising by quite a reasonable level, small output rises in both India and China, and there is certainly a growing list of positive indicators.

So a new bull market or a bull rally in a bear market? Time to look at some fundamentals. The global economy has been damaged, the banking system is still in a very poor state and unemployment will continue to rise for some time to come - even after the technical recession has ended. To me this adds up to a reason for a decent rally, but then an inevitable pull back as reasonable profits are taken and the bullish enthusiasts gasp for air. A key measure may well be during these rallies to see if the level of new market lows keep rising – this will be a trend  that will be a sign of growing confidence.  For the time being, enjoy the Spring bluebells - before they wilt.

And finally... if ever you thought you might be feeling a little lonely, then spare a thought for Afghanistan’s only known pig.  Although previously able to happily graze and gambol with goats and deer, Khanzir the lonesome pig has, because of swine flu fears, now been quarantined. The result is that the chances of finding a companion for the swooning swine are now dwindling.

Have a good week.

Justin A. Urquhart Stewart
Director
Seven Investment Management Limited