17th September 2009

An Air of Palpable Excitement

I can't remember seeing such group ecstasy for a long time. Suddenly it's all over! The announcement of the return of M&A bids was greeted with the joy and relief of a chocoholic licking their first Mars Bar of the day. This was perfectly illustrated by Kraft’s cheeky bid for Cadbury  which was almost greeted with euphoria and, although Cadbury's themselves stuck two chocolate fingers up at the Kraft bid, this is going to be a story that may well be with us for some weeks to come with others like Hershey and Nestlé no doubt increasing their interest.  For parts of the City the fact that corporate deal making was back on the agenda and seen once again as an acceptable form of capitalism, will have been greeted with huge relief as just another indicator that the investment markets are slowly but surely easing from their year of cramp.

However, before the school children get too over-excited, this is no return to the heady days of two years ago, but rather opportunist action by those able to use cash and paper to try and do a deal. It does mean though that “risk”, albeit in restricted amounts, is back.

But if that wasn’t enough the breaching of 5000 points on the FTSE100 has seen a rash of re-rating of expectations from quite a few retail houses seemingly oblivious of either how far we have come or the risks of weaker growth expectations in the next year. Now markets are always said to be able to climb a “wall of worry”, and they often do as they try to look ahead and discount future value. However, there seems this time almost a denial that certain key elements are still badly damaged and will provide only limited support to any recovery – this is of course namely the banking and finance system. Still, let us enjoy our Indian Summer of calm, cooling weather and use it to finish off the last of the Summer rosé wine – we must appreciate the gains but not let the feelings of mellow fruitfulness be replaced by sleepy complacency.

In fact I think there was actually some far more encouraging news which seemed to get very little overall coverage. This was the investment by China and one of the Abu Dhabi sovereign wealth funds in some strategic investment overseas. If there was one thing that the G20 should be looking for, it would be the recycling of reserves by those countries who have built up secure cash piles. The global economy needs those with the cash to get spending - even more especially as they can no longer rely on those deficit laden nations to spend their way out of the impasse.

With China it is worth stepping back to see the bigger picture and see if we can try and “join the dots” to try and find a pattern. Not only have we been seeing the Chinese investment funds being exported, but also the continuing pressure to make the role of the Renminbi more acceptable as a trading currency – or more to the point to try and move away from their reliance on the weakening US $.

In the past twelve months China has signed deals with Malaysia, South Korea, Belarus, Brazil, Indonesia and Argentina, all in order to start allowing it to receive Renminbi instead of the greenback for its exports. Since 2007 quite a number of Renminbi bonds have already been issued by some of the main Chinese banks in Hong Kong,  now even HSBC has joined in with its own issue earlier this year.  Now China is taking a further step towards the internationalisation of the currency by the issuance of sovereign bonds now available to offshore investors. At the end of this month they plan to sell Rmb 6bn ($870m £544m) with the stated aim of “improving the international status” of the currency.

So now try and join the dots and we can see a clearer picture of growing Chinese financial influence. Their currency is going to have greater traction and at some stage soon the authorities must start to introduce a plan towards proper convertibility and tradability. Not necessarily as easy as it sounds.

Part of this Chinese concern is coming from their continuing worry over the value of the Dollar and the Chinese reserves of over $2trn, 70% of which are thought to be in Dollars. The Chinese have thus been promoting an idea for a new currency order – maybe a new Bretton Woods agreement? - which could look to see an extension of the use of the IMF’s shadow currency the SDR (Special Drawing Rights) which is made up of a basket of currencies. Actually it currently consists of 4 with different weighted percentages – US$ 44%, the Euro 34%, Yen 11% and £ 11%. As these nations together only account for 28% of global exports, perhaps a broader participation might be more appropriate and provide potentially greater stability?

One of China’s views has been to expand the SDR basket to some 10 currencies, which potentially could leave the Euro and the Renminbi with 20% each, the US$ down to 16%, the Yen 9%, with £ and the Russian Rouble with 9% each. So one day your cash ISA might just have Renminbi in it!

And finally... a sad story of inequity. RBS are saving £100million by cutting the pensions of 60,000 of its employees; I am sure you will recall the somewhat generous £17million awarded to their previous leader having trashed the business. A fair share of the pain?

Have a good week.

Justin A. Urquhart Stewart
Director
Seven Investment Management Limited