29th October 2009

An interesting beat-combo

So how was your 'beat'? This has become the favourite word for US commentators for the past few days when discussing the recent string of quarterly corporate earnings coming out of the States. This most recent verbal confusion now uses the term as a noun usually with an attached descriptor of quality or size. Thus we can now apparently have a 'good beat', 'big beat' or even a 'no beat' and 'under beat', all to describe the quality or otherwise of the expectations of these important earnings figures.

At mid point it seems that it is open for all to see what they want to see (or are hoping to). The Bulls are seeing good recovery figures laying the foundations for a more solid outlook for 2010; the Bears are inevitably more cautious and point to weaker top line sales numbers rather than larger bottom results. Overall though it would appear that over 70% of those reporting seem to have come out with quite good 'beats'.

However, there are themes definitely appearing from which we can make some deductions. Domestic consumer demand in the US generally still seems relatively flat, with earnings from the likes of Coca-Cola looking far more promising overseas with double digit growth in both China and India. The bright sparks from Apple also provided an air of optimism but much of this is still around product specific issues and fashions especially around the iPhone, which has managed to make the Blackberry look 'positively passé darling' in less than a year.

Others like Caterpillar are seeing signs of 'improving economic conditions throughout most of the globe', which again seems to be a description of improvement outside the US and not necessarily inside. However, despite the optimists looking for growth, the theme of cost cutting is still prevalent - as perfectly described by the FT last week 'US companies have cut costs faster than revenues have fallen', which sums up what seems to have been going on.

It has of course been the banking figures that have grabbed the headlines with their astonishing profit recovery figures just a year on from near Armageddon. Again these figures need separation, as those with retail and commercial banking businesses have still been languishing in 'the slough of despond' with more write-downs and losses to come, but on the other hand those investment bankers are showing eye watering figures that seem almost to ignore the events of the past twelve months.

These figures and the related populist row over bonuses have created a not unexpected furore. Following on from the huge government bailouts, both direct and indirect, these organisations have benefited not from just these palliatives, but also from having even fewer competitors. After a year in which it was said we didn't want to have banks that were too big to fail, we now have fewer investment banks doing an even greater percentage of the business - that is to say making it even riskier! Brilliant.

I personally am with the Governor of the Bank of England and look forward to seeing certain banking functions and businesses being separated. In my view the only thing that an investment and commercial bank have in common is the same title - bank, thereafter there is little in common. There is though, in my view, one compelling issue for such separation of business. It's not just risk, attitude and business, all of which are sound reasons, but really that linked and intertwined banking systems mean that depositors' savings might be used and potentially at risk by the investment banking side, especially in times of squeeze and pressure. This is wrong. An economic utility is a different beast from a financial trading and investment business. One is essential for the effective running of a capitalist system, the other is a separate risk taking business.

The fact that the Prime Minister and the Chancellor regard these ideas as simplistic and out of date is more of a reflection of their knowledge and understanding. Comments that a US style Glass Steagall Act (brought in the 1930's to provide such separation) are not appropriate in the 21st Century seems in itself simplistic. Mervyn King though is not alone in his views, with President Obama's economic adviser Paul Volker, the highly respected predecessor of Alan Greenspan at the Fed, who also wishes to see such banks keeping out of riskier activities. We must remember that the level of risk and concern only started to rise when it was repealed and the two cultures were allowed to mix- blending nitro and glycerine may seem simplistic - it is - but it's dangerous.

What I do find simplistic is that we must now establish new international bodies to manage banks and provide advance warnings of upcoming risks and concerns. Do they not realise that we already have them - and they warned us all in advance - and what happened? Nothing. None of the politicians or their advisers took any notice. The Bank of International Settlements, the 'bankers' banker', warned, to my memory, at least twice of such concerns, but who was willing to possibly infer that the emperor might be somewhat sartorially challenged? No, we were still too focused on prolonging our booming economy on our bubble of debt.

However, separating the two styles of banking itself wouldn't have prevented all the events of the past two years, but it would have meant that we should have had far clearer and focused regulatory understanding on the different areas. This could have meant that the risks being run by the bad business models of Northern Rock and Bradford and Bingley could have been addressed, the over indebtedness of the population being properly understood by the politicians, and even the reckless commercial (almost private equity) lending by the Bank of Scotland being addressed.
There is of course no single answer or solution, but there is a need for a greater appreciation of understanding and managing risk in different areas - making things too complex to manage means that they are inevitably too complex to understand.

And finally.... measure of the state and quality of British 'edjakashun' - graffiti in a Gatwick airport loo I noted last week - 'West Ham is a poof' - I suppose there might just be a Mr Ham sadly given a first name of West? Even so, his sexual orientation is of no interest to me.

Also I overheard in the same airport, "I only usually have one because I can't count past two" - I wonder in fact if that was the author of Mr Ham's statement?

Have a good week.

Justin A. Urquhart Stewart
Director
Seven Investment Management Limited