Sleeping giant awakens
We are in the midst of a seismic upheaval in the global financial system and a nasty recession looms. The collapse of US bank Lehman Brothers as we went to press last month was dramatic, but it pales into insignificance compared with events over the ensuing five weeks. The law of unintended consequences, a direct result of allowing Lehman Brothers to go to the wall, has been applied to devastating effect, with some savers and all equity investors losing big time.
The consequences have yet to be fully seen. Yes, central banks and policymakers around the world have followed the lead set by the UK government in bailing out the banks. That, and the guarantees offered to help banks start lending again, are the first steps on the path back to financial stability.
Unfortunately, it is a long, steep and winding path, and we don’t know what’s around the next corner. It could be something that has the potential to render the action taken so far inconsequential.
I alluded to this last month when commenting on the credit default swap (CDS) market – estimated to be worth around $60 trillion (that’s 60 with 12 zeros after it). But the Bank for International Settlements estimates that, at the end of 2007, CDSs accounted for just one 10th of the entire outstanding market in derivatives. And the net risk inherent in the derivatives market amounts to $14.5 trillion.
It is just one of the fear factors behind extreme volatility and unprecedented levels of ‘distressed’ selling over the past few weeks – from commodities to corporate bond markets as well as equity markets. Even gold has failed to make progress over the month. Why? Because leveraged investors in commodities indices which include gold have had to liquidate their positions to raise cash.
This disorderly de-leveraging could turn into a rout if sentiment in derivatives markets turn markedly worse. An investment banker says: ‘A net risk of $14 trillion compares with the annual GDP of the US. Consider a disorderly unwinding of this market that is roughly 12 times the size of the global economy. This pool of silent derivatives can suddenly come to life any day with the failure of a multinational financial firm.’
That is the Doomsday scenario and if it does dawn, it will render the comments below largely redundant. Rarely, however, has there been a more compelling time for the brave to buy shares, although for the reasons above, a drip-feeding approach would be prudent, and also because volatility will reign well into 2009.
Five tips for the financial crisis... and beyond
BlackRock World Mining
This investment trust has been hammered as investors take flight from emerging markets and commodities. At 250p, the shares are down 70 per cent on the June high and are quoted at a 10 per cent discount to net assets. The reasons for a potential uplift remain valid – the commodities super-cycle has some way to run. Analysts have droppped earnings forecasts for mining shares by 40 per cent, yet the sector trades at a forward price/earnings ratio of 5.
You can see the August 2008 interview with Graham Birch, the trust’s manager, on www.moneyobserver.com
Peter Spiller
Fund manager Peter Spiller is a very clever man (see page 20). Don’t bet against him being wrong about resurgent global inflation – central banks may well crank up the printing presses. Spiller’s CG Real Return does what it says on the tin. In previous downturns Spiller has also shown an uncanny knack for picking up distressed assets in fire sales via the more conventional Capital Gearing Investment Trust.
Lloyds TSB
We should all show solidarity with shareholders who thought they’d backed a stick-to-your-knitting, dividend-paying, retail bancassurer. Join the shareholder register and vote against the government-enforced merger with HBOS. In the more likely event that institutional shareholders are persuaded to back the merger then take comfort in the fact that ‘LloydsBOS’ has been given carte blanche to make obscene amounts of money for shareholders (at the expense of customers). The shares are 150p.
Emerging markets
The transfer of economic wealth and power is inexorably moving from east to west. Aspiring middle classes in the emerging markets can be numbered in their hundreds of millions. Traditionally savers, Asians are discovering consumerism and spending: Chinese shoppers contribute more to global GDP than US shoppers. In the last two market crises the worst performing sectors – emerging markets and Asia-Pacific – subsequently bounced back to be the best performers. Advance Developing Markets investment trust, a fund of funds, has been holding cash in anticipation of picking up bargains in a sector suffering from the ‘flight to quality’. The shares are 270p.
Don’t panic!
Ten years ago, in the immediate aftermath of the Asian currency crisis, the collapse of hedge fund LTCM and the Russian government debt default, I wrote in the October 1998 edition: ‘Unless your investment outlook is apocalyptic, do not offload your equity holdings and pile into gilts – you have already missed the boat. The flight to quality has been underway for some time and gilt prices have risen sharply as a result, coupled with expectations that interest rates have peaked and will inevitably fall.’ It’s more scary out there now, but you should stay cool and try not to join the stampeding herd.
