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By Stewart Richardson on 05/08/12 | Category - Economy

Expectations for further stimulus ahead of last week's central banks meetings were certainly rising. Mario Draghi, head of the ECB got the markets very excited the week before when he said that the ECB would do whatever it takes to save the Euro. Ben Bernanke chairman of the FED had also allowed expectations of more stimulus to build.

Despite "allowing" the markets to get so excited, both the FED and the ECB failed to deliver any fresh stimulus and the markets were rightly disappointed. There is no doubt that the FED will do something if the economic data shows further weakness in the economy, and the ECB is trying to build consensus for a plan. It is possible that equity markets will now react to signs of economic weakness as good news as it will bring forward central bank stimulus.

Friday also gave investors a newish twist. Post the disappointment of no fresh central bank stimulus, markets celebrated rumours that Spain would formally ask for a full bailout. This relates to the budding ECB plan where details are lacking. It seems likely that the ECB will intervene in a sovereign bond market (i.e print money to buy bonds) only when a sovereign has applied for a full bailout. The ECB will have to work with politicians and any bailout will likely come with conditionality (i.e austerity and reforms). Whilst we are lacking details and German support at this stage, the nuances between this ECB plan and previous sovereign bailouts are such that the outcome will be little different from previous European bailouts (which have not solved the European problem) in our opinion. We are therefore a little bemused as to why equity investors greeted the rumours of a Spanish bailout with so much excitement.

In short, financial markets last week went through some wild gyrations as expectations for stimulus were high going into the central bank meetings, only to be dashed, and then to be raised again on rumours of a Spanish bailout as well as a mixed US employment report. These wild gyrations are possible as market volumes are very low and even small transactions have an impact on prices. With markets now reacting purely on hopes for central bank money printing rather than the fundamental drivers that would usually be used, coupled with low summer volumes, the next few weeks may see further erratic market movements.

We continue to believe that printing money is a policy that can only lead to temporary boosts to financial assets, and at some point, will actually begin to be counter-productive. Perhaps the downside in equity markets is limited in the next month or two as hopes run high that any signs of weakness (both economic and equity market) will bring forward fresh stimulus. In this environment, tactical strategies are likely to be the best approach, and we will be positioning our funds accordingly.

By Stewart Richardson on 28/07/12 | Category - Economy

The economic data of late has indicated a sharp global slowdown is at hand, and this past week has been no exception. This global slowdown has been taking its toll on corporate earnings which have been disappointing. If this is all true, then why are equity markets rallying again?

Equity markets seem convinced that the FED will announce more QE when they conclude their meeting this coming Wednesday. With the FED having kept open the possibility of more QE for some time, many believe that the deteriorating economic data (which in some cases actually looks like the US economy is back in recession) leave the FED no choice but to print more money. In the past, with the economy this vulnerable, we too would have been advocating central bank stimulus. However, we are NOT fans of quantitative easing and we do not believe that the FED should fire its only remaining bullet. Of course, our views won't stop the FED doing what they want to do, so it is our job to work out what they may do and the potential market moves thereafter.

Back in early November 2010 just after the FED announced QE2 which then pumped $600 billion of new electronic money into the financial system, Ben Bernanke was kind enough to explain some of his thinking in a Washington Post op-ed. Explaining why they had embarked on this policy and what they were hoping to engineer by printing money, Bernanke had this to say;

"This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion."

Bernanke must therefore be happy with the result of his policies. For example;

  1. US 5 year Treasury bond yields have fallen from around 2.5% in November 2010 to 0.65% currently. The 10 year bond yield has declined from 3.5% to 1.5% over the same period.
  2. The S&P 500 has risen from about 1200 in November 2010 to 1370 currently.
  3. The 30 year fixed rate mortgage has declined from 4.5% to below 3.5%.
  4. The yield on the Moodys Baa corporate bond index (which measures bond yields for long dated bonds) has declined from about 6% to below 5%

Everything that Bernanke hoped would result from his actions happened except a self sustaining economic expansion. Rather than admit that his policies don't work and that any benefit that may be derived may actually be countered by some of the potential costs (i.e. higher food and energy prices hurting the economy), there seems to be an expectation that Bernanke looks set to potentially print more money.

It would seem strange to us that Bernanke would have to focus on weak "financial conditions" if and when he prints because QE and QE2 were supposed to fix this. He will have to focus on the nasty economic developments that have been seen in the last few months. Given the evidence in front of us, it is certainly plausible to say that any QE3 may not trigger the economic recovery. Following this argument through, Bernanke must be prepared to keep printing money in the form of QE4,5,6...until he runs the economy into the ground, helped by his politician friends.

Time will tell, but we believe that the whole QE experiment is beginning to lose credibility and any positive impact on equity markets will be relatively short lived. In fact, with the S&P 500 benchmark index up 8% from the early June low, there is a case to be made, especially considering the deterioration in both economic data and corporate earnings since early June, that the equity market is already pricing in some degree of more QE. Consequently, if the FED decides not to print at next week's meeting, equity markets may be disappointed- we certainly think they would be.

There are also two big hurdles for markets to overcome in the next few months, namely a European event and the US fiscal cliff - which, if allowed to happen, could knock US growth by nearly 5% and confirm a recession. It would seem to be more prudent to keep their powder dry and not use its only real weapon plus some of its dwindling supply of credibility by not announcing QE3 so that they can be prepared for these events take a nasty turn. It certainly seems to be a close call, but if QE3 is used now, and the economy gets sideswiped by either Europe or the US fiscal cliff, the FED will be left with few options. It is a legitimate question and one that the FED may well have to answer.

Part of the reason for the equity markets rallies last week was the ECB head Mario Draghi announcing on Thursday that the ECB will do whatever it takes to save the Euro. Frankly, we've heard this sort of talk before but, because it comes from the head of the ECB, desperate investors will grab any anything. Hopes are now running high that the ECB will start buying Spanish and Italian government bonds in the open market and that they may give the (yet to be created) ESM a banking licence which would allow the ECB to print money.

With the ECB meeting next Thursday, what can we expect? First, they cannot print money outright. This is simply not allowed under current treaties which Germany continues to confirm. They may start to buy bonds in the secondary market, although with the current bailout fund (the EFSF) already equipped to do so, why should the ECB put its already massively bloated balance sheet at risk? With Draghi having got the market so excited, it would be dangerous for him to do nothing. That said, we do not believe he has got the mandate to do enough to prolong the current rally in European assets by much.

For the record, we note also that the Bank of England meets next week, and there is no expectation of any change to policies.

So, the central bank scene is set. The economic case for stimulus is strong but underlying financial conditions are already in place so the justification is dubious. If the FED does announce more QE, markets may continue higher for a bit, but unless there is something new and unexpected in the FED's policies, the markets may already be pricing a good deal of the QE potential. The ECB may well do something, but we doubt they will be able to offer the markets much more hope with their lack of printing press facilities at the moment.

We believe there is a good chance that both the FED and the ECB will disappoint markets next week with what they deliver, and so we are not convinced by the current equity market rally. One amongst many reasons that we are sceptical of any shock and awe QE policies is that, if the market really thought that the major central banks were hell bent on debasing their currencies, Gold would be a big beneficiary. The chart below compares the performance of the S&P and Gold since coordinated central bank actions started late last year. Since then the S&P is up 25% and Gold is down 2%. Gold is not displaying the price action that would seem logical in anticipation of imminent QE and we believe that equity investors are basing their buying decisions on misplaced hope that printing money may work this time when the evidence refutes this. Time will tell if we are right.

Ahead of the FED and ECB meetings next week, we remain a little bit bearish of risk assets overall. If we are wrong and full QE is announced, we will move to neutral stance overall and decide what to do from there. If we are right, we will look to add to our bearish positions.

By Stewart Richardson on 21/07/12 | Category - Economy

We have undertaken a whirlwind tour around the world to re-acquaint you with what we believe to be the major issues facing economies and markets. Stops on the tour include:

  • A few subtle yet dangerous developments in Europe (mainly Spain).
  • The corporate results season in the US which is looking a bit mixed.
  • Economic data remains poor.
  • Energy and food prices are rising again which will act as a tax on consumption and may inhibit the ability of global central banks to ease policy further.
  • The embedded belief that central banks can and will print money (embarrassingly egged on by US politicians and the IMF this week) is overriding these concerns allowing equity investors to shrug off these worries and drive markets higher.


As a quick reminder, the markets rallied strongly around the end of June summit as it appeared that policymakers had found a way to break the "death-spiral" link between Sovereign and Banks. It is therefore disappointing that Germany has confirmed that Spain remains liable for the debts that will be assumed in bailing out their banks. On Wednesday, the Bank of Spain revealed that bad loans increased again in May to an 18 year high and that more money has been withdrawn from banks, where deposits are 5.75% lower than they were a year ago.

As part of the agreement for the bank bailout, Spain has to reduce the government deficit. PM Rajoy proposed a EUR65 billion deficit reduction plan last week. Spending cuts and tax increases will push the economy further into recession but key structural issues (such as Pensions) that are simply not affordable given current law were left unaltered. Why the authorities believe that spending cuts and tax rises (the policy mix that was enacted in Greece - and incredibly now being enacted by the New French administration) will work is beyond us.

What is required is reform to the tax system, the employment law and the entitlements system, as well as a significantly cheaper currency. Of course, these will not happen and Spain is now on a slippery slope. Even though equity investors are fawning over actual and expected central bank stimulus, the yield on the 10 year Spanish bond has closed above the elevated 7% level and the 5 year bond yield is at its highest for the last 16 years at 6.8%. Spain is having to pay interest rates on its debt that are far higher than the nominal growth rate of the economy, thereby ensuring that their debt/GDP rises. This circumstance is simply not sustainable and there is a growing belief in the bond market that Spain may require a full bailout.The fact that hundreds of thousands of protestors are taking to the street to protest against the austerity is certainly not a healthy development.

The United States

We made the case in last week's note that the US equity market valuation is at best fair value. That said, if earnings growth is very strong then the market may be cheap, and so some may take heart from the fact that some 65% of companies that have reported so far have beaten earnings estimates. Unfortunately, 70% of companies are missing their revenue forecasts and this means that companies are working hard to manage costs - i.e. headcount. The more companies manage costs, the lower personal income will be and the less consumers will spend. Indeed, we saw this week that retail sales fell for the third month in a row, something that has always happened either in recession or on the eve of recession.

At best, the economy is now at stall speed (economists are predicting annualised growth of about 1% for the second quarter, down from 1.9% in the first quarter), the FED has no effective tools left to help stimulate the economy and the US fiscal cliff will have to be addressed by year end. We frankly struggle to see how domestic corporate earnings can grow strongly in this environment especially with no help from overseas operations and when corporate profit margins are still close to multi-decade highs.

For the equity market to rise from here, in light of the deteriorating corporate environment, the market will have to enjoy a re-rating which is doubtful given the incredibly poor global macro environment.

Central Bank Stimulus

So much for all the bad news, there has actually been some good news of late as central banks have been busy. In the last two weeks, the Bank of England has increased its money printing from £325 billion to £375 billion and the ECB, the Peoples Bank of China, the Bank of Japan, the Bank of Korea, the Reserve Bank of South Africa and others have reduced interest rates. Where monetary policy is still effective (i.e. emerging markets) this will help the domestic economy. In the developed markets, we believe that these central banks are pushing on the proverbial piece of string when it comes to helping the economy, although the rate cuts will force investors to increase their search for yield. With talk that both the UK and US could cut rates to zero as the ECB did, the search for yield could well become a scramble.

In this environment, we believe that high quality corporate bonds could perform well and from a risk perspective, they offer a safer investment opportunity over the next 6 to 12 months than equity markets do. In light of this renewed global central bank stimulus, we have introduced some US corporate bond exposure that has a yield of just less than 4%. As well as generating a significantly better yield than cash, we believe that this exposure can perform well in a period when investors are seeking to take on more risk. It would also be well protected if investors suddenly shift to risk aversion mode as this would indicate a poor economic environment that is supportive for high quality corporate bonds.

Having said all that, we have written before ( link here) about how printing money is exhibiting diminishing returns for equity markets. We wonder how much further markets can rally even if the FED does announce more money printing on 1st August. If they don't announce more, equity markets could be vulnerable.

Rising food and energy prices

There were hopes that after falling by 30% in the Spring, lower energy prices would act as a stimulus for the global economy. Unfortunately, rising tensions in the middle east have driven oil up by nearly 20% in recent weeks and if prices remain around here or higher then they will begin to act as a drag on global growth. Perhaps of greater concern has been the dramatic rise in food prices, particularly Corn and Soybeans. This will impact absolutely limit the room for central bank stimulus where hopes have been high that China for example would be able to stimulate further. Rising food and energy prices may also limit the ability of the FED to print more money as it is clear that QE has not only driven equity markets higher it has also driven commodity prices higher. Simply put, rising food and commodity prices are a very unhelpful development at a time when the global economy is as vulnerable as it is.


The global macro environment continues to be a head wind for financial markets. The US economy appears to be stalling and is at risk of slipping into recession. The deteriorating environment coupled with a market that is expensive on historic measures makes US equities (and global equities for that matter) unattractive. Furthermore, Europe is not fixed despite the excitement after the end of June EU summit.

Central Banks are easing policy and many pundits are hoping the FED will print more money on 1st August. If they do, equity markets may add to recent gains otherwise equity markets are vulnerable. Under either scenario, we think high quality bonds that still offer some yield are reasonably attractive and so we have added some US corporate bonds to the funds that we manage.

The current environment, backed by the indicators we use mean that the next few months are not likely to be a rewarding time for equity markets and we remain defensive on equities overall. We are searching around in other assets for investment opportunities that offer better reward versus risk characteristics.

By Stewart Richardson on 28/04/12 | Category - Economy

It's been a busy week with lots to report on. Rather than cover just one topic, we thought we would touch upon some of the noteworthy news and then share some of our observations. We'll start with the US, move on to have a quick look at the UK and finish up with Europe and then our conclusions. The European section is a bit longer than the US and UK, but there is just so much to talk about there!

First, last week we explained at length why we remain bearish of Spain generally, although we noted the oversold condition of equity markets in Europe and that this was the reason for reducing our bearish positions temporarily. Blowout results from Apple and a dovish Ben Bernanke (more on that below) helped markets rally, and we re-entered our bearish positions in Spain and Europe on Wednesday and Thursday.

Thoughts on the US

The economic data in the US continues to disappoint - two thirds of data points have been worse than expected in the last month. Q1 GDP rose by 2.2% it was announced this week. This data, was also below the expected 2.5%, but in a world where growth is at a premium, this was by no means a disaster.

The Federal Reserve's policy committee met this week, and managed to confuse the market despite their commitment to greater transparency. Interest rates were left at 0% to 0.25% and there was no change to unconventional policies - all as expected. The committee also released their updated economic forecasts which show that they expect slightly better growth and slightly lower unemployment in the quarters ahead. Their inflation forecasts were nudged higher and are at or just below their target of 2%. All in, the members of the committee brought forward their forecasts for when interest rates should start to rise. This, we thought, would mean that further quantitative easing would be off the agenda. Then, Ben Bernanke spoke at the post meeting press conference and, in answers to questions, said that he remained ready to do whatever it takes to ensure the US economy remains on a steady footing. QE3 therefore remains on the agenda!

It would therefore seem that the committee is split, with the majority forecasting modest improvement and no need for more quantitative easing whereas Bernanke remains hovering over the printing presses with the engineers ordered to keep them oiled and warmed up. A divided FED is not a positive long term development.

With regards to what we need to watch, the unemployment data is becoming more and more important. We believe that if the unemployment rate moves higher in the next few months, the FED will print more money. If the rate declines, the FED will not print. It is as simple as that. Not only is the unemployment picture key for trying to gauge whether there will be more money printing, it is also key for the direction of the equity market. The chart below shows the US equity market with the weekly jobless claims numbers. If jobless claims start rising (they have been rising for two months or so) then we can expect the S&P to come under some downside pressure.

Thoughts on the UK

The data released this week shows that the UK economy is in recession. Some will argue that construction spending impacted the data negatively. We would say that construction is booming ahead of the Olympics and will grind to a halt afterwards. No matter what is said, the UK economy is not doing well, and the outlook is deteriorating.

The UK economy is very reliant upon our friends in Europe so the economic circumstances there should be a serious headwind for the UK in the months ahead. Furthermore, despite EUR 1 trillion of fresh liquidity from the ECB, European banks are still very vulnerable. With the banking sector in the UK being so important to our economy and so interlinked with the European banking system, there is a growing vulnerability that will increase the headwinds coming across from Europe.

We remain slightly perplexed at the strength of Sterling on the foreign exchange markets, and in particular against the US Dollar. With the US economy growing at 2.2 % and the UK in recession, we would expect Sterling to be moving a bit lower, not higher. In particular, with the problems afflicting European banks, we would expect Sterling to be lower than it is currently. The chart below illustrates the correlation between European banks' share price performance and the exchange rate between Sterling and the US Dollar. The only time in the last 12 months when Sterling looked this "expensive%u201D compared to European banks was in August last year just before a 6% decline for Sterling. We think that Sterling is vulnerable on this basis.

Thoughts on Europe

It is generally understood (outside of Europe at least) that putting a currency union together before there is full fiscal and political union is a nonsense. When times are tough, voters will naturally vote for policies that benefit themselves rather than policies that hurt them. Austerity policies are crucifying the periphery countries, will hit the core too and there is no sign of any improvement - in fact, things may be getting worse. It should therefore not be a surprise to see voters in France move away from the centre to the extremes. Approximately one third of voters voted for either the left or right wing candidate in the first round.

The second round vote in France is on the 6th May and Greek voters go to the polls on the same day. It is likely that Francois Hollande will win in France and his policies are anti austerity (which will not sit well with Brussels, Berlin and the ECB) and pro income redistribution. This is clearly pro French as opposed to pro EU and could be economic suicide at a time when growth is required. On the Greek front, the two main parties that garnered 77% of the vote in the 2010 election are polling at a combined 35% or so. The left and right wing parties combined are polling at about 42%. There is a real chance that Greece will elect officials that decide that they cannot bear the economic cost of remaining in the Euro.

The markets were also shocked by the Dutch coalition budget talks collapsing. Here is a country that has been at the core of Europe since the beginning and has been a beacon of fiscal rectitude. Not only are they struggling to meet the fiscal criteria set out in the recently agreed "fiscal compact" but the politicians are struggling how to make the necessary adjustments. Holland is already in recession and an austerity programme will make matters worse with fresh elections to be announced.

It just gets worse and worse for Spain. On Thursday night Standard and Poors downgraded Spanish debt and retained a negative outlook. It is likely that the other ratings agencies will follow (Italy may get downgraded too). On Friday, Spain announced that their unemployment rate rose to 24.4% (higher than the estimates of economists at 23.8%) which the highest in 18 years. Youth unemployment is at 52% which is simply staggering. Earlier in the week, the Bank of Spain confirmed that growth was negative in the first quarter and that the economy was back in recession. Retail sales were released showing them to be down 3.7% on the same period a year ago, the 21st month in a row that sales have fallen. "In Spain today, a cycle similar to Greece is starting to develop" said HSBC chief economist Stephen King.

Europe is in recession and the periphery is in a depression. Voters always shift from the centre ground to the extremes in this environment ("it's the economy, stupid" as Clinton once said). We believe that as countries veer away from Brussels and become more nationalist, the breaking up of the Euro gets closer.


The rally in European equities early last week was well within our expectations and we used that strength to re-establish the bearish positions that we had exited the week before. Europe (and the UK) is getting worse, and even the mighty US may not be doing quite as well as the most bullish commentators believe (although much better than Europe and the UK). Equity markets look vulnerable in the weeks/months ahead especially without any imminent central bank money printing. Elsewhere, Sterling is looking vulnerable against the Dollar and could reverse lower at any time.

By Stewart Richardson on 17/03/12 | Category - Economy

Central banks have been incredibly active in employing extraordinary measures in recent years. The balance sheets of the FED, ECB, Bank of England and Bank of Japan have been expanded by well over US$4 trillion since late 2008 and now represent about 30% of their combined annual economic output (or Gross Domestic Product - GDP). We believe that these extraordinary policies are beginning to reach an inflection point. If central banks continue to print money at the same rate, then we fear that they could well lose control of inflation, and the likely economic outcome will be a mixture of higher inflation and poor growth in output - what economists call stagflation.

Although there was a recent Wall Street Journal article hinting at more stimulus (the "official" term was "sterilised QE") being discussed by the FED, Ben Bernanke did not mention this during recent testimony to US politicians, and there was no hint of immediate QE at this week's FED meeting. In fact, our reading of the FED's statement released after this week's meeting is that the FED has marginally increased its assessment of the US economy. Whilst they expect inflation may be temporarily higher due to higher energy prices, they seem confident they can meet their dual mandate of maximum employment and stable prices over time but still see the risk of inflation undershooting their target. This seems to leave open the possibility of more QE at some point, but only if the economy (and presumably the equity market) deteriorates from here.

At a recent press conference, Mario Draghi, the head of the ECB, was quite clear in that the recent EUR1 trillion liquidity operation has been enormously beneficial to the financial sector and that he wants to take a step back now to assess the effects over a longer period of time. Furthermore, the German central bank (the Bundesbank), who was at best a grudging supporter of the recent liquidity operations, is calling on the ECB to start thinking about their eventual exit strategy.

Our view is that the FED and the ECB are on hold for now and no more money will be printed unless there is an economic deterioration in the weeks/months ahead and/or there is a greater than 10% correction in equity markets.

There has been some excitement in recent weeks that the US economy is strengthening especially when looking at the employment data and the manufacturing surveys. However, we would caution against too much excitement as the seasonal adjustments have been very supportive of the data and the weather this winter has been much milder than last year which also boosts the numbers. It will require some validation over the next few months before we can say for sure that the US economy is out of the danger zone, and even then, we need to bear in mind that as we head into 2013, there are a number of tax changes that could upset the party.

Despite our caution over sounding the all clear on the US economy, the bond market is getting a bit worried. Since 28th February the yield on the 10 year bond has risen by 0.4% to 2.34% and the yield on the 30 year bond has risen by about the same amount to 3.45%. The big question for investors is whether the recent trend of higher yields marks the end of the secular bull market in bonds, and if so, will there be a massive asset allocation shift away from bonds and into equities? (after bonds have significantly outperformed equities for 12 years at least)? Our answer to this is NO. It is not yet time for investors to switch from bonds to equities. In fact, we believe that higher bond yields actually represent a real risk to the economy especially when coupled with higher energy prices.

Let's not forget that we were in a very similar position last year when the investment community got very excited that the US economy was reaching "escape velocity", equity markets were getting very frothy and bond yields and energy prices were rising. We believe that 2012 will prove to be a near carbon copy of 2011 therfore we do not see the recent rise in yields as an inflection point in the US bond market. In fact, we continue to see strong headwinds for the US economy and we believe that the equity market is vulnerable again.

The chart below shows the long term picture of bond yields in the US. For the last 25 years, yields have been locked in a well defined down-trend. Yields need to break above 4.25% in the next few months for the secular bull market in bonds to be declared well and truly over. We think that this sort of move in yields is unlikely for the time being.

In conclusion, it appears to us that the US economy is doing enough to ensure that the FED does not print any money for at least a short while. Rather than this being a sure sign that the US economy is healing very nicely and no longer requires support from the FED, we believe that equity markets have become addicted to QE and will in fact decline sharply without a further QE hit - just like they did in the summer of 2010 and the Autumn of 2011. On many levels, 2012 looks like 2011 and now is the time to be battening down the hatches and moving to defensive positions in portfolios.

Stewart Richardson
Chief Investment Officer

By Stewart Richardson on 07/01/12 | Category - Economy

Happy New Year to everyone.

It's been an interesting first week in the financial markets and there is quite a bit to discuss.

First, we wish to start with the European banking system.Prior to Christmas, the ECB launched the first ever 3 year lending operation at which commercial banks can lend (perhaps not pristine) assets to the ECB and receive back cash for 3 years at a minimal rate of interest. The hope was that Banks would make full use of these cheap loans and take the cash and either lend it into the real economy or buy more European sovereign debt. In short, this was the ECB's version of money printing.

It may be too early to make a judgement as to whether the ECB's 3 year loans are a success, but the early evidence is not encouraging. The gross amount of 3 year lending was approximately EUR490 billion, of which approximately EUR200 billion was new loans (the remainder being shorter term loans that were rolled over). The chart below shows the amount of cash that commercial banks park with the ECB overnight, clearly, the trend has been higher since the summer. A commercial bank only parks money with a central bank (at minimal interest rates) when they are fearful of lending to other commercial banks. In this case, the higher the amount of money deposited with the ECB, the more fearful banks are of lending to each other. I would also contend that if banks won't lend to each other, especially when they know that the central bank is tripping over itself to flood the system with cash, then they are unlikely to lend into the real economy where the central bank is not supporting real businesses.

So why are commercial banks hoarding the cash that they have borrowed from the ECB? I suspect that with more than EUR200 billion worth of bonds maturing during the current quarter, the commercial banks are hoarding cash in case investors are unwilling to rollover their loans to the banks. In short, the ECB 3 year loan programme can be seen as a palliative rather than a cure. European banks are still focused on deleveraging and balance sheet management whichwill hamper the economy at a time when thrifty households and austerity focused Governments are already driving the economy into recession.

In the United States, the monthly employment reportwas released on Friday, and the headline report must be seen as modestly positive news on the US economy. The US economy generated 200,000 new jobs in December which was more than expected and was sufficient to see the unemployment rate come down from 8.7% to 8.5%. Taking a step back and looking at the wider picture, it is widely accepted that the US economy needs to generate about 125,000 new jobs each month for the unemployment rate to remain steady. The average number of new jobs created in both the 4th quarter and for 2011 as a whole was 137,000 and so in the big picture, we would argue that the US economy is now generating enough new jobs so that the unemployment rate should be steady, albeitathigher levels compared to the pre-2007 levels.

The unemployment rate hasdeclined from 9.4% in December 2010 to 8.5% in December 2011. This large decline was achieved by potential workers becoming discouraged and leaving the workforce rather than significantly more jobs being created compared to the number of people in the workforce. I would describe the US employment report as broadly in line with expectations and illustrative of a steady rather than a robust employment picture. This is undoubtedly better than the economic environment in Europe, and is supportive of our long US Dollar versus Euros and Sterling positions in our client portfolios.

Moving onto the financial markets, the first few days of the year are traditionally positive for equity markets. The first day of 2012 was again positive, although the follow through during the rest of the week leaves something to be desired, especially in Europe. The table below shows the daily performances of selected equity indices for the week.

We are not going to base our market opinions on the activity of the first week of the year, although we do find it interesting that there really has been at best (US, UK and Germany) little follow through from the gains seen on the first day of the year. Periphery Europe remains in trouble.

The Santa Claus rally appears to be over, and the deteriorating fundamentals coupled with lack of investor appetite for risk seems to be reasserting itself. Before we get too bearish, we need to remember that Merkozy are meeting this coming Monday and on the 24th January the European finance ministers meet ahead of a full summit at the end of the month. The cycle of last year was generally that markets rose ahead of summits and declined after them. Although we wish to be bearish of European equities, we do not wish to push this trade idea too aggressively at this time.

And finally in thecurrency markets,the US Dollar has started the year with a bang. We have been talking positively for months now about the US Dollar, and with the Bank of England, the Swiss National Bank and now the ECB all printing money, and the Federal Reserve not, the case for being positive on the US Dollar is very strong. Furthermore, as noted above in the US employment comments, the US economy is performing much better than the rest and this should translate into a stronger US Dollar in the months ahead.

The chart below shows the Sterling/US Dollar exchange rate. For 18 months now, Sterling has found support in the 1.53 to 1.54 area, and as we close trading on the first week of the year, the rate is touching 1.54 again. Our view is that at some point in the not too distant future, Sterling will break down below 1.53 and will weaken further over time. We own US Dollars in our client portfolios in expectation of further Sterling weakness.

In conclusion, the European problems that we discussed at length last year remain unresolved, and we believe that the bear market in European assets will re-emerge after taking a breather during the latter part of 2011. Furthermore, a severe European recession may even knock the US economy which has been performing better than expected of late. The environment is not conducive for risky assets such as equities, cyclical commodities and high yield debt, and is positive for safe haven assets such as high quality bonds, and in particular, the US Dollar. We remain defensively positioned in client portfolios and we expect to benefit from any weakness in European equities and strength in the US Dollar.

Stewart Richardson
Chief Investment Officer

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RMG Wealth Management LLP is authorised and regulated by the Financial Conduct Authority (FCA). These reports are for general information purposes only and do not take into account the specific financial objectives, financial situation or particular needs of any particular person. It is not a personal recommendation and it should not be regarded as a solicitation or an offer to buy or sell any securities or instruments mentioned in it. This report is based upon public information that RMG considers reliable but RMG does not represent that the information contained herein is accurate or complete. The price and value of investments mentioned in this report and income arising from them may fluctuate. Past performance is not a guide to future performance and future returns are not guaranteed.