Market Review 14 September 2010

In the end, equity markets were broadly unchanged last week but bond prices continued to erode.  These moves were not without their challenging moments. 

The macro economic data coming out of China exceeded expectations. The CPI figure was 3.5% up and the Industry Production was up 14%, 1% ahead of expectations.  Hong Kong and Chinese markets had particularly strong start this morning after these releases. 

An agreement has been reached at the Basel III conference regarding banks’ minimum capital ratios.  The Financial Sector in Europe rallied after the new banking requirements, known as Basel III, confirmed that banks will be required to hold a minimum core tier one capital ratio of 7% and a long lead-in time eased fears that lenders will have to rush to raise capital.

The new capital ratio represents a substantial increase from the current requirement of 2%, but is significantly lower than what banks had feared earlier this year and comes with a phase-in period extending in part to January 2019. Banks will not be required to meet the minimum core tier one capital requirement, which consists of shares and retained earnings worth at least 4.5%, until 2015. An additional 2.5% “capital conservation buffer” will not need to be in place until 2019. There will also be an additional counter-cyclical capital buffer of up to 2.5%, which national regulators will apply during periods of excess credit growth.

A number of European Banks have already raised their core tier 1 ratio to over 7%, while weaker banks have the benefit of time to raise the necessary capital. The National Bank of Greece, which is proceeding with its plan to raise €2.8 billion in capital, will see its core tier 1 rise to 13.4%.  Similarly, the Deutsche Bank capital raising plans would raise its core tier ratio to 8%.

Now that August is over the next round of sovereign debt refinancing in Europe has begun again in earnest.  Eurozone governments are trying to raise the equivalent of €88 billion in September, compared to half that in August.  Spain expects to raise €7 billion in September compared with €3.5 billion in August.  Last week Greece, Portugal and Spain made positive steps in this direction, albeit that in the case of Greece, the rate the government had to pay was greater than it might have done a week earlier.

Governments will not be alone in seeking funds. The Association of German Banks announced on Tuesday that the German banks would need €105 billion in additional capital to meet their eventual capital requirements and cover losses and by the end of the week Deutsche Bank was said to be looking to raise €9 billion via a rights issue.

Nonetheless, the glow created by modestly improved employment data in the United States proved to be the dominant sentiment. It is worth repeating the simple fact that US household employment in August rose by 891,000, which was the biggest month-on-month increase in a decade. It is now up 3.3% at an annualised rate over the past 8 months. 

This equates to an additional 3.5 million jobs. Lay-off announcements also made a new low. Hours worked in the third quarter are on track to increase at a 6.1% annual rate, which significantly reduces the odds of an outright decline in the US third quarter GDP. Meanwhile, the US manufacturing PMI instead of declining, as had been expected to 52.0%, rose to 56.0%. 

Even more extraordinary, ISI’s house price survey after moving sideways for a number of weeks, made a new high last week and mortgage refinance activity is continuing to rise sharply.  The fact is that employment is increasing in Germany, Australia, the UK, Taiwan, Korea, Poland, Brazil and Mexico.

All this data can be read in different ways and can be counter balanced by other bits of data. The likelihood is that US growth will be positive in the third quarter but subdued. Nothing in all these numbers is too frightening and, for the time being, we are happy to hang on in there.

Andrew Dalton is Chief Investment Officer of the Dalton Strategic Partnership, an investment management boutique in London which he founded in 2003 after 30 years as a senior investment professional at S.G.Warburg, Mercury Asset Management and Merrill Lynch Investment Managers.