Market Review 28 September 2010

Last week proved to be another strong week for equity markets. The strength was particularly visible early in the week on Monday and then again on Friday following the publication of the US durable goods data. It seems clear that selling pressure has generally been low in recent weeks suggesting that buyers are reluctant to sell stock and more inclined to buy on dips.

September as a whole has been a positive month and has taken the US equity market, in particular, into new higher ground. In general this month, stock performance in individual areas has been helpful, notably in North America. Over the month-to-date, the Melchior Selected Trust North American Opportunities fund is up 11.02%, against a rise in the S&P 500 index of 9.47%. The MST Resources fund is up 15.66%, which is well ahead of the Canadian index that, strangely, is up only 2.44%. The Melchior Asian Opportunities fund too, which is up 13.64%, has convincingly outpaced the MSCI AC Far East ex-Japan index, which is up 8.51%. During the course of the week, the US dollar slipped against most major currencies. Put another way, the euro has been recapturing some of the ground that it lost in the second quarter.

On Friday, the August US durable goods orders fell 1.3% on the back of a 54.5% decline in civilian aircraft orders, the most volatile subcomponent of the report. However, excluding transportation, orders rose 2.0% but more importantly, core durable orders, defined as non-defence capital goods orders excluding aircraft, increased 4.1%. Furthermore, this was after a nearly 2% upward revision to the previous month, which is now reported to be down 5.1%. Most of the decline in core durable orders in July was in the machinery component, which after revision is now down -9.6% – it had been down -13.6%, the biggest decline on record.

The original print for core durable shipments was -1.0% in July. Over the last three months, core durable shipments which go directly into the capex component of US GDP are up 11.1% annualised. This is down from a 20%+ pace early in the second quarter but is still sturdy. Durable goods inventories were up 0.4%. All of this would suggest that the US economy appears to be growing at least 2% in the current quarter. It also suggests that our key thesis that this is an investment led, not consumer led recovery, is on track.

Spain, Portugal and Ireland all successfully managed to accomplish market refinancings last week, albeit at rather high prices. The last to complete was Ireland. Ireland sold €1.5 billion worth of bonds. €500 million took the form of debt due in 2014 at an average yield of 4.767%, which compared with 3.627% at the previous auction on 17 August. The government also auctioned €1 billion of 2018 securities at a yield of 6.023%, up from 5.088% in a sale in June. The extra yield investors are currently demanding to hold 10-year Irish bonds over similar maturity on German bunds narrowed on the sale having risen above 400 basis points for the first time the day before. The difference in yield, or spread, between Portuguese 10-year bonds and German bunds was 404 basis points having earlier widened to a record 420 basis points.

In the case of Greece, there appears to be no intention of rescheduling any debt yet. The Greek Prime Minister, Papandreou, made it clear that in his view at least Greece is not going to default. “Default”, he said “would be a tragedy. If we were going to default, we would have decided that many months ago.”  The Greek spread on 10 year bonds relative to German bunds is still 909 basis points, shy of the intra day high of 973 basis points on 7 May but still high. Greece’s budget deficit has shrunk 32.3% in the first 8 months of this fiscal year compared with a target reduction of 26.5%. The deficit has contracted to €14.5 billion from €21.4 billion a year ago. The EU/IMF handed over another €9 billion last week in emergency loans to Greece. The principal concern, if there is one, is that revenues are not coming in as fast as was anticipated. Net ordinary budget revenues rose 3.4% versus a target of 13.7%.

Investors bid for 5.1 times the amount of the 2014 Irish bond offering. Demand for the 2018 bond had a bid-to-cover ratio of 2.9. The Irish 10-year bond yield fell 14 basis points to 6.40%, narrowing its premium over bunds to 380 basis points. Progress of sorts is being made.

Meanwhile, gentle steps are being made in the direction of further quantitative easing. The US Federal Open Market Committee on 21 September said that it “will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery”.

The Fed’s statement indicates it is focused on an inflation level below the preferred long-term range as the main reason to provide additional stimulus. Consumer prices excluding food and fuel costs rose 0.9% in August from a year earlier, matching the smallest increase since the 1960s. The Fed retained its policy, begun last month, of re-investing proceeds from mortgage debt repayments into long-term Treasuries and has bought $34 billion since it began the programme on 17 August. It is slightly a question of ‘watch this space’.

It looks too as if the UK authorities are moving in a similar direction. Various commentators such as High Frequency Economics are painting a picture of a UK economy with “an irrevocable monetary and credit crunch, fiscal austerity and trade decay”. This, to our minds, is overly dramatic, although fiscal austerity is clearly coming and the UK Chancellor of the Exchequer, on 20 October, will announce the principal outcomes of his major spending review.

The Japanese currency intervention on 15 September, which has not yet been followed up, because unsterilised, similarly constitutes a form of quantitative easing. Meanwhile, other countries also remain sensitive to their foreign exchange rate. The Bank of Korea failed to raise interest rates today, contrary to expectations. Mr Mantega, Brazil’s finance minister, declared earlier this month that the Brazilian real was caught up in a ‘silent war’ in currency markets, as nations compete to speed up their economic recoveries by putting their exporters at an advantage.

The difficulty with intervention is that there can be no internationally co-ordinated agreement because so many countries are seeking to achieve export led growth by means of devaluation. In these circumstances, investors will continue to look for stores of value – equities, the euro, natural resources and gold all appear relatively attractive safe havens, at least for the time being.

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.