Andrew Carnegie once said that “as I grow older, I pay less attention to what men say. I just watch what they do.” In a tumultuous week in investment markets politicians talked and investors acted. What was done? What was said?
It was not the finest hour for elected leaders. Finally, finally the US Congress, Senate and President passed an increase in the debt ceiling on Tuesday, thereby avoiding a technical default. The fiscal legislation provided for $0.9 trillion of cuts in Federal spending , over ten years, to fund half of the debt increase and the announcement of a bi-partisan committee to decide on where the other half ($1.2 trillion) of the cuts will be found.
Oddly this deadline beating solution didn’t appear to please anybody on Capitol Hill. The Tea Party grumbled that it was a compromise too far; the GOP felt they had been held hostage by the Tea Party threat; and Democrats and the President had to come to terms with their inability to get any tax increases included to balance spending cuts.
Although Moody’s & Fitch immediately reaffirmed the AAA credit rating of the US, the breathing space lasted no more than three days. On Friday night the S&P credit rating agency downgraded their credit rating of the United States from AAA to AA+. This is probably academic for most investors in valuing or accepting US Treasuries as collateral, but coupled with the recent weaker economic data points it clearly adds to investor uncertainty in an already uncertain period.
In Europe there were announcements during the week, but no action. It dawned on investors that although the beefed up EFSF was announced on July 21st it could be some time before individual member parliaments and governments passed the legislation to allow it to go into action. In the meantime Italian bond yields rose, even French yields rose, and German bond yields fell. And still no action from policymakers.
It has now been twelve months of market driven crises followed by palliative announcements and policy shuffles. The latest crisis trigger is the most serious to date. Italy is the second largest eurozone bond market after Germany, representing a quarter of the entire zone’s stock of outstanding debt. Once again ministers conference-called on a Sunday and ended a difficult week with another promise, this time that the EFSF and the ECB would step in to buy bonds if needed.
Benjamin Graham described the stock market as a weighing machine in the long run, but a voting machine in the short run. Last week investors voted very clearly, and they voted in favour of risk aversion. Despite the uncertainty in the US and Europe, bonds were mostly up. The US 10 year yield fell from 2.8% to 2.57% over the week and the German 10 year fell from 2.5% to 2.4%.
It was a brutal week in stock markets, the worst since February 2009. The MSCI All Countries World Index was down 8.3% in sterling total return terms. Japan, down 5%, and the US, S&P500 down 7%, fared better than Europe, where Germany was down nearly 13% and France, down 12%.
The MSCI World Index is now down 14% from its peak in February. All major equity markets are now below their 200 day moving averages, and for several the moving average itself has started to trend down. Only three markets, Indonesia, Thailand and Venezuela, are still in an uptrend.
Investors face the coming week attempting to process the implication of the S&P downgrade of the United States; another (yet another) crisis driven policy announcement by the eurozone; and the fear that signs of slowing economic activity could herald a slide back into recession.
Investors think associatively not deductively, and particularly when the pattern of events they are trying to frame is changing rapidly, the consequences can be dramatic and then set in place for a while until a new situation shakes that particular mind set. In the current situation, where investors are very nervous of taking on market risk, attractive valuations can have little short-term effect.
Major market bond yields are clearly at historic lows. Major equity markets, even allowing from some attrition in profit expectations, stand on very reasonable earnings and dividend yields. Significant medium-term growth disappointments are largely priced in.
Issued by: Rupert Caldecott, CIO of the Global Asset Allocation Team, Dalton Strategic Partnership LLP, an investment management boutique in London founded in 2003 by the late Andrew Dalton