Market Commentary - 2012 - Quarter 3 October 2012

Market Commentary - 2012 - Quarter 3

The returns so far in 2012 have remained unpredictable, although they haven’t quite repeated the volatility of the previous year. We have at least seen a stabilisation of markets in the third quarter with no significant moves until mid-September when a rally supported by statements from the ECB and the Federal Reserve saw markets get their liquidity support.

Global growth has stagnated rather than moved ahead. In particular, data from leading economies has not improved and has, in some cases, deteriorated - China and Germany are examples of this, despite often seen as the most resilient of economies. Fundamentals however have not changed and with Bloomberg’s latest world growth projections falling to 2.6% it shows that there is much ground to be made up between the current market positivity and economic reality. Economics aside however, we have seen greater stability in the quarter with sentiment not dictating markets as much as in previous quarters. Politics still has significant influence especially in Europe where continued procrastination threatens the work being done by the ECB.

The actions of the central banks must also be considered, and in particular those of the Federal Reserve headed by Ben Bernanke. Much of the recent market resilience has been created by the potential for more quantitative easing (QE) which the Fed sees as crucial to stabilising the key economic issues of employment and market confidence. On 13 September, following two days of deliberations, Bernanke duly detailed an asset purchase program in which $40bn per month would be concentrated into the Agency Mortgage Backed Securities market. The announcement did not give an end date to these operations, simply stating that they will continue until an improvement is achieved in employment conditions. Inflation was mentioned in the press release - not, as one would expect, warning that the stimulus package would end as inflation picks up; instead mentioning that a stable, but positive inflation rate is being targeted. Put simply, the Fed is less concerned with increasing inflation than potential deflation. This stands to reason; one easy way for countries to achieve a reduction in their long-term debt is to inflate their way out of the problem. In Europe the
ECB offered a different package to support the banking system, assisting the peripheral economies and the Euro in general through cheap bank credit. In addition, the German courts also waved through the proposals for the European Stability Mechanism (ESM) helping to move the negative sentiment to a more neutral stance.

This has helped the banking system in the US and particularly in Europe where banks have seen the money markets closer to normal and their creditworthiness in the Credit Default Swaps market (CDS) back in line with non-bank investment grade companies.

All this has also raised an interesting debate across the globe about whether austerity is the best way of paying back the debt that many western economies face in the coming years. There has been some shift in the economic thinking on this in recent months, in that whilst debt needs to be brought back to less expanded levels, cutting back expenditure and increasing taxes may not be the most appropriate or quickest way of addressing the problem.

It is recognised there is a need to reduce debt expansion but increasing economic growth needs to be a balanced part of this process. All the recent monetary injections by central banks have not yet found their way into the economy, and consequently have not yet increased consumer confidence, which is seen as essential to delivering higher growth rates. Companies also need to feel confident to expand and hire employees, which can only come from an improving and confident consumer. The answer may require a careful balance of austerity and fiscal expansion based on a flexible political approach which has not yet been seen in the key area of Europe.

Market commentary provided by Rayner Spencer Mills – Quarter 3 2012

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