tony's blog

Thursday, October 13, 2011

Making sense of the markets

What’s happening out there I hear you cry? Well debt markets are still in a bad place. In effect they have never really been entirely fixed from the original credit crisis 4 years ago brought on by optimistic overleveraging by banks which have stimulated economies far too much and led to unsustainable asset price inflation. There was a sense that things had recovered but since July they have slipped back again. In truth, it isn’t because they have got worse, its more to do with the earlier optimism slipping away and realisation that things are still fundamentally in a bit of a pickle. They have been since August 2007 when this all kicked off.

Today we are seeing banks building up capital and liquidity to more prudent levels. Good news then. Well yes however what this does is to remove, by a geared factor, the amount of credit available in markets. No wonder economies are slowing and stopping. We have seen many analysts lower their growth forecasts for the UK but my expectation is for the UK growth to go negative.

Unfortunately while this is going on a negative feedback loop is initiated whereby slowing economies engender higher levels of defaults which eat into banks Tier I capital ratios which causes them to reserve more and so more capital is taken out the system on a geared basis and so on and so on….

I mention this as the background to the markets as I see them. Add to all of this defaults and other shocks in Eurozone and elsewhere, plus ongoing problems in the US and it all gets a lot more troubling. Markets don’t like shocks (unless you are a trader – short selling and so on – volatility is where a lot of money can be made).  So we have a nervous global financial market looking for some clarity and strong signals from leaders as to impacts on economies, markets and banks as a result of default/no default. And they aren’t tending to get it, notwithstanding the recent approval from Germany to expand the powers for the EU’s main bailout fund. We have the usual market reaction to this – large swings in market prices on the back of comparatively small amounts of news.

So impact on UK? Definitely. We are less exposed to Greece than some countries but are not immune. We have larger exposures to countries like Ireland (which seems to be doing a good job in recovering at the moment). What is the extent of the impact – impossible to say right now. The entire market has seen Greek default as a near certainty with 2 models: unplanned default or planned default.

My view is that default itself seems to be a dead cert. It looks like the Europeans are working on plan B and buying enough time with the latest bail out to move to Plan B – the planned default with banks bolstering their capital in anticipation. As I mentioned though, losses or increases in capital to meet potential losses have a multiple effect in the amount of credit and liquidity they remove from the markets. This is already happening and I suspect will get worse before it gets better.


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