August Market Commentary

26th August 2011

The last few weeks have been difficult in financial markets as politicians failed to reassure them that they would deal with the major issues facing their economies and find a longer term solution to the large amount of national debt that has built up over many years. One thing is for sure there are no quick fixes. We shouldn’t lose sight of the fact we are investing over the mid to long term and some of the recent moves will appear to be of less significance when the markets return to some kind of normality.

There has been some distressed selling reducing some stock prices to levels not seen since 2008. Whilst there are some parallels, most companies are in better shape than in 2008 (excluding the obvious ones that aren’t, e.g. banks, retailers, and house builders) and are being sold off rather indiscriminately. Credit markets have not seen yields fall as much in one month since the aftermath of the Lehman crisis.

There is a major policy announcement from Bernanke (Chairman of the Federal Reserve Bank) today and this will also have some impact on the short term volatility in markets as they react to the news flow. The Fed has already indicated they will have a lower interest rate policy for at least 2 years.

Here are our key thoughts:

US

US Growth is slowing and will probably be around 1% next year. Chances of an outright recession increased to around 40%. This still does not seem the most likely outcome but the risks are increasing. Jobless claims and auto sales are still not indicating recessionary levels.

We have commented before there are some very unusual things happening in markets now. The worsening economic news from the U.S.A. led to 10 year U.S treasuries falling below 2%, a level not even seen in the great depression of the 30’s or during World War 2. We can contrast this with the Eurozone countries where debt is an issue and yields are rising strongly. It makes little sense to us that markets are prepared to lend money to the US at a return that guarantees a loss after inflation. It does however tell us that markets do not expect any kind of default on American debt.

Commodities

The data coming from China indicates growth is being managed and is unlikely to decline significantly. This ought to be positive for the commodity sector as emerging markets generally are not subject to the same debt levels as the West, and growth should keep demand quite high.

Most companies announcing results are reporting very significant uplifts in profits and whilst the future may be more challenging the higher commodity prices will support their profitability. Therefore although these sectors have fallen quite heavily we do expect a very sharp bounce as the share prices reconnect with the underlying commodity and the economic outlook gets a little clearer.

The only thing that has risen strongly recently is Gold as a safe haven and that is correcting now. We think the Gold price will attract buyers again soon. Our Gold holdings which invest in the miners have not reflected this rise. Most analysts think Gold miners are currently very cheap and they are at last beginning to reverse the recent losses.

Conclusion

Currently stock markets are recovering some of the recent losses and this will give us a further opportunity to assess if we wish to become more defensive by raising some more cash. Our view is whilst the situation is far from good it is not anything like as bad as 2008/9 when we had a full blown banking crisis.

We will be back in touch when the outlook becomes clearer. There has been some evidence of distressed selling over the last few weeks which we expect to subside considerably over next few weeks.

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