Hamish McRae: We can only wait for the policy-makers
Sunday 02 September 2012
It was, after all, a quiet August, with little of the anguish that scarred holiday seasons of the past. The reason? Well, as much as anything else, it has been a general expectation that the policymakers on both sides of the Atlantic will "do the right thing", whatever that is, come the autumn.
The problems of the world economy remain as daunting as ever, while the levers that governments and central banks can pull seem pretty ineffective. At best, the charge is, they are only buying time. But, in recent weeks, the market response seems to have been that buying time is worth it, for it allows businesses to adapt, and so the authorities have been given the benefit of the doubt.
Now it is back to work – Labor Day tomorrow is the traditional end of the US holiday season – and the focus will shift to what the policy-makers will do rather than what they say they might do. For the moment, though, we still only have hints and indications rather than action.
One such hint, the promise earlier in August from Mario Draghi, the president of the European Central Bank, to do "whatever it takes" to save the euro, did have a remarkable impact. It turned around the market for Italian and Spanish bonds, as you can see from the right-hand graph. This week's meeting of the ECB's governing council is expected to flesh out a little of what this might mean, but few people expect any firm commitments for some weeks.
The key point here is that the ECB does not have a mandate to buy Italian or Spanish government bonds, but it does have a mandate to maintain orderly financial markets. So you could imagine it buying such bonds as a temporary measure, with the idea that any such purchases would be passed on to the eurozone authorities as and when they got their permanent support fund running some time in the autumn. It could also buy short-term debt, again in the name of maintaining order.
However, to do more than steady the markets would be going beyond the ECB's mandate, with all the risks that would entail for its long-term future. Since its ultimate guarantor is the German taxpayer, the ECB's policies have understandably become extremely unpopular there.
There is now a majority of German voters who say they would prefer to have the deutschemark back and there have been rumours that the head of the Bundesbank (who has a seat on the ECB board) has threatened to resign. You are not really allowed to say it, but I suspect there is an unspoken fear in Germany that having an Italian at the head of the ECB makes the bank more relaxed about the lack of fiscal probity in Italy over the years than it would were the head a northern European.
The Italians for their part feel hard done by, being lumped in with the Spaniards as being next in line for a bailout. The government feels it is doing all the right things, including imposing huge tax increases – petrol in Italy is now over €2 (£1.60) a litre in some places – and cutting spending. Yet it gets little credit for this, with 10-year bond yields close to 5.9 per cent last week, compared with UK rates for example of around 1.5 per cent.
As for Spain, some sort of sovereign bailout (i.e. not just a bailout of its banks) looks inevitable in the coming weeks. If the flight of money from its banks becomes even more of a stampede the estimates that they will need up to €100bn in support may seem a serious underestimate, which would put yet more pressure on the Spanish government.
All this bodes for an extremely difficult autumn for the eurozone. But all our experience suggests things can muddle along much longer than expected and it looks as though this will be the case in the coming weeks. That will exacerbate the underlying economic problems of slow growth.
You can see in the graph on the left how European (and UK) experience has diverged from the US's over the past year. In America growth has continued, albeit at a disappointing pace, whereas here and in Europe we are back below the waterline. Even if, as quite a lot of us believe, the US statistics are overstating its growth and the European and UK statistics are under-estimating their growth, this is worrying.
So what can be done? Well, let's assume that we will get some sort of patch in Europe. Let's assume too that if US growth falters in the run-up to the election, the Federal Reserve will bring in another bout of quantitative easing. Some people read that into the speech of its chairman Ben Bernanke at the central bankers' conference at Jackson Hole on Friday – a meeting from which Mario Draghi suddenly withdrew.
My feeling is that the US problem is no longer a monetary one; it is a fiscal one. There is enough money swishing around to keep the economy growing and the housing market, at last seems to have bottomed out. But the fiscal cliff that the US reaches at the end of the year when the Bush-era tax cuts expire, coupled with the obvious electoral uncertainty, has started to undermine confidence. So businesses are postponing investment and hiring plans, while consumers are delaying big purchases.
This is not a disaster; my point is simply that the US, like Europe, faces a period of uncertainty and will require cautious, measured policy-making through the autumn if confidence is to be retained.
And us? We, of course, also face huge uncertainties. The latest data is confused: some supportive bit of news, such as strong house prices in August and solid retail sales, coupled with troubling signs from manufacturing and exporters.
Politically, this is difficult for the coalition, and it has added to those difficulties by poor attention to detail. But, it has retained the broad support of global investors and if it had to slow down its fiscal consolidation, the markets would cut it some slack. Not easy; but for the moment we remain a "safe haven", even if it does not feel like that.
Looking for a safe haven? Try Italian and Spanish shares
The other notable feature of last month is that equities have consolidated their position as the "safe haven" of the investment world, or at least seem to be coming to be perceived as the safest way of preserving wealth.
US shares have done particularly well, with the S&P 500 index sustaining its third month of gains on the trot. German shares have had a decent three months too. The FTSE 100 index, which remember, reflects the global economy more than the British one, is up nearly 6 per cent on a year ago and 2.5 per cent from the start of this year.
And, of course those are capital changes; in addition you get, in the case of the UK, a 4 per cent dividend yield.
It has been a gradual change in perception and it has not yet worked through the markets, but now equities are being bought for a combination of wealth preservation and yield.
Many people assume that at some stage the massive amounts of money printed by the central banks will result in a rise in inflation. They also are reckoning on the next 30-year bear market in bonds starting soon.
And, while it is hard to see the case for another bull market in shares quite yet, you can easily make the case that they will be a less-bad investment than most of the alternatives. Goldman Sachs recently reckoned that there could be a 95 per cent chance that shares would outperform bonds over the next 10 years.
The true contrarian would also look at the countries that are currently the most unfashionable.
As Matthew Lynn of Strategy Economics writes in a recent note, Italian and Spanish equities have performed badly and there are plenty of good companies in both countries. If the countries were to leave the euro those companies will greatly benefit from the devaluation, as their economies take off.
Moral: buy Italian and Spanish shares, not bonds.
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