Graphic evidence from Investec Asset Management (below) highlighting the demise of the carry trade. It shows returns from borrowing low-yielding currencies such as Japanese yen to buy high-yielding ones over the past 7-1/2 years or so. There has been a roughy 50 percent decline since the end of July.
Financial markets might be in distress and stocks are falling through the floor, but according to James Montier, global strategist at Societe Generale, we are not in the final stage of bubble burst yet. For one thing, the Financial Times is still too big.
At a fund managers conference in London today, Montier — a renowned bear — noted a thesis by economists Hyman Minsky and Charles Kindleberger that bubbles go through five stages — displacement, credit creation, euphoria, critical stage/financial distress and revulsion.
Currently, he says, financial markets are going through the critical/distress stage but we are not in revulsion yet.
“In revulsion, the Financial Times will be three pages long and we will all be ashamed to be working in finance. Stocks will be unambiguously cheap,” he told a group of financial professionals.
Every month, the financial services company State Street studies the trillions of dollars in institutional investor money it looks after as custodian and tries to gauge where things stand. Over the years, it has come up with a map consisting of five different regimes, or moods, to reflect this. They range from the bullish “Liquidity Abounds” in which investors buy equities and focus on growth, to the uber-risk averse “Riot Point”.
Guess what? Investors moved into “Riot Point” last month after flipping about for four months in the slightly less bearish but still risk averse “Safety First” regime. This essentially means that they gave up in October – which is not a particularly stunning finding given that many stock markets had their worst performance in decades.
So now comes the bad news. In the 11 years State Street has been drawing its map, the longest period of risk aversion as measured by investors being in “Riot Point” or “Safety First” was the nine months between February and October 2001. This almost exactly coincided with the then-U.S. recession.
Some mind-boggling numbers from the MSCI all-country world stock index, which is one of the broadest measures of how equity markets are doing and is a benchmark for many institutional investors. The index has some 2,500 companies in it from 48 developed and emerging economies.
First off, it has lost around $15 trillion in value since the end of October last year (graph below). That is more than 21 times the $700 billion U.S. bank rescue plan. It also more than the annual gross domestic product of the United States. It is more than three time Japan’s annual output and more than four times that of Germany.
Secondly, the speed with which this fall has taken place has been breathtaking by investment standards. It took companies that make up the index about four years to gain the $15 trillion in share value before hitting an all-time peak last November. About a third of the losses since hitting that peak came in a free fall from mid-September to mid-October this year.
According to banking sources, a U.S. bank in Canary Wharf has banned colour printing and has asked employees in the back office to chip in 25 pounds each for the office Christmas party.
A bank in Mayfair has told its employees to only hail cabs on the street instead of booking on the phone. Another bank in the City has pushed back the time employees can take taxis home to 9.30pm from 8.30pm previously.
You know things are bad on financial markets when an investment research note starts talking about Dante‘s visit to the nine circles of Hell with tormented lustful souls and gluttons living in filthy slush.
In the case of State Street Global Markets’ latest report, however, there is a more direct link than simple hyperbole about the way investors are feeling. The firm recently had a chat with former U.S. Treasury Secretary Larry Summers who defined what he saw as the five vicious circles of the current financial crisis.
It goes like this:
Circle One: House prices fall in value, putting some people into negative equity and leading some to default on mortgages. Foreclosures further erode asset values.
Iceland is for sale — on ebay.
It has great scenery and wildlife but the financial situation is in need of repair and a buyer must collect in person.
Bidding started at 99 pence but had reached 10 million pounds ($17.28 million) by mid-morning on Friday.
Globally renowned singer Bjork was “not included” in the sale, according to the notice, but there were nonetheless 26 anonymous bidders and 84 bids.
Nobody knows quite what the landscape for financial services will be after the mayhem of the last three weeks. There is much talk of the investment banking model being dead in the water and swingeing regulation aimed at firmly bolting the door of a horseless stable, but few are ready to hazard at the details.
One aspect on which we have seen almost universal agreement, however, is that investors have cottoned onto the immense risk of bankrolling investments they don’t quite understand. The trend for increasing pension fund investments in alternative strategies starts to look like a busted flush, and you have to question whether demand for the UK’s planned retail funds of hedge funds will sustain the new industry.
Schroders CIO Alan Brown told us this week: “People will be taking a long hard look at complex financial products.”
After the collapse of Northern Rock, AIG and XL group – which sponsored Newcastle United, Manchester United and West Ham respectively — the curse of English football is getting stronger.
Today Iceland’s Landsbanki went into receivership. Its chairman Björgólfur Gudmundsson owns West Ham football club.
In November 2006, Gudmundsson, Iceland’s second richest man, led an 85 million pound buyout of the east London club in November 2006, investing another 30.5 million pounds in December 2007.
Former Thai Prime Minister Thaksin Shinawatra sold his Manchester City football club to an Abu Dhabi-based company having gone into exile in London in August on corruption charges.
Republican presidential candidate John McCain has admitted in the past that economics is not his strong suit. In an interview with Reuters this week, he expressed a desire for a Treasury secretary who inspires confidence and trust if he should win the White House. McCain also aid he could balance the budget by 2013 if the economy gets going and if nothing is done to harm growth.Nothing worrying about any of that.
But the odd eyebrow may have been raised when the Arizona senator got onto the dollar, which he wants to bolster, and China. “The first step that has to be taken is obviously we have to stop mortgaging our economy to China … and asking them to finance our debt,” he said. This sounds like he wants China to stop buying U.S. Treasuries.
“That I think would have the most salutary effect in the short term,” McCain added.