'Sell every asset except gilts'

'Sell every asset except gilts'
Conventional assets – even gold – are no good as hedges against the inevitable deflation, says one asset manager.

By David Kauders
Last Updated: 12:17PM GMT 11 Mar 2009

At the end of last week, gilt prices soared and yields fell again. The market reacted positively to the Bank of England's announcement of quantitative easing. Yet in the preceding days and weeks the market had been spooked by concerns that the bail-outs would create inflation. Why the sudden change in sentiment?

It has long been our view that inflation scares have been seriously overstated and the real risk is deflation. Deflation occurs when a shrinking economy leaves businesses and consumers who have already borrowed heavily earning less and therefore unable to afford their existing debts.

There is the danger of a downward spiral caused by less income to pay interest. This is what the authorities are trying to avoid.

In a deflationary environment, only fixed-coupon gilts prosper: even index-linked stocks are ineffective. This is because the real rate of interest (nominal interest less inflation) has historically been around 2pc to 3pc for centuries.

If prices are falling rather than rising, fixed-coupon gilts gain in value, whereas the indexation formula for index-linked gilts indexes downwards with no floor. Other asset classes such as shares, property and many commodities depend on the continued take-up of more credit – which is why they did so well for many years.

As the credit crunch proceeded, governments introduced more and more bail-outs to keep banks lending. Real money, which has to be raised by increased taxation or by selling new gilts, was spent. This gave rise to fears that excess supply would depress gilt prices. Yet events show that the fears were mistaken. There are a number of reasons for gilt prices rising as supply expands:

• The biggest beneficiary of lower interest rates is government, as lower rates cut the cost of servicing the national debt;
• Pension funds are willing buyers and therefore absorb any supply offered to them;
• Risk elsewhere leads to a flight to quality and safety, irrespective of price.
• In addition, the Treasury have been selling new gilts to the market through the Debt Management Office's auction programme in order to fund the Government's spending. This takes cash out of the economy, yet the Bank of England wants to buy gilts back to put public money into the economy.
  
  

If the policy works it may ameliorate the recession, but the result is that the Bank of England counteracts the effect of the Treasury's extra supply of gilts.

Being realistic, there are many reasons why this quantitative easing may be of only cosmetic effect: why should banks lend to over-indebted businesses and consumers? What if they just run down their derivatives positions further?

Banks and building societies have to hold capital in reserve to ensure they can meet any losses. Historically, they had significant holdings in gilts and deposits at the Bank of England, but over the past 30 years standards were relaxed and other types of debt security were brought into those reserves.

Now they are rediscovering the advantages of having highly saleable assets such as gilts in their core capital and are therefore willing buyers of government bonds. Such bank purchases are significant, just as pension funds will be material buyers when they opt for certainty instead of risk to stem their losses in stock markets.

These large investors are the only ones who can sell to the Bank of England, yet they have good reasons for being net buyers.

However you look at it, institutional demand is increasing no matter what the supply of gilts. Nearly 20 years ago, in the recession of the early 1990s, the Government sold more gilts and prices rose (yields fell), in that case from around 13pc in 1990 to around 9pc in 1993. Inflation then was around 10pc and about to fall sharply. Notice the parallels as inflation now threatens to turn into deflation, the Government issues more gilts and prices rise again.

Investors have been pursuing property and gold for protection against financial risk. But property is an inflation hedge, not a deflation hedge, since its price level depends on the continued supply of credit.

There are also demographic factors that have favoured property in the postwar years but now turn against it: the lower birth rate, extensive owner occupation and the shift from net immigration to net emigration. Add this to the current financial pressure, and you can see why property is no longer a viable investment.

As for gold, it is the ultimate inflation hedge, since easy money provides the fuel for more people to buy it. But it is not a deflation hedge, for one simple reason. No currency is exchangeable into gold and no government is going to wreck its country's economy by adopting a gold standard.

This explains why the gold price perks up occasionally then always slips back again. The safest asset in the financial system is the promise of government to honour its own debt.

Private investors need to go with the flow. Investing in stock markets, like property, is proving singularly unrewarding at present. We believe the bear markets have much further to run before shares and property are cheap enough to buy again.

Since income offered by gilts is still above that earned from many bank accounts and there is a continuing flight to quality, gilt prices must go on rising until this deflation is over.

Investors should change to a gilt-only strategy to preserve capital and income. This way, they will have the cash to buy the bargains when stock markets offer them.

David Kauders is a partner at Kauders Portfolio Management.

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http://www.telegraph.co.uk/finance/personalfinance/investing/4969399/Sell-every-asset-except-gilts.html

U.K., French Industrial Production Falls, Worsening Recession

U.K., French Industrial Production Falls, Worsening Recession
By Simon Kennedy and Brian Swint

March 10 (Bloomberg) -- Industrial production plunged in the U.K. and France in January, threatening to push Europe into a deeper recession.
U.K. factory output fell 2.9 percent from December and 6.4 percent in the three months through January, the most in at least four decades. French industrial production sank 3.1 percent on the month, five times the pace predicted by economists, and 13.8 percent from a year earlier.
Companies from IMI Plc to Valeo SA are being ravaged by the global economic crisis as demand slumps and credit remains tight. With the worst recession since World War II driving up unemployment, the European Central Bank and Bank of England are under mounting pressure to keep easing monetary policy.
“Manufacturing is being very hard hit and there’s little prospect of a turnaround,” said Collin Ellis, European economist at Daiwa Securities SMBC Europe Ltd. in London. “The data raises fresh questions about the severity of the European downturn.”
British manufacturing has now dropped for 11 months, the worst streak of contraction since 1980, when Margaret Thatcher was prime minister. Factory production accounts for about 15 percent of the economy, compared with about 75 percent for services and 6 percent for construction.
“This is unbelievably grim,” Alan Clarke, a London-based economist at BNP Paribas SA, said in an interview. “There’s no sign of the slowdown abating. The Bank of England will probably need to do more.”
Out of 13 categories of manufacturing, nine fell and four rose on the month, the statistics office said. Transport equipment, electrical, optical goods, and machinery and equipment led the declines. Production of motor vehicles and auto parts drove the slump in the transport category, the data showed.

Car Sales
European car production will probably fall 25 percent and sales are likely to drop 20 percent this year, the European Automobile Manufacturers Association said on March 5.
Separate reports today showed the French trade deficit swelled in January as the value of exports fell to the lowest in almost four years, while German shipments slid for the fourth straight month by declining 4.4 percent on the month.
“The pace of contraction remains extremely strong” in France, said Frederique Cerisier, an economist at BNP Paribas in Paris. The figures may prompt him to further downgrade his forecast that the economy will contract 2.3 percent this year.
To combat the slump, President Nicolas Sarkozy’s government is injecting funds into banks and helping them raise cash to lend to companies and households. In December, he introduced a 26 billion-euro ($33 billion) economic-stimulus package to spur construction.

U.K. Aid Package
U.K. Trade Minister Ian Pearson will set out how a 2.3 billion-pound ($3.2 billion) aid package for automakers will work and which companies will be eligible when he meets executives tomorrow. The government is considering separate help for General Motors Corp.’s Vauxhall unit.
The European Central Bank last week cut its benchmark to a record low of 1.5 percent, while its U.K. counterpart lowered its to a record 0.5 percent and took the unprecedented step of printing money to buy assets and replenish bank balance sheets.
IMI Plc, the world’s biggest maker of pneumatic controls, said last week it reduced its global workforce by 10 percent and plans further reductions in the coming weeks. Valeo SA, France’s second-largest auto-parts maker, has temporarily shuttered plants.
To contact the reporter on this story: Brian Swint in London at bswint@bloomberg.net. To contact the reporter on this story: Simon Kennedy in Paris at Skennedy4@bloomberg.net. Last Updated: March 10, 2009 08:32 EDT

http://www.bloomberg.com/apps/news?pid=20601102&refer=uk&sid=aUvgE0D.somI

Bank of England to warn recession will last far longer than Government's forecast

Bank of England to warn recession will last far longer than Government's forecast
The Bank of England will this week come into direct conflict with the Treasury as it warns on recession.

By Edmund Conway and Angela Monaghan
Last Updated: 12:40PM GMT 09 Feb 2009

In its quarterly Inflation Report, the Bank's Monetary Policy Committee will slash its economic growth forecast to the lowest level since it was granted independence in 1997, and will indicate that it is now poised to start buying up securities directly in a bid to pump extra money into the economy.

It comes after the MPC voted to cut borrowing costs to an all-time low of 1pc, despite warnings from savings groups that such a move would undermine incentives to save money.

The Bank is expected to cut its growth forecast from the already-bearish projection that the economy would shrink by 1.3pc in 2009 made in November, to one which factors in a far steeper decline. It undermines the Treasury's assessment in the pre-Budget report that the economy would start growing again in the second half of the year.

The Inflation Report is the Bank's three-monthly opportunity to indicate its outlook for the economy, and economists will be watching the event closely on Wednesday to determine how much further it will cut borrowing costs.

They expect further rate cuts towards zero, as well as quantitative easing, whereby the Bank would increase the money supply by buying assets like corporate and government bonds, complementing the £50bn Asset Purchase Facility scheme already announced by the Treasury. The Governor, Mervyn King, will also indicate how soon the Bank will embark on this.

Despite better-than-expected data from the services sector last week, more gloom is in store next week in the form of labour market statistics, which could show that unemployment surpassed the two million mark in December.

Figures from the Office for National Statistics are also likely to show the number of people claiming unemployment benefits jumped in January, after a series of high profile failures including Woolworths.

"We are looking for a nasty surge of 110,000, the largest increase since March 1991," said Philip Shaw, economist at Investec. That would take the number of claimants to about 1.27m.

http://www.telegraph.co.uk/finance/financetopics/recession/4561002/Bank-of-England-to-warn-recession-will-last-far-longer-than-Governments-forecast.html

UK banking system so close to collapse

For short and sharp, read long and slow when talking of the R-word

Mervyn King, Governor of the Bank of England, certainly wasn’t pulling his punches in Leeds last night. In a blunt speech Mr King uttered the “R-word”, warning that “it now seems likely that the UK economy is entering a recession”.

By Richard FletcherLast Updated: 8:40AM BST 22 Oct 2008

If that wasn’t bad enough, the Governor provided a rare insight into the worst-case scenarios that the BoE has grappled with in recent weeks. “Not since the beginning of the First World War has our banking system been so close to collapse,” he said.
The speech topped a day of gloomy economic news that included a dire industrial trends survey from the CBI which showed that even if the financial markets are returning to normal, the downturn in the real economy has a lot further to run. Meanwhile, Capital Economics predicted house prices could drop by 35pc, which, if correct, would be the biggest fall ever recorded.
It seems our only hope is that this is a short, sharp recession.
Unfortunately, I even have bad news on that front: the Governor ruled out a “quickie” recession last night, warning that it would be “long, slow haul” before the economy returns to normal.

Arcadia’s debt beats Debenhams’ £1bn
The Bank of England Governor may be gloomy but Sir Philip Green laid on a Champagne breakfast for 125 loyal lieutenants yesterday at the Arcadia headquarters just off Oxford Street. As his senior team tucked into eggs Benedict and bacon (or yoghurt and orange juice for the more health-conscious) Sir Philip unveiled Arcadia’s full-year results and presented a jeroboam of Champagne to the heads of the fashion group’s brands.
Given the carnage on the high street, the billionaire retailer can be rightly proud of the results announced by Arcadia yesterday: a 0.6pc fall in sales and 6.1pc fall in operating profit.
A sterling performance by Topshop finally laid to rest the suggestion that it was former brand director Jane Shepherdson who drove its phenomenal success. Meanwhile, Yasmin Yusuf’s success in reviving Miss Selfridge may leave beleaguered M&S shareholders asking why they didn’t hold on to their former creative director of womenswear.
A short stroll down Oxford Street at Debenhams’ headquarters, Rob Templeman, the department store chain’s chief executive, was taking the red pen to its dividend – which he slashed from 6.3p a share to 3p a share.
Both Debenhams and Arcadia are stealing market share from a battered M&S. Like Arcadia, Debenhams’ 0.9pc fall in like-for-like sales is a (relatively) good performance in the current market.
But no matter how impressive Templeman’s performance, the market has become obsessed by the level of debt in the Debenhams business. With almost identical sales, Sir Philip is servicing £695m of debt at Arcadia, while at Debenhams Templeman is having to juggle just shy of £1bn (a hangover from the leveraged buy-out of the retailer by a private equity group in late 2003).
Yesterday, Templeman laid out his plans to reduce the burden: cutting costs, reining back capital expenditure and asking shareholders to take what is left of the dividend in shares rather than cash.
Templeman has a record of delivering: but slashing the group’s debt will take years, not months. And all the time Sir Philip is busy plotting – eyeing up retail brands including those owned by troubled Icelandic investor Baugur. Not only do his two businesses – Arcadia and Bhs – have relatively conservative borrowings, we can safely assume that Sir Philip still has a large chunk of the £1.2bn dividend he paid himself in 2005.
Its may only be a short stroll down Oxford Street from Arcadia to Debenhams but the two retailers are worlds apart in an environment where cash is king.

Evolution bags a banking bargain

Sir Philip is not the only entrepreneur who has been rummaging around the wreckage that is now Iceland.
Alex Snow, chief executive of Evolution, appears to have bagged a bargain by buying Singer & Friedlander Investment Management from the administrator to failed Icelandic bank Kaupthing.
Evolution has paid just a “few million pounds” for the business, which manages £1.5bn on behalf of 4,000 private clients. In better times, the fund management arm would have sold for closer to £30m (valued on the basis of 3pc of funds under management).
If Evolution’s investment management business – Williams de Broë – can retain the Singer & Friedlander clients, the funds under management will grow by 50pc on the back of the deal.
Until the onset of the credit crunch, Snow had been under pressure from activist shareholders to return the pile of cash the group was sitting on – pressure he largely resisted. Having done so, he is now putting his £150m war chest to good use.
richard.fletcher@telegraph.co.uk

http://www.telegraph.co.uk/finance/comment/richardfletcher/3237854/For-short-and-sharp-read-long-and-slow-when-talking-of-the-R-word.html

Comment:
There are opportunities in this dire economic times.