Investment Management Blog - Montague Capital

Yesterday’s bloodbath in equity markets came in two phases.  In neither case is there reason to believe that the causes will be temporary.  In neither case should the reaction have been a surprise.  In neither case should we think we’ve seen the end of the story. Europe started the day already alert to the fact that the Bank of England had begun to rumble ominously about the approaching end to the Special Liquidity Scheme.  No-one, sadly probably not even the Bank, knows just what the banks have done with the tens of billions thrown at them, beyond the grim fact that it is certainly not filtering down to the companies and households where it is most desperately needed.  (Cutting interest rates wouldn’t alter that, whatever the “doves” might hope.)  Similarly, no-one knows how the banks intend to survive when the lifeboat is hauled back up in to the boathouse.  Scrabbling around for funds to meet the financial year-end accounting sleight-of-hand is going to be an unedifying spectacle at best.  Time for a few more “final” rights issues, or a fire-sale disposal of assets? So, markets sprinted for cover when European Central Bank President Jean-Claude Trichet announced that he would be clamping down on what the ECB has regarded as deliberate abuses of its liquidity operations.  One example quoted was that of Macquarie Bank, that well-known European institution (not), which had thrown together a bunch of securitised Australian car loans and somehow managed to pass this off as qualifying for ECB liquidity support.  How?!  The details of what the ECB will be doing are arcane and technical, but the gist of it is that the cost of accessing extra liquidity will rise sharply as the rules on qualifying collateral are tightened and the size of “haircuts” on that collateral increased.  The drive for greater transparency continues too, with penalties to be imposed on collateral which has been “valued” using proprietary models rather than the open market. Two broad explanations are being offered for this tougher ECB stance.  Firstly, it is still far from happy with the “value” of the toxic waste being put up as collateral.  Secondly, as a consequence of the first there is no visibility as to how long it will take to clear up this mess, so resources need to be doled out more gradually.  Together these mean that the banks are going to have to take much more responsibility, and financial pain, for a mess that they alone created.  Stick all this against a background of a Pan-European economy which is grinding to a halt, which raises the potential incidence of corporate defaults, and housing markets showing all the aerodynamic qualities of a brick (sic), and a very large dose of whacky baccy is then needed to rustle up a bull case for financials.  How could anyone sensible ever have thought that this was going to get cleared up overnight? The second blow came for the other side of The Pond, where weak August retail sales figures and an unexpected rise in jobless claims reminded traders that the US is not out of recession yet.  Indeed, the President of the San Francisco Federal Reserve went on record as saying that things have got to get even worse before they get better.  This was something of an exercise of stating the “bleeding obvious”, but it would appear that somebody had to say it, so Ms. Janet Yellen duly provided a concise summary.  The US financial system is fragile, as witnessed by the highly uncertain future of the foundation stones that are Fannie Mae and Freddie Mac.  Several private sector “shoes” could yet drop, with the likes of Lehman Brothers scrabbling desperately around to find a rescuer.  Elevated measures of affordability and a glut of unsold stock mean that the housing market is still headed south.  And the market for US exports is rapidly closing for business as overseas growth slows and the US dollar strengthens.  Other than that, it’s all hunky dory.  What’s not to understand?  There is no pill to pop for a quick fix and there never has been. 

Against all this carnage, Unilever’s decision to appoint an outsider as the new CEO was a welcome breath of fresh air.  Unilever has made a tradition of developing its talent from within, preferring evolution to revolution.  As a result, while it has rarely managed to generate much excitement, it has not got hearts beating faster with panic that often either.  Now, however, it appears that it is time for a change.  Unilever has picked Paul Polman, recently passed over for the top job at Nestlé and who previously spent most of his career at Proctor and Gamble, over the heads of four high-quality internal candidates.  The company says that Polman will not be attending this month’s strategic review conference, suggesting that he will simply continue to oversee the initiatives put in place by his predecessor.  Even if that should be true, the least we can expect is that the strategy will be executed with the flair traditionally associated with his rather more exciting and successful previous employers.

The latest UK car sales may have set us up for an Office of National Statistics-style bit of data confusion in a month’s time.  August’s new registrations fell 18.6% y/y, prompting the Society of Motor Manufacturers and Traders to become the latest special interest group to plead for direct government support.  Quoth the SMMT, “[Industry] is concerned by the reluctance of consumers to commit to major purchases.”  Well, duh!  But given the truly barking UK obsession with demonstrating the new-ness of its cars via what goes on the number plate, could it not just be that cash-strapped buyers are pushing their August purchases out in to September?  As some dribbling acolyte of Jeremy Clarkson might put it, “I’m not so poor that I can’t afford a new car at all, but I’m not going to buy one which will be ‘old’ just a month after I’ve bought it.”  Don’t be the least bit surprised if this month’s “boom” number is greeted with wild enthusiasm as “proof” that the recession is over.  Unfortunately, as October’s numbers will subsequently show, the trend in this industry is unremittingly down.