I am pleased to say that such an anniversary has little to do with today’s current financial turmoil so any connection or illustrative analogy is somewhat limited – but that has never stopped me extending a tiresome metaphor.

Although the current financial firestorm will - and has already - caused some significant damage, I think it is time to put some perspective into the current situation. First of all in terms of value the current sub-prime concerns, whilst still worrying, are following a long and tediously regular line of financial ructions that the global economies have had to absorb. By no means an exhaustive list will quickly bring back some concerning memories for some. These would include the Asian crisis of 1997, the Russian crisis thereafter and the fall of Long Term Capital Management in 1998, which nearly pulled down a British clearing bank. Add to that the US Savings and Loans or “Thifts” crisis in the 1970’s and 1980’s which saw the failure of over 1000 financial institutions and was described at the time as “the largest and costliest venture in public misfeasance and larceny of all time”. The total cost of the debacle was estimated to be around $150 billion. 

Add to that “9/11” in 2001 and the “Tech Rout” the year before and it seems remarkable that the global economy has actually not just survived but has been so robust.

The bottom line therefore is that so long as the central banking and regulatory authorities keep cool heads, the present frightening firestorm will pass and although there is every likelihood of significant financial damage, the global economy continues to operate successfully.

It has been interesting to see the reaction from numerous public company directors who, I am sure many will agree, should have better (and legitimate) insider knowledge, than most of us. These directors have seemingly been buying their own company’s shares in droves. We have also seen heightened company share buy-back operations and even loan facilities being given for directors to extend their purchases. Cynics would argue (and sometimes justifiably) that this is at the behest of the PR operations to support the company share price. Critics would argue that buy-backs boost the stock price to raise the value of executive bonuses but others would also highlight the underlying value of many corporations and, even if there were to be an economic slowdown, they would still be in a financially strong and robust position.

As yet we do not know the extent of the damage from the current financial firestorm, however there is likely to be significant damage to the hedge funds and speculative investment vehicles involved, as well as also losses for the banks. There are going to be forced “fire sales” as assets are sold to fund short term liquidity issues, but perhaps we should look at this as a frankly painful but necessary cleaning out of the smoking debris of failed investment structures.

However, once the smoke clears we will have a better idea of what happens next. Some have already been talking about potential recession in the US, but that is by no means a certainty. Watch out now for the round of investment bank profit warnings and downgrades, along with their related job cuts and “restructuring”.  For the moment an economic slowdown seems almost certain, but in the UK the risk could be somewhat higher. Here it is not just the old hoary stories of debt, houses and interest rates but also the unbalanced nature of our economy.

In the UK our national spending is dominated by the consumer but it is the financial services industry that accounts for 33% of our national income (compared to the US at 20%). Within this, the impact on London is crucial, with financial services accounting for over 66% of the capital’s income. London is the most international financial centre in the world and therefore potentially the most exposed to changes in financial markets. A combination of a financial and consumer downturn could be tough for an economy which is over-dependent on London and the South East and where personal indebtedness is high and savings rates are low. The effect on jobs is already being felt and I suspect that there will be more to come. Previous financial conflagrations often show a similar effect with swift and significant surgical restructuring and swathes of roles cut. This of course will ripple on to affect other related roles in service industries and yes – it will even affect the excited London property market. Yet through the smouldering  remains of a financial boom going bust, we will start to see that in fact the global economy will still be there and still likely to be growing.

Perhaps I should also mention the likely impact on Government finances. The last downturn in 2000 and 2003 saw a drop of 30% in corporation tax paid by the financial services sector. The Institute of Fiscal Studies points to some direct correlation between asset prices and “the movement of fiscal balances”. So just as Gordon Brown as Chancellor benefited from extra corporation and income tax revenues in a rising market, so Alistair Darling  will suffer the reverse with lower tax revenue from both sources and especially with the disappearance of those excessive bonuses.

So a combination of a slowing in consumer spending, and the effect on the financial services industry would indicate that the domestic economy is likely to be somewhat laggardly. However, other economies will not suffer so much of an effect and thus this may prove a more opportune moment to use our currently more highly valued Sterling to buy high quality investments elsewhere around the globe.

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And finally… to mark the end of the “silly” season, news has just come in that a pantomime horse has reached the top of Snowdon – why?

Have a good week, 

Justin A. Urquhart Stewart
Director
Seven Investment Management