Bulletin - The Credit Crisis Part II
While western financial and legislative authorities strive to contain potentially excruciating outcomes from the banking crisis, what have we been doing?
In our view the economic impact of the crisis is initially deflationary; we also believe that the danger of shorter term inflation is past. Thus interest rates in the UK and elsewhere should begin to fall soon, and they should continue falling for some time. We should not be surprised if they reach 3½% by mid-2009.
In theory lower interest rates are good for the value of financial assets, but for now there is a "flight to quality" and many investors are buying government bonds, while eschewing stock markets and property.
We too have been buying sovereign bonds, both in the UK and abroad. There have been two strategies driving this move.
First we wish to protect the returns our clients have been receiving on their cash deposits. Fortunately we have held large amounts of cash for some time, and as we expect those returns to fall we have bought some medium term gilt-edged securities. Their initial yield is slightly less than that currently available from cash, but as base rates fall they have the potential to make some capital gains. They have the added benefit of being highly liquid, but outside the banking system, which provides some peace of mind.
Second we have bought some exposure to sovereign bonds in other currencies through investment funds. We believe that the Pound may be weak for some time, and thus hope to see gains from both rising bond prices and rising currencies.
In a tentative way we have also started buying some international equity funds. History suggests that the way to make good long term gains is to buy when everyone else wants to sell. Fear prevails amongst equity investors, and it seems right to make occasional purchases on bad days. This will feel uncomfortable as volatility is likely to remain high for some time, but we hope that longer term it will prove to have been correct.
We have been buying international funds because we predict that the UK economy will struggle to bounce back strongly following the inevitable recession. Consumers are the engine of growth in this country, but they are also the most indebted per capita among the richer nations. After spending too much of tomorrow's income for so long, British people were not going to escape a period of retrenchment. That period is now and it will last for some time.
Much depends upon the sum of the efforts of the various central banks and national treasuries, whether acting in concert or unilaterally. It is difficult to imagine that they will not continue to make concerted efforts to unblock the clotted arteries of the banking world. There is no single magic formula, but the collective cleansing of the global banking system will leave ultimately a stronger, more transparent, financial structure.
6th October 2008
Gore Browne Investment Management points out that past performance is not a guide to the future and that the value of investments, and the income derived from them, may fall as well as rise, and investors may not get back the full amount originally invested. The information and opinions contained in this document are for background purposes only, are for the purposes of discussion, are not for public dissemination and do not purport to be full or complete. This document does not constitute or form part of an offer to issue or sell, or any solicitation of any offer to subscribe or purchase, any shares or any other interests nor shall it, or the fact of its distribution, form the basis of, or be relied on in connection with, any contract thereof. The information provided does not constitute investment advice or recommendations. The partners, members and employees of Gore Browne Investment Management LLP, and members of their families, may have positions in the securities mentioned.
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