Politics and slowly emerging from the dead

I took a brief break from trading after my call on the beginning of the double dip proved to be wrong. That is not to say that I do not believe that the double dip will happen - I am still convinced that this will happen, especially in the UK. I refer readers to read my article in GX Magazine for more details.

I closed my short ESM0 positions at a decent profit of £570, but if I had closed at the bottom I could have realised £870. Luckily I employed a trailing stop. The reason I held the trade for so long following the bounce was that I had intended to keep the position open for the long run if the ‘W’ shape were to be fulfilled. This was not the case, and even though I could have made more money by closing the position when it was in profit, I stuck to my initial conviction. Put it this way, if I had closed near to the bottom, but the market fell even further confirming my initial view, I would be kicking myself even harder than I am now! But that’s the name of the game; you have to take risks to make the big bucks!

I have been watching news of the election in the UK unfold and the sentiment seems to be that we may be heading for a hung parliament (where no one party has an overall majority). This would be terrible news for the pound. I have taken a couple of short sterling trades based on technicals. I will post the graphs another time.

I am in favour of a change in government and that means that I am supporting the Tories, but that is mainly because they are the best of a bad bunch! The fact that they plan to tackle the UK's deficit as soon as possible is a positive step and I think that a continuation of the Labour government would be bad news for the British economy and our credit rating.

I have also taken a couple of short term short positions on the S&P (ESMO - June contract) and the FTSE (Z HO) again based of the technicals - you can see the graphs below.

The portfolio is perfoming steadily with a 20.8% return over the initial investment.

Bring on the Euro!

Back in the day before it's inception in January 2002, I remember saying that I was against Britain joining the Eurozone. Back then a mixture of youthful inexperience and British pride made that decision for me. Looking back in light of the knowledge I have acquired since, I still agree with the decision made back then. Sterling was a pillar of strength for the country and essential to maintain the strength of the FS industry in the City. Also, the nature of the housing market in the UK meant that more people are exposed to variable rate debt which could have been susceptible to unfavourable interest rate changes by the ECB. Since 2002, the government, media and the public have employed traditional hostility towards adopting the common currency.

As Paul Taylor in the Telegraph put it, "For most of the past decade, as the flexible, finance-driven British economy was roaring ahead of its sluggish Continental cousins, the economic and political case for joining the single European currency was hard to make."

The picture changed on Monday when the president of the EU commission, Jose Manuel Barroso, said Britain is "closer than ever before" to joining the euro. There is obviously an element of political spin from Mr.Barroso - the UK, being the fifth largest economy in the world, would be a boost to the standing of the EU. However, he has spotted an opportunity to take advantage of a drop in confidence in the country due to the financial crisis which may make even the staunchest cynic of the euro reconsider the option.

We are entering an era where he pressures on the pound are mounting. Next year, total government borrowing will be a whopping 8% of GDP and total government debt by 2014 will reach 57.4% of GDP. The housing market is collapsing and the pound has fallen 21% against a basket of currencies in 15 months. It is very likely that the Bank of England will drop interest rates to unprecedented new lows and they are likely to stay low for the foreseeable future. The result - downwards pressure on the pound, higher import costs, higher prices, lower consumer spending, higher unemployment...hardly what we need right now(see my last blog entry).

The mantra expelled by the commission is that "the euro protects." In my opinion, that is exactly what this country needs right now - protection from an over exuberant government, more interested in scoring political points than the future welfare of the public. The government would be obliged to follow the rules set out by the ECB for sound financial and economic prudence. In fact, if the UK were a member of the euro, the commission would already have initiated an "excessive deficit procedure," demanding that the UK gets its borrowing under control. In effect, it gives the government some accountability to a higher body.

Some would argue that this is a disadvantage since the government would not be able to employ monetary tools to safeguard the UK's economy. Interest rate decisions made by the ECB would be made for the benefit of the eurozone as a whole and may not be to the benefit of the UK's economy, for example if a majority of the eurozone is in a recession and the UK is not. Essentially, the UK would be at the mercy of the euros performance in those countries within the zone. A bad thing when the UK's economy was healthy, but remember that forecasts are that the UK will be hardest hit economy during the global recession. Through joining the euro, we may be able to seek strength from the more prosperous European countries (I am mainly thinking of Germany here).

There are also benefits for business and employment. A single and transparent currency will tempt more UK businesses to compete in mainland Europe and, visa versa, will encourage European businesses to venture into the UK - both boosting job creation. A prosperous combined Europe could think of challenging the USA in new and existing markets. A weak pound means higher prices for imports, a stable euro will encourage imports.

The idea of joining the euro will be seen by most people as an extreme one. The government have responded to Mr.Barroso's comments by reaffirming their position against it. And I am not stupid enough to believe that public opinion will change enough overnight to force the government into reassessing their position. However, I do think that the impending problems facing our economy and currency should force at least a rethink in near future. The government at least have a duty to explore whether the pound is a sustainable currency. Unfortunately, in reality the situation is going to have to become much worse before we see anything significant happening.


FTSE....

The FTSE has been swinging in roundabouts since my last post on the 21st Nov. Some of the big levels I mentioned before have come into play (support @ 3700, 3830, 3945 and 4075).

Last week the FTSE bounced back above 4200 following news of the Citi bailout and fiscal stimulus plans in Europe with the EU Commission set to formally unveil a plan aimed at stimulating the economy, amongst other news. Some commentators have gone so far as to say that the deleveraging process which has largely contributed to the fall in the FTSE is coming to an end which may stimulate the markets. Again, in the short term, this is nothing but a temporary bull in an otherwise bear market, confirmed when the markets opened on Monday.

This week has seen the FTSE fall below 4000 again due to further recessionary concerns and the release of some terrible economic figures. Since then the FTSE has fluctuated violently in a tunnel between 3950 and 4170. Short term support @ 4035 and resistance @ 4165.

There are no outstandingly obvious entry points at the moment - in a week that one of Britain's oldest retailers Woolworths faced administration, the FTSE rallied. It seems that market sentiment is not reacting rationally which makes it so hard to read. I think the FTSE will end the year below 4000 - 4165 provides an entry point.

Once in a century event and a quick note on the FTSE

This week has seen a once in a century event occur - but it seems to have slipped under the media's radar. On Wednesday the dividend yield on the S&P 500 closed above the 10-year US Treasuries for the first time since 1958 - that is dividend yields from holding equity have surpassed yields from holding bonds. It is only the second time that the two have crossed in 109 years that data has been available.

This signifies two things - firstly that the crisis we are living through is a once in a century crisis. This cannot be understated, the global slowdown is going to continue to be one of the most difficult periods in modern economic history.

Secondly, it shows that the expected return on equity is now higher than bonds. There has been a shift to entice investors to put their money into equity. The optimists amongst us could be tempted into thinking that this may signify that equities are cheap. I, on the other hand, believe that there is still room for the markets to fall and we are still yet to see the bottom of the market.

FTSE....

A terrible week for the FTSE as it fell below the 4000 mark again.

As I expected, the FTSE approached, but did not quite hit, the 4075 mark again following my post on Wednesday - it hit 4062.5. This was a good shorting opportunity, although it would have fallen outside of the ± 10 pts margin I give myself.

From there it has fallen approx. 300 pts with huge swings. The 3945 level proved to be a support late on Wednesday and, following the penetration, resistance on Thursday with it bouncing off on the 1hr graph in the morning. This shows another shorting opportunity with a target of 3830, which it hit late yesterday evening before falling further.

Big drop in Inflation - good or bad news?!

Every couple of days it seems there is an economic release which triggers a change of sentiment. As a consequence of the drop in the base rate and a fall in commodity prices, inflation has fallen from 5.2% in September to 4.5% in October - the biggest drop in 16 yrs! Despite the drop, the rate is still well above the BoE's 2% target.

So is this good or bad news?

A few months ago, inflation was the main concern for the Monetary Policy Committee (MPC). Inflation was above the 2% target and the pressure was on the MPC to curb the rise in prices. The problem was that the economic outlook was also bleak so there were two separate forces pulling the committee. Preceding the minutes of the MPC's interest rate decision meeting published today, Tim Besley (a member of the committee) cited that "the outlook for inflation had changed dramatically between August and the rate cut in early November. "

The rate cut was a tool to encourage consumer spending and to lower the cost of borrowing. The effect of this (if it works) is inflation. But the problem is that people are not spending money - despite the rate cut people would rather save because there is no short term confidence. Add that to falling commodity prices and we have a new buzz word - deflation.

Deflation in the short term is a not necessarily a bad thing - prices fall which encourages people to spend. The knock on effect into the medium term however, is dangerous. In prolonged periods of deflation, consumers hold off buying goods, reckoning they will be cheaper later. This can lead to further falls in demand and output. As firms sell less, they respond by cutting jobs or cutting wages. Overall, consumers then have less money to spend - and demand falls yet again. And the spiral continues....

What this means is that we can expect further cuts from the BoE in the next few months as they try to avoid deflationary pressures. Good news for borrowers, terrible news for savers.

The key point I would like to note is how the BoE's sentiment has changed so quickly. One second inflation is the worry, they react (quite late I must add...a criticism which has been frequently aimed towards the MPC) and now deflation is the worry. It strikes me that the mandate which gives the BoE monetary control over inflation is nothing but a political tool.

Controlling inflation through interest rates is virtually impossible in the UK because we are so reliant on imports. The UK runs on a current account deficit - we import more than we export - and the cost of imports is determined by the cost of inputs (raw materials, labour etc) in the exporting country and the relative strength of the importing currency. The pound is weakening so the cost of importing has gone up so we should be seeing inflation. However, the the cost of raw materials is decreasing, which suggests deflation. So the overall effect is determined by these offsetting factors.

We are seeing falling inflation due to the culmination of decreased consumer spending caused by the bleak economic outlook which suggests that the fall in the price of raw materials is greater than the pound has devalued (arguable point). What I predict will happen is that we will see the fall in inflation overshoot into deflation for one simple reason - the MPC are reactionary. They act to and not in anticipation of the future economic climate. Some may even argue that their goal of controlling inflation is redundant since there are so many externalities involved that their weapon of choice namely interest rates, is not influential enough to make a difference.

I can see the reasoning behind both schools of thought. My opinion is that, regardless of which one you agree with, expecting the MPC to control inflation is an absolute joke!

FTSE......

And another great call if I do say so myself!

FTSE hit 4075 mark early on Tuesday morning before retracing back to 4200 mark. Was trading in that channel for a while until falling heavily today. As I write this, it has fallen below the 4075 mark with next support at 3945. I expect a retrace back to 4075 where another shorting opportunity may arise.

What do we have to look forward to....unemployment!

This morning the CBI have today announced that the recession in the UK will be tougher and last longer than expected with the economy set to contract 1.7% in 2009 and unemployment to hit 9% in 2010 (3m people out of work).

Add that to the news last week that BT are cutting 10,000 jobs, RBS 3,000, Virgin Media 2,200 Yell 1,300, JCB 400, Friends Provident 280, Leyland 250. And expect the list to continue growing as firms look to scale back operations and cost cut - according to the Press Association, Next are planning to cut jobs next year. Figures released last Wednesday showed unemployment to be at an 11 year high of 1.82m in the 3 months to September as firms cut jobs to cope with the economic slowdown.

The good thing is that in the medium to long term the recession should (in theory) push firms to become more efficient which should result in lower prices.

However, that obviously is not the immediate concern. Job security is essential for confidence in everything from politics to the markets. If people feel their jobs are unsafe, they save money for a 'rainy day' - less consumer spending, negative impact on GDP, further recessionary pressure...more job cuts! Again, more evidence to suggest that we are still far away from the worst this era has to offer.

The Financial Service industry, which was the single largest contributor to the period of sustained growth in the lead up to the 'credit crunch' (and cynical people may argue they were also the cause - but not me!), has also been hit hard. This trend is set to continue says Mark Kleinman in the Telegraph:

"In recent weeks, investment banks including Citigroup, Goldman Sachs and the former ABN Amro operations owned by Royal Bank of Scotland have embarked on new waves of redundancies, at the likely cost of thousands of City posts. Both Citigroup and Goldman are letting about 10pc of their workforces go, a proportion which, if applied to JP Morgan, would result in more than 3,000 jobs being slashed around the world. "

This is major blow for the City and the British economy. Despite being criticised by many commentators for causing the crunch through excessive risk taking and accepting ludicrously high bonuses (and pretty much any other buzz phrase that I am sure most of them don't fully understand) it is ironic that developments and enterprise in the FS industry which led the London becoming the financial capital of the world also led to economic prosperity, near to full employment and a generally higher standard of living. Without it, the City is dead and the British economy would be soon to follow.

During the much documented, and historically significant, G20 summit, the 20 biggest economies in the world agreed a plan to stimulate economic growth with interest rate cuts and government spending. They also insisted that Financial Institutions (banks, insurers, hedge funds, private equity) should hold more capital which will means less business and lower profits. As Robert Preston puts it:

"The City of London will shrink. And what was for many years the engine of the British economy, generating a third of economic growth and a significant proportion of tax revenues, will be running at 30mph, not 90mph. There is a cost to making the world a safer place. And much of the bill is being picked up by the UK."

Last week Germany officially plunged into a technical recession following worse than expected economic activity and, as Ralph Atkings at the FT put it, "intensifying fears about the depth and duration of continental Europe's downturn." A technical recession is defined as 2 consecutive quarters of negative growth (GDP is the measure of growth). This was followed by similar announcements by the Euro Zone, Italy and today the world's second biggest economy, Japan, added to the woes. Growth in Japan has been hit by the global economic slowdown which has curbed demand for Japanese exports. The US is expected to follow suit in January.

The key question is - how long will it last? Following the dotcom bubble, the US went through 2 quarters of negative growth followed by a rapid recovery. The recession that began in 1980 lasted 5 quarters as did the one in 1990. The National Institute of Economic and Social Research expects four quarters of negative growth and then stagnant economic output for some time after that.

Hugh Pym, the BBC Economics Editor notes:

"Those two recent recessions saw big declines in manufacturing output which led to factory closures and sharp rises in unemployment among manual workers. But manufacturing now accounts for a much smaller share of GDP. What no-one knows is how an economy with a much bigger share taken by financial services will react in a downturn."

My guess would be 'not well.'

My solution - and this good - there isn't one! As any economic academic will tell you, we are following the classic business cycle model. Following every boom there is a bust. And this is no different. Government intervention through monetary and fiscal policy and initiatives to stimulate spending and employment, can help find the bottom sooner but there is no simple fix to the problem. We have to ride an endure the recession storm for at least the foreseeable future.

FTSE.....

The FTSE continued to react of the support and resistance points which I noted on my blog on the 7th November towards the end of the week.

There was an opportunity to go long @ 4075 following the double bounce off it on Thursday (against the trend, very risky).

This could then have been closed and reversed @ 4440 late Thursday evening into a short position. The short could have been doubled up @ 4335 and again @ 4200 late Friday/today. Look to close @ 4075 early this week.

New points of note:

Support – 3830
Resistance – 3945 (previous resistance could provide support)

Tax Cuts and Falling House Prices - really bad news?

Gordon Brown and his rivals have come out this week with tax cut proposals ahead of the pre-budget report which is expected next week. One thing they all agree on, consistent with the announcement of such cuts in the US and Germany, are that tax cuts are a useful tool during an economic crisis to increase consumer spending. The theory is simple, people pay less tax, they have more disposable income so they spend more (interest rates are low so incentive is to spend rather than save). Sounds like good news right?

The problem arises when the question is asked "how will the tax cuts be funded?"

The government is currently 43% of the UK's GDP or approx £640bn. A lot of this debt was accrued during the economic expansion and was used to fund public ventures (health care, education, etc). One obvious issue is that by lowering taxes now the government are prolonging the time it will take to pay it back - hence future generations will be burdened by our debt for which they will see little benefit (lower taxes now mean higher taxes in the future).

This is not my main concern. And this is ties in closely to falling in house prices. A cut in taxes could lead to a deterioration in the standard of living. All forms of public services run the risk of suffering cutbacks, the NHS, emergency services, public transport, schools, just to name a few. In my opinion, the public sector is full of unnecessary bureaucratic paper pushers burdened by inefficient management who have no incentive to streamline practices like competitive private firms (my economist side rears it's head!). And I doubt tax cuts will make the system efficient, but could rather reduce further the (somewhat questionable) levels of service. As a nation, we enjoy a high standard of living supported by our public services despite the issues I have highlighted above, if all of a sudden we were to find things not up to the standard we have grown to expect, I think many people would be angry.

In this weeks Money Week magazine, in a discussion about the outlook post the Troubled Asset Relief Program (TARP) in the US, have noted:

"According to John Hardy at Saxo Bank, the “best case” outlook from here is that the housing market bottoms out in 2009 as Tarp limits further price falls to around 10%. Foreclosures fall sharply as mortgages are rewritten, allowing most people to stay in their homes, and by the end of 2010 much of the unsold housing stock is absorbed. The more likely “middle case” would be that house prices fall a further 20%, while a sharp recession forces unemployment above 8% by 2010, and consumption contracts faster than ever before. Glimmers of a recovery might appear by 2011. But in the worst-case scenario, America lurches into depression, with GDP collapsing at its fastest rate since the 1930s. This lasts well into 2010, with unemployment nearing 10% and ‘underemployment’ approaching 25%. The housing slump grinds on into 2011, with some suburbs turning into looted “squatters’ towns”. Public unrest and criminality become endemic."

It may seem a little extreme, but the last scenario is a definite possibility. One only needs to look through history to see the social issues that have accompanied economic instability. Add this to the insistence of Mr.Darling that government economic policy should be implemented in accordance with Keynesian economic theory and we have a potential disaster! The theory that governments should save public money when times are good and spend on public ventures when times are bad is itself a good one. When the economy is growing, cut public spending and jobs so that when things get bad and private employment levels fall (as we are seeing now - unemployment is at an 11 year high) the government spends more money on public ventures (building schools, hospitals etc) which itself creates public jobs. Sounds good...apart from the fact that during the 'good times' the government increased public spending (government debt increased) and public employment is over-inflated. Why is it that Darling cannot see such an obvious fundamental flaw to his proposal??!

Going back to house prices - as a first time buyer looking to get on the property ladder, falling house prices is great news. The fact that the bubble did not burst sooner is testament to how sub prime debt was packaged in such a complicated manner by so called financial geniuses. According to the HBOS UK House Price Index prices have fallen back to what they were in mid-2005. I'd be looking for prices to fall to levels at the end of 2003 which is a further 18% drop before we even consider to be looking at the bottom of the market.

FTSE....

I hope people took some notice to my FTSE chat on Friday...if anyone was tracking the markets you would have seen the support and resistance points I mentioned come to fruition this week. The announcement of China's $586bn stimulus package on Monday gave the markets confidence, but that feel good factor soon wore off.

As you can see the FTSE touched the 4545 level which as a major resistance shows a sell signal. Further shorting opportunities at the 4440 and 4335 can also be seen as it hovers around those levels (add to the existing short position). In total from the top to the current level, one could have bagged 310pts. At £2 a pt and increasing the stake at each level one could have made £1550 (not considering he cost of the spread)!

Who said trading was difficult?!!

UPDATE - by the time I finished writing this the FTSE hit 4200 which is a recognised support. Closing here would have caught 345 pts.

A bold move by the BoE

End of my first week writing this blog and what a week it has been. We've seen Lewis Hamilton become the youngest ever F1 Champion, Barack Obama become the first black president of the United States and the BoE unexpectedly slashed interest rates by 150bps - the biggest cut since 1981! The ECB also cut rates by 50bps.

The reasoning behind the rate cut is simple - to stimulate lending and revive the credit markets. Bad news for savers but good news for mortgage holders...well not quite. If you have a tracker mortgage (which tracks the BoE base rate) then happy days. Otherwise, it is still not known whether the cut will be passed on by the banks...I know a couple of banks have said they will be passing on discounts on their variable rate deals but others have withdrawn some products altogether (an interesting stat I read recently - the number of mortgage products available in the market has fallen from 15,000 a year ago to just 5,000 now - a fact that will not be helped by the concentration of the retail banking market which will lead to less competition and higher prices). The UK Council of Mortgage Lenders has said that its members would not automatically pass a base rate reduction on to customers in the form of cheaper loans.

They blamed this on a “dislocation” between the base rate and the higher interbank borrowing rates. LIBOR, which is more relevant to banks when pricing credit, is still high despite falling below 6% this week. This means that banks are finding it harder and expensive to borrow money which impacts the consumer. Easily available credit is what caused this crisis in the first place. The banks are now risk averse - they are not willing to lend as readily - and if they do they want to levy a risk premium. So don't expect things to change dramatically anytime soon.

Was the decision a good one - well only time will tell. The markets were expecting a 50bps cut so the initial shock was a good one. I can think of a few reasons for the size of the cut; (i) to keep up with the US and Japan whose rates are extremely low; (ii) to force the banks to pass on at least some of the cut onto customers; and (iii) because they realised the sheer severity of the recession that is ahead of us and a realisation hit that they should have acted earlier (see Robert Preston's blog on the BBC website).

Other bits worthy of a mention - M&S reported 34% fall in profits; BA have reported a 91.6% fall in half year profits ; BT issued a profit warning which sent its shares below the 1984 floatation price; a Goldman Sachs fund posted $990m loss after 10 months trading; the IMF have predicted the British economy will shrink by 1.3% in 2009 and will be the worst performing of the developed economies; house prices down 2.2% in October according to the Halifax, brings total drop to 13.7% for the year.

And the FTSE....

Last week was the most successful week in the history of the FTSE100 Index. The FTSE enjoyed a consecutive 6 day winning streak which was probably a combination of excitement around the US presidential election (the markets rallied due to the belief that an Obama victory would lead to the quick implementation of policies and initiatives aimed at fixing the US economy) and in anticipation of rate cuts by the BoE and ECB. That finished on Wednesday when disappointing results from ArcelorMittal and Carlsberg A/S overshadowed the presidential election victory for Obama (the so called 'Obama bounce' never materialised). Add to this the terrible UK factory production and services figures which cemented the opinion that the country is heading for a recession. Yesterday property developers led the decline following news about a further fall in house prices.

This tells me that the current rally in the FTSE is no more than a temporary bull in a bear market. The trend is still down - a grim economic outlook for both the US and Europe will be the main factor driving the trend. Expect the markets to continue to be volatile.

Points worth noting (those in bold are major):

Support – 4200 ; 4165 ; 4335 ; 4830 (previous support may become resistance)
Resistance – 4440; 4545 ; 5065

What a week to start a blog!

This is the first of what I hope to be many entries on my weekly blog...and what a week to start!

It all starts with the US Presidential elections which kick off tomorrow. It goes without saying that I am backing Obama to be first past the post...although I am weary of the deep seated discrimination of many of the US electorate. I doubt, despite the indications of all the polls, that the election has already been won. The problem with McCain is that he is too old (just think that if he were elected the US could be one heart attack away from Sarah Palin as president!) and his economic policies are no different to that of Bush's. The US economy needs new ideas and the country itself needs a new front which will accepted into the international political sphere. Obama is that front.

The BoE and ECB are expected to cut interest rates (again) on Thursday following dire economic news in recent data releases. The FTSE100 already seems to be buoyed by the expected cut...which many analysts are expecting to be 50bps.
As the FT have put it, "British and EU monetary policymakers are facing mounting pressure to slash interest rates to historic lows...amid a clamour for rate cuts unprecedented in their brief histories."

Of course the actions of the BoE, ECB, FED and other central banks around the world are a reaction to the Global Credit Crisis. I have had first hand experience of working in the industry during this difficult period which has moulded my opinions which I will document when writing my blog. In short, I believe the government actions so far have generally been poor or without foresight (for example, the US bailout plan - why try to push it through so quickly when the consequences for it failing to go through congress would be, and were, dire?! Add to that the ban on short selling, the nationalisation of Northern Rock, the "rent now, buy later" first time buyers plan aimed at reviving the housing market, the following of a Keynesian Economics policy- sure we can spend our way out of a recession...and the list goes on!), and that things are going to get worse before they get better!

Just a word on Lewis Hamilton - he's the man of the moment! 23 years old and on top of the world!! A legend in the making!

I will be posting my first full entry on Friday and every Friday from then onwards.