Global Markets Weekly 29 November 2010

• Market fallout from ‘known unknowns’ was muted by reassuring economic data

  Equity and bond markets fell back last week as political risks increased in the form of a financial crisis in the euro-zone and a military crisis on the Korean peninsula. Investor reaction was initially muted, given familiarity with the long-standing, although very different, problems of Ireland and North Korea, but intensified ahead of the weekend. However, there was offsetting news on stronger economic growth from around the globe. Commodities rebounded from their recent sharp sell-off, led by oil and gold.

• Ireland’s banks can be bailed out, but euro-zone structural and political problems remain

  A combined IMF, European Union and euro-zone package of €85bn announced over the weekend should be sufficient to support the Irish banks, roughly doubling the previous domestic bail-out that threatened the country’s solvency. Investors in the senior debt of Irish banks will also be reassured by news that they won’t face a ‘haircut’ on the value of their holdings, as had been rumoured last week. However, Portugal and/or Spain could yet require a bailout and Ireland’s failure to rescue its own financial sector and consolidate its finances highlights the long-term structural risks within the euro-zone. There are a number of possible ‘end-games’, including the emergence of a ‘hard-core’ euro after ‘periphery’ members are shed. However, we believe the euro is more vulnerable in the short-term to uncertainty and the possibility of the ECB being called on to provide unlimited liquidity to the region’s troubled financial sector.

• Widespread positive economic data was the other surprise of the week

  Calling the turn in an economic trend is an inexact science, but the news from the US was clearly better than consensus. The weekly initial unemployment claims were below trend for the third consecutive week, falling to 407,000, the lowest since mid 2008. Income figures were also better than expected, suggesting that the US consumer’s debt and savings situation is improving, while third-quarter (Q3) GDP growth was revised up to an annual pace of 2.5%. But the news was far from uniform. The housing market is still in recession and the Federal Reserve’s (Fed) key measure of inflation fell to just 0.9%, underpinning the Fed’s decision to engage in further quantitative easing to combat the continuing threat of deflation. Even in Europe, the IFO survey of German business confidence rose to a record level of 109.3 in November, highlighting the strength of the euro-zone’s largest economy and driving the positive tone of the region’s PMI survey of manufacturing. Similarly, 2.8% annual UK Q3 GDP growth was ahead of expectations, though driven by exports to the euro-zone and surprising strength in domestic construction.

• Emerging markets hit by Korean attack and China tightening, but positive economic and market outlook remains intact

  It is impossible to be sure about the motivation for the latest events in Korea and resulting tragic loss of life. However, the history of previous incidents and the fact that it coincided with the deliberate revelation of North Korea’s uranium enrichment programme and a call for direct talks with the US, suggest that economic motives were paramount. Cynicism appears widespread among investors in the region – while markets have fallen, this could be as much due to further Chinese monetary tightening measures, with bank reserve ratios hiked again, and Hong Kong’s increased taxes and tightened mortgage-credit limits. Despite these necessary calming measures on booming property markets, we remain positive on the region’s outlook, with annual Q3 GDP growth of 6.7% in Thailand and 5.3% in Malaysia. We would see the correction as providing an attractive opportunity to increase exposure to the region.

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