Investor Confidence Commentary - The shine comes off confidence
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In 1741 at the start of the War of the Austrian Succession, Cardinal Fleury described the French position as “brilliant”. The Prussians had seized Silesia and a combined Franco-Bavarian army was on the brink of conquering Bohemia. A noose was tightening around the House of Austria. However, even in this moment of triumph the wily courtier warned: “glass has the lustre of brilliance but is also fragile”.
Fragility has also been the defining characteristic of investor confidence in 2008. After rising last month and falling the month before, State Street’s Investor Confidence Index is now back to levels last seen in March. The 6.8 point rally in the index to last month’s reading of 84 was always a relatively modest affair. Its reversal is hardly surprising in the light of gloomy economic news.
Whereas the preeminent concern since the start of the credit crunch in August 2007 has been a looming US recession, it is now clear the rest of the G7 are also suffering. The negative Q2 GDP reading in the euro area and the Bank of England’s downbeat Inflation Report have added to fears that a global economic slowdown has started. Supporters of the decoupling hypothesis are keeping quiet. In the UK consensus forecasts on the probability of a recession have increased from under one-third in June to 45% in July.
These economic headwinds are reflected in cross-border equity flows. Demand for equities was buoyant in the early summer, partly because inflation was the predominant fear. Though an imperfect hedge against rising prices, equities generally perform better than government bonds in an inflationary environment. At the same time there was a surge in demand for inflation-linked products.
However, as the bad news from leading indicators begins to be reflected in hard economic data, such as employment figures and GDP growth, interest rate expectations across the developed world have adjusted downward. Bonds are back in vogue and it is equities that are feeling the strain. Demand for developed market equities as tracked by State Street Global Markets Cross-border Equity Flow Indicator has fallen to the 7th percentile in the last month (flows have been higher on 93% on monthly time periods in the 11-year history of the indicator).
The enduring nature of the credit crunch and financial sector woes continue to undermine sentiment. The TED spread, the difference between the three-month Libor rate and the three-month Treasury bill yield and a good proxy for confidence in the banking system, has been widening again this week. The cost of buying credit default protection in the banking sector has also increased, though it remains within its two-month range.
The falling oil price is unalloyed good news for the world economy. It dampens inflation and allows central banks greater elbow room to cut interest rates. However, faltering growth has dulled its lustre. By the summer of 1743 Fleury, the preeminent European politician of his generation was dead. The French army was in flight across the Rhine. The old Cardinal had been right to be cautious. Given the worsening economic backdrop institutional investors might also be forgiven a renewed bout of timidity.
Whereas the preeminent concern since the start of the credit crunch in August 2007 has been a looming US recession, it is now clear the rest of the G7 are also suffering. The negative Q2 GDP reading in the euro area and the Bank of England’s downbeat Inflation Report have added to fears that a global economic slowdown has started. Supporters of the decoupling hypothesis are keeping quiet. In the UK consensus forecasts on the probability of a recession have increased from under one-third in June to 45% in July.
These economic headwinds are reflected in cross-border equity flows. Demand for equities was buoyant in the early summer, partly because inflation was the predominant fear. Though an imperfect hedge against rising prices, equities generally perform better than government bonds in an inflationary environment. At the same time there was a surge in demand for inflation-linked products.
However, as the bad news from leading indicators begins to be reflected in hard economic data, such as employment figures and GDP growth, interest rate expectations across the developed world have adjusted downward. Bonds are back in vogue and it is equities that are feeling the strain. Demand for developed market equities as tracked by State Street Global Markets Cross-border Equity Flow Indicator has fallen to the 7th percentile in the last month (flows have been higher on 93% on monthly time periods in the 11-year history of the indicator).
The enduring nature of the credit crunch and financial sector woes continue to undermine sentiment. The TED spread, the difference between the three-month Libor rate and the three-month Treasury bill yield and a good proxy for confidence in the banking system, has been widening again this week. The cost of buying credit default protection in the banking sector has also increased, though it remains within its two-month range.
The falling oil price is unalloyed good news for the world economy. It dampens inflation and allows central banks greater elbow room to cut interest rates. However, faltering growth has dulled its lustre. By the summer of 1743 Fleury, the preeminent European politician of his generation was dead. The French army was in flight across the Rhine. The old Cardinal had been right to be cautious. Given the worsening economic backdrop institutional investors might also be forgiven a renewed bout of timidity.
