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Risk is a foreign concept to the markets these days.
An amusing, but ultimately rather serious note from fund manager Bedlam Asset Management, points out that the premium investors demand for holding South Korean bonds over nigh-on risk-free US Treasury bonds has actually fallen since North Korea exploded its nuclear bomb.
As Bedlam puts it: “Buyers concluded that the risk of investing in South Korea declined by over 85% this year, because North Korea now has nuclear armaments and, as evident from the rockets seen at frequent military parades, the ability to deliver.”
Clearly, this makes no sense, but as the group points out, this kind of non-sense is widespread. Thailand’s government debt has also shed some of its risk premium since the coup there. Again, revolutions (even peaceful ones) are rarely the best way to improve a country’s risk profile – but it seems the markets disagree.
And the fearlessness – or carelessness – afflicting markets is not restricted to exotic locales – it’s rampant in the UK too…
Financial markets are carefree at the moment. Various measures of volatility are near record lows, stocks are near or at record highs, and high-risk junk bonds are being snapped up left, right and centre, as if bankruptcy had been abolished.
The phenomenon is at its most visible in the markets. But the Financial Services Authority is worried that Britain’s bank managers are also adopting a rather too cavalier approach to risk. The FSA has told banks they should assess how they would cope if house prices fell by 40% and 35% of defaulting mortgages ended in repossession.
It’s nice to know that it’s not just us who worry about a housing crash, though the FSA does emphasise that it’s not a forecast – just a “severe but plausible scenario”. The FSA’s quite right to be worried – we’ve been going on for quite some time now about the race to the bottom going on in the lending sector, with banks chasing business by making their lending criteria ever less stringent. And it seems that their disaster planning is not all it should be.
In a letter to bank chief executives, reports The Times, the FSA’s director of major retail groups, David Strachan wrote: “We were struck by how mild the firm-wide stress events were at some of the firms we visited.” Some banks were “weak in all respects” when it came to stress-testing.
The trouble is, although banks are supposed to run various scenarios to make sure they’ve got enough capital to cushion them against any unexpected problems, there’s no benchmark. So in the good times, it’s clearly very tempting – a problem we all suffer from – to assume that things will never get that bad. And judging by the FSA’s comments, the stressful scenarios currently being modelled by banks simply aren’t that stressful.
However, the truth is, there’s actually rather a lot out there to be worried about. It can’t have escaped anyone’s notice that the US is currently in the midst of a rather nasty housing correction. And despite all the reassuring words coming from such luminaries as Alan Greenspan (having caused the house price bubble in the first place, he of course will be eager to call the end of any downturn in the hope of sparing his reputation), there’s every possibility that things will just get worse, rather than better, from here.
Regular MoneyWeek contributor James Ferguson believes the chances of the US heading into a full-blown recession are now very high indeed. And as the old saying goes, when the US sneezes, the rest of us catch a cold.
So in this world priced for maximum optimism, where can you put your money? Well, the truth is, it’s pretty hard to get a clear-cut answer when almost nothing could be described as an out-and-out bargain – but our RoundTable experts have some ideas. You can find out their eight top tips for an uncertain world – and read more on why James thinks the US is headed for trouble – in this week’s issue of Money Week – out tomorrow.
And if you’re not yet a subscriber, you can get access to all the content on the MoneyWeek website and sign up for a three-week free trial of the magazine, just by clicking here: Sign up for a three-week free trial of MoneyWeek.
Turning to the stock markets…
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In London, the FTSE 100 rallied to end the day 43 points higher, at 6,229. British Airways was the biggest riser of the day after announcing an agreement to tackle its pensions deficit. For a full market report, see: London market close
Elsewhere in Europe, stocks closed higher. The Paris CAC-40 closed 35 points higher, at 5,511. In Frankfurt, the DAX-30 closed 43 points higher, at 6,430, driven by strong car stocks including Volkswagen and DaimlerChrysler.
Stocks also had a good day on Wall Street. The Dow Jones closed 33 points higher, at 12,251. The Nasdaq was 12 points higher at 2,442. And the S&P 500 ended the day at 1,296, a 3-point gain.
In Asia, the Nikkei closed down 79 points, at 16,163.
Crude oil was trading slightly lower this morning, at $58.75 a barrel. In London, Brent spot was at $58.01.
Spot gold was hovering around $624.35 this morning, just off an intra-day high of $624.60.
And in London this morning, Reed Elsevier – owner of the LexisNexis database and educational publisher Harcourt – said it expected sales to rise 5% this year, meeting forecasts. The group expects sales from its legal and business units to make up for weakness in the textbooks market. Shares in Reed Elsevier had fallen by as much as 6% this morning.
And our two recommended articles for today…
Why the price of gold is set to rise
– What does the future hold for the yellow metal? Will demand for gold from emerging markets such as China and India increase? Will supply continue to grow? To find out what The Daily Reckoning‘s Mark O’Byrne thinks economic, demographic and political changes around the world will mean for the price of gold, click here: Why the price of gold is set to rise
Should investors expect more from hedge funds?
– Do hedge funds really make investors big enough returns to justify their fees? It depends on the fund, but investors should be wary of high-risk equity funds dressed up as hedge funds. For more of Jan Vilhelmsen of Absolute Return Partners insights into hedge fund strategies, read: Should investors expect more from hedge funds?