This is meant to be the season to be merry, but I don’t see many people looking jolly in the City.
With the banks once again refusing to lend to one another and signs of the credit crunch spreading to new markets, such as covered bonds, fixed-income specialists – a pretty gloomy bunch at the best of times – are now openly discussing whether we’re heading for a repeat of the 1973 crash.
A board director of a major US investment bank even tells me she thinks we might be heading for a repeat of the 1930s. The boss of one of the big supermarket groups says middle-class shoppers are tightening their belts, while a taxi driver complains about the lack of Americans.
At this rate, we’re in danger of talking ourselves into a recession. But do we really have to cancel the turkey and wrap our homemade presents in newspaper this year? It’s easy to scare ourselves with scenarios where the only rational thing to do is stockpile baked beans. But things haven’t got that bad yet. So in the spirit of Christmas, here are five things to be cheerful about in the festive season.
1. Corporate balance sheets remain strong
Throughout the boom years, firms rebuilt their balance sheets after the trauma of the dotcom crash, repaying debt and returning surplus cash to shareholders, rather than embarking on expensive debt-fuelled acquisitions. In aggregate, the UK corporate sector is sitting on a huge cash pile and debt to Ebitda ratios are quite low.
Of course, the aggregate hides a wide variation, with a small but significant hard core that are heavily geared. But on average – and certainly on a pan-European basis – much of the corporate sector should be able to weather a downturn. Although I wouldn’t want to be a retailer next year.
2. Banks are well-capitalised
That may seem an odd thing to say in a week when the world’s biggest bank, Citigroup, shored up its balance sheet by selling a stake to Abu Dhabi and Northern Rock entered negotiations with Sir Richard Branson over a possible cash injection. But the truth is that European banks currently have tier-one capital – that is core capital, as defined by banking regulators – of nearly 8%, well above the minimum required of 4%. Even if the banks were forced to bring back on to their balance sheets all their dodgy commitments, it would still only cut tier-one capital to around 7.5%.
True, everyone knows there are more hefty write-downs to come, and other banks may have to raise fresh capital over the next few months. But even if subprime losses reach $200bn, that would still be less, as a proportion of US GDP, than the savings and loans crisis in the 1980s, or the UK property crash in the early 1990s, says Credit Suisse research.
3. The Middle East and Asia are awash with liquidity
Abu Dhabi’s decision to buy a stake in Citigroup was the latest in a series of recent deals by Sovereign Wealth Funds – state-controlled funds that invest the proceeds of the natural resources boom. These include China’s investments in Barclays and Blackstone and the Middle Eastern interest in Northern Rock.
Between them, SWFs now control some £1trn of assets, of which some $30bn has been invested in the US and European financial sector so far this year. If any US or European banks do need fresh capital, expect SWFs to play a vital role, as they did at Citigroup.
4. Emerging markets are still booming
It’s one of the biggest debates in the City right now: have the emerging markets decoupled from the developed world? Personally, I’m not convinced. Any slowdown or recession in the US is bound to hurt emerging markets, which rely heavily on exports. Meanwhile, the fall in the dollar potentially creates problems: do they maintain their domestic currency peg and risk domestic inflation or revalue their currencies and risk domestic slow-down?
Even so, the world has changed a great deal since 1997. Many emerging market economies are much larger and more diverse than ten years ago, giving them greater insulation against shocks, while their governments are solvent. Many developing countries, including China, India and Brazil, have vibrant domestic economies, while intra-regional trade is also important. So even if emerging market growth slows from its recent giddy pace, it is still very unlikely to swing wildly into reverse.
5. The political climate looks good
Should investors be worried about the remarkable implosion of Gordon Brown’s authority? Not a bit of it. A bigger risk would have been an undamaged Brown trying to meddle his way out of a slowdown. In his current enfeebled state, he’s less likely to try to do too much – or get away with it.
Markets work best when governments leave them alone. The difference between now and 1973 or the 1930s is that all the leading economies are run by people who understand this. Bush, Sarkozy and Merkel, for example, all understand the importance of open markets. One can’t be complacent. Protectionism has been on the rise over the last few years and could flare up if economic pressures became severe. But we’re a long way from that yet – far enough away not to let it ruin Christmas.
Simon Nixon is executive editor of Breakingviews.com