The financial crisis of 2008 isn’t even over yet, and the finger-pointing and mud-slinging have already begun. Silvio Berlusconi, uniquely well-positioned to lecture others about ethical behaviour, railed against what he called “speculative attacks” on Italian banks. German finance minister Peer Steinbrück called for a worldwide ban on “purely speculative short selling”. God even got dragged in. The archbishops of Canterbury and York waded into the fray on the evils of the short sale. John Sentamu, archbishop of York, called short-selling traders “bank robbers and asset strippers”.
Which would all be fine, were it not hopelessly wrong. As Simon Ruddick of Albourne Partners pointed out in a letter to the Financial Times this week, short selling, and hedge funds more generally, are not the problem, but part of the solution. Directing one’s anger at short sellers and hedge-fund managers is a classic example of shooting the messenger. “The global credit binge was neither created nor fuelled by hedge funds. They are now being vilified for having played a role in bringing this madness to an end. Investment banks running with 29 times leverage, or building societies lending out radically more money than they had received in deposits, were fully-regulated entities. Did the regulators blow the whistle? Or the management or shareholders of those banks…?”
The biggest irony of the crisis is that ever since Long Term Capital Management failed in 1998, investment commentators have expected hedge funds to trigger the next market meltdown. But this mess was caused by regulated banks, not by unregulated hedge funds – many of whom will also be exiting the market involuntarily on the back of this autumn’s spike in volatility.
We certainly can’t blame hedge funds for the collapse in financial stocks, because financial authorities across Europe had by then forbidden the short selling of banking and financial shares altogether. So the finger of blame there must be pointed at lazy and incompetent long-only portfolio managers waking up a little belatedly to the fact that most of the financial sector is effectively insolvent. It’s questionable whether suspending normal market practice is even particularly effective. Short selling was prohibited in the Chinese market until the Securities Regulatory Commission decided on 26 September to allow it. By that stage the Shanghai Composite Index had already fallen by 56% this year alone.
But if you stick around in the markets long enough, you get to see everything. Sometimes you get to see it twice. While this year’s volatility has been extreme by anyone’s experience, the fact that it was triggered by venal behaviour at commercial and investment banks is nothing new. Nassim Taleb observes that after defaults in southern and central America, “in the summer of 1982, large American banks lost close to all their past earnings (cumulatively), about everything they ever made in the history of American banking – everything”. American financiers then walked straight into the savings and loan crisis, which saw more than 700 American thrifts (similar to our building societies) fail. The cause of the crisis? Imprudent real-estate lending. So the circumstances are really nothing new – only the scale of the shock.
So what should investors do now? It almost feels too late to be panicking. Equity investors looking at the wreckage of their portfolios should be selective when it comes to spring cleaning or deciding new purchases. The downfall and widespread nationalisation of the banks suggests credit will be unavailable across the board for some time to come.
It is hardly new news, but retailers, homebuilders, and all businesses dependent on consumer spending are in for a grisly future. The classic defensives are what they have always been: food groups, brewers, tobacco-makers, healthcare and utilities. And dividend yields cannot be trusted, especially those on financial stocks. Investors hoping for growth should look East. And while the energy sector is currently under a cloud due to softer oil prices and the presumption of far slower global growth in 2009, energy infrastructure still strikes me as one of the most compelling longer-term investment themes.
Hedge funds have not been exempt from the slaughter, but compared to equity markets have held up pretty well. A number of strategies still show gains year-to-date, among them short-bias funds (unsurprisingly), global macro and trend-followers. What seems clear is that the banks – those that make it through this crisis, at least – aren’t going to be in rude health anytime soon. Given their role in this and past crises, perhaps we should all be profoundly grateful.
• Tim Price is Director of Investment at PFP Wealth Management. He also edits The Price Report investment newsletter.
•Simon Nixon is away.