This feature is part of our FREE daily Money Morning email. If you’d like to sign up, please click here: sign up for
Money Morning
The risks facing the global economy are growing by the day, even as stock markets boom and the bidding wars escalate.
As the FTSE 100 surges inexorably towards its all-time high, so the warnings are coming thick and fast. Apparently, hedge funds are now taking more risks than at any time since Long Term Capital Management (LTCM) collapsed in 1998, threatening the stability of the global financial system.
Meanwhile, housing markets are looking vulnerable across the world – yes, even here in the UK. And a former deputy chairman of the Federal Reserve, Professor Alan Blinder, is warning that a quarter of jobs in the Western world could be rendered obsolete by offshoring, including many white collar positions.
So how long can the party continue in the face of such headwinds?
The warning about hedge funds came from US derivatives consultancy Tavakoli Structured Finance. The company’s president, Janet Tavakoli told the FT that, although the current status of the hedge fund industry was different compared to the days of LTCM, it was in fact probably even more risky.
“Due to the use of structured products and derivatives, hedge funds can take on hidden leverage over and beyond that which can be explained by polling prime brokers.”
In other words, they could be even more overstretched, with tentacles in even more parts of the market, than anyone suspects.
Because the industry got away with the Amaranth collapse last year, with barely a murmur, practitioners seem to think nothing can go wrong. And of course, that makes them even more foolhardy in the bets that they place – making it more likely, as Warren Buffett warned at the weekend, that “some very unpleasant things” will happen because of derivatives.
Then we have housing. Prices are falling in the US and Ireland, and the brakes are on in Spain (though now, of course, the estate agents are claiming that prices in Spain have been falling for ages, and in fact, now’s the time to buy). And it looks as though, slowly but surely, the interest rate squeeze is having an effect on us here in the UK too.
Prices are at their least affordable for “a generation”, claims Lombard Street Research. It costs nearly seven times the average wage to buy an average property, and mortgages take up 45% of the typical salary. That’s a level not seen since the crash of 1989.
It’s no surprise that even at the top end, asking prices are being cut, according to a piece in The Sunday Times at the weekend. And with interest rates almost certain to rise this week, the news for housing in the UK is not going to get any better.
This doesn’t mean that the merger frenzy gripping the stock market can’t continue for now. Indeed, as Tom Stevenson says in The Telegraph, with $300bn raised by private equity funds, there’s plenty more money where the funds to bid for Reuters came from. Every sector is up for grabs – including one of MoneyWeek’s favourites, the miners. A Merrill Lynch report last week on the prospects of a buy-out and break-up of BHP Billiton pushed share prices in the company and its peers higher, as the markets start to realise just how cheap the sector looks.
Stevenson reckons that it will be “very surprising” if the FTSE 100 doesn’t breach its all-time high of 6,930 this summer – and faced with all that money and hype, he’s probably not wrong.
But the credit squeeze is on. And as conditions tighten across the world, at some point, all that debt is going to go from being a useful tool to an insufferable burden. As Stevenson says, quoting Buffett: “Appropriate prices don’t guarantee profits in any given year, but inappropriate prices almost certainly guarantee eventual losses.”
He could be talking about anything from the M&A market to the housing market right now. One thing’s for sure – in the not-too-distant future, some people will be regretting the ‘inappropriate prices’ they paid for what seemed like prize assets in the heat of the boom.
Turning to the stock markets…
Enjoying this article? Why not sign up to receive Money Morning FREE every weekday? Just click here: FREE daily Money Morning email
In London, the FTSE 100 closed at six-and-a-half year high of 6,603 on Friday, having soared 65 points as M&A activity fuelled gains. Shares in Reuters surged 25% on news that the financial information group had received a bid approach. For a full market report, see: London market close.
On the Continent, the Paris CAC-40 closed 8 points lower at 6,071 yesterday, whilst the Frankfurt DAX-30 closed 2 points higher, at 7,525.
On Wall Street, stocks closed mixed on Monday. The Dow Jones was 44 points higher, at 13,308. The tech-heavy Nasdaq fell one point to close at 2,570 as internet stock Yahoo weighed. The S&P 500, meanwhile, added 3 points to end the day at 1,509.
In Asia, the Nikkei fell 13 points, closing at 17,656 today.
Crude oil futures had risen to $61.71 a barrel this morning, whilst Brent spot was nearly 1% higher, at $63.64.
Spot gold was last traded at $687.10/oz, whilst silver was at $13.51.
Turning to currencies, the pound was last trading at 1.9921 against the dollar and 1.4669 against the euro. And the dollar was at 0.7362 against the euro and 119.87.
And in London this morning, shares in Reuters had added another 7% on confirmation that Thomson Corp is in talks to buy the company for £8.77bn.
And our two recommended articles for today…
What Turkey’s constitutional crisis means for your investments
– The Turkish equity market may have settled down again following recent events. But can the serenity last? And what insights has the episode given us into emerging market investments in general? asks Jeremy Batstone. For more on the circumstances that led to the crisis – plus key themes any Turkey investor should understand – read: What Turkey’s constitutional crisis means for your investments
Can Mervyn King win the war on inflation?
– Shortly before voters went to the polls last week, Governor Mervyn King celebrated ten years of Bank of England independence in the City. And his version of the Bank’s achievements in that time would put most vote-chasing politicians to shame, says Adrian Ash. For more on where the credit for low inflation is really due and how much our central bank can actually do as it begins to rise, read: Can Mervyn King win the war on inflation?