Events yesterday were in the main driven by the improved figures from HSBC which produced figures which exceeded expectations. Combining this with purchasing managers surveys in both Europe and the UK being positive lit the blue touch-paper for a rally in equity markets. Indeed the whole UK stock market bathed in the sun from the HSBC figures with the FTSE 100 rising by 2.65% and as well as HSBC rising by 5% we saw Lloyds Bank and Royal Bank of Scotland rise by around 4 %. Investors seemed to forget that HSBC has less and less to do with the UK these days as it does more and more of its business in the Far East. World stock markets also rallied strongly with the US Dow Jones Industrial Average rising by some 208 points to 10674. I notice that although the Japanese Nikkei rallied too, the gap between its close at 9694 and that of the Dow Jones is now some 980 points or just over 10%.
HSBC and banking figures
Having taken a look at the figures which at £7 billion or US $11.1 billion were better than expectations by around US $ 2 billion they made me think a little. If you look at net operating income for HSBC before loan impairment charges and other credit risk provisions then this came in at US$35.551 billion which was only US$810 million, or 2.3 per cent, higher than the first half of 2009. So to find the improvement in the figures we have to look further. We find it in the bad debts area where what are called loan impairment charges and other credit risk provisions were US$7.523 billion in the first half of 2010, which is a whopping US$6.408 million lower than the first half of 2009. So in essence HSBC’s improvement simply involves it estimating that its bad debts have fallen.
So we find something of a moral hazard at the base of the improvement in HSBC’s figures. A lowering of their estimate of bad debts makes their figures out-perform and everybody is happy. Now I am not saying that there is no basis at all in HSBC’s estimate of her bad debts what I am saying is that such “surprise” improvements should be taken with a pinch of salt.After all it is only 2/3 years when we saw supposedly rock solid bank profits disappear across the banking sector and somewhat shamefully we have seen no real reform since.
I notice that this mornings figures from Northern Rock have a weakness in this area too. Once you look past the slightly confusing position of the bad bank making a profit and the good bank making a loss then you see that bad debt provisions at the bad bank are falling in spite of the fact that the number of mortgages which are more than three months behind on their payments has risen. In fact as the bad bank has been winding down some sections of its book it is curious that the number of people in arrears has actually risen and therefore even more curious that bad debt provisions have fallen.
The UK economy: manufacturing and the exchange rate
Two different sources yesterday suggested that the UK economic situation is improving. The Purchasing Managers index for manufacturing came in at 57.3 on a scale where a number above 50 indicates expansion and the Engineering Employers Federation reported that it feels that manufacturing will grow by 3.8% this year and 3.4% in 2011, outstripping that in the economy as a whole, which is forecast to expand by 1.1% in 2010 and 2.1% in 2011. So good news overall although the EEF’s forecast for UK growth in 2010 needs revising as we got that in one-quarter! Ooops
The improved news for the UK economy recently has impacted on the UK exchange rate. At the time of typing the pound was at US $1.593 and at 1.207 versus the Euro giving it a further rally. The effective or trade-weighted index has improved to 81.96 but this lags events by a day or so and therefore does not yet have yesterdays leg of the rally.
The Monetary Policy Committee will welcome the anti-inflationary effect of the recent rise in the pound against the US dollar although our rise overall will not be so welcome amongst our exporters.
Equity and Government Bond Markets
Back on the 1st July I wrote on this subject as there were in my view some concerning trends.
Something interesting has gone on in the relationship between these two instruments. By government bonds I mean those of the UK US, Japan, Germany and similar countries. I wrote earlier this week that in my view the yield levels for government bonds in these countries were in my view at such a level that they were predicting a double-dip in the respective economies of these countries and in fact were so low that they were in effect forecasting it.
Since then we have received some further economic updates which whilst not confirming the view expressed by government bond market yields have in fact suggested a slowdown particularly in the US and Japan as I wrote yesterday. However since then we have seen a rally in equity markets which is somewhat at variance with the economic news particularly if you take the view that equities are a forecast of the future.
So what have bond markets done since the 1st of July? US ten year yields have in fact changed very little they were 2.93% then and are 2.96% now. Indeed after the US GDP figures on Friday ten year yields had fallen below 2.9% they only moved a little higher yesterday in response to the equity market rally. The Japanese equivalent has fallen slightly from 1.08% to 1.06% and the UK’s has risen slightly from 3.33% to 3.35%. So overall little change.
And equity markets? In my article I wrote of a Dow Jones Industrial Average of 9774 and a Nikkei 225 index of 9191. Since then we have seen a solid rally to 10674 and 9694 respectively an increase of 9% and just under 5.5% respectively. So equity markets have got more optimistic over this period with most of their improvement taking place in the last 2 weeks or so. Yet government bond markets are still walking to the beat of the same rather downbeat drum. Returning again to my article on the 1st of July I wrote this.
To put this into context when these yields last fell below 3% the S&P was at 857 (thank you to the FT for the numbers).
As of today we have US ten-year government bond yields below 3% but the US S&P 500 closed last night at 1126 some 31.3% higher. Quite a difference.
When I previously looked at this subject I felt that it was an area that was giving us a signal as to what may happen next. As it turns out we will have to wait longer for that as the divergence has in fact extended (as is often the way with financial market divergences which leads to the aphorism “what happens to a stock which is cheap? ( in the short-term) it gets cheaper!”). Thinking back to past experiences of this sort of anomaly then it is usually the government bond market which is more forward thinking than equity markets. Not always but usually. If you think of it logically then this probably should not be true as it is more part of an equity markets role to consider the future but in my experience it has been.