After talking about a Santa Rally for equities yesterday we saw several equity indices go to new highs for 2010. For example the UK FTSE 100 touched 5958 and the German Dax touched 7088 giving annual returns of 13% and 19%. Indeed if we go back to the falls of the credit crunch period we have now seen some extraordinary rallies. For example the American S&P 500 hit a closing peak of 1565.15 on October 9th 2007 and then fell to a closing low of 676.53 on March 9th 2009 for a fall of 56.8%. However the rally up until now taking it to 1254.6 represents a rise of 85.4%. Indeed this rally seems able to ignore all the bad news from places like the Euro zone and just carries on regardless.
Commodity Price Inflation
This continues to be a theme of 2010 and it is true to say that in the latter part of 2010 equity market rallies have been accompanied by commodity price rises. The Commodity Research Bureau’s spot index of commodity prices rose to 511.5 yesterday with all of its sub-components rising. As this index was at 420 some 6 months ago then there has been an increase of 21.6% since then which is worrying for inflationary trends.
Various metals and foods have hit the headlines during 2010 with fears over wheat and corn harvests and metal prices being strong. Yesterday it was the turn of sugar and coffee to hit highs and headlines. For example the futures contract for raw sugar hit a 30 year high at 33.5 cents per pound and somewhat bizarrely there were reports that Portugal had run out of sugar last week in another triumph of European central planning (and yes it did come with an official claiming this should not be happening in a eerie echo of the financial crisis!) The futures contract for Arabica coffee hit a 13 and a half-year high at US $ 2.2695 per pound. The latest metal to have a price surge is copper which is now priced at US $425.2 per tonne which is up some 26% since the beginning of September.
We are also seeing strength in the price of crude oil as the price of a barrel of West Texas Intermediate grade crude is now US $90.20. This represents a rise of some 21% in 2010 but this does not represent the scale of the recent acceleration as we had falls earlier in the year and the price is up some 26% since the beginning of September. Linking equity markets to crude oil then courtesy of the Financial Times I have just been comparing the S&P 500 to the crude oil price in 2010 gives an interestingly similar pattern. This reminds me of my comments earlier in the year of how difficult it is to get any investment diversification in these times.
So it looks as though 2010 with one of its themes of commodity price rises leading to inflationary trends as strong as ever.
UK energy prices and institutionalised inflation
A problem in the UK is the way that many of our prices are set by institutions who feel that they can raise prices with impunity and sadly they are often correct in this. However in our current cold snap where our energy supply resources and infrastructure are being tested I though I would give you a counterpoint to the usual cry for higher prices that come from our mostly foreign-owned oligopolies.
The price for natural gas on the Nymex futures exchange in New York is currently US $4.07 per therm.The high for the year was US $6.07 back in January so as you can see this is an area where there has been an increase in supply due to higher prices leading to a fall in the price, or perhaps capitalism at work. In fact prices are at a five-year low. So whilst there may be supply issues for getting enough gas to the UK there is in world terms no particular shortage and no reason for a rise in price. Sadly for those who rely on heating oil there has been a rise in the price of around 28% in 2010 so there is more justification for price rises here.
More Problems in the Euro zone
I expect 2011 to be a year where inflationary trends of the sort I have discussed above are combined with deflationary trends. Plainly the peripheral nations in the Euro zone are an example of a deflationary influence with Greece and Ireland clear example of this and Portugal is in a situation where she too is in an unsustainable position. I reported yesterday about the rather self-fulfilling nature of the Moodys report which was something along the lines of Be afraid. Be very afraid. There was some hope as China appeared to promise to buy some of Portugal’s bonds but the truth is that China keeps making such promises and we have yet to see action on this front. With China’s surpluses she could easily save Portugal and the yield is much higher than from her usual investment of US Treasury Bonds but she too must be concerned about possible default.
The last couple of days have seen something rather disturbing happen in Ireland’s situation as her ten-year government bond yield has surged above the levels seen when she called in the EU/ECB/IMF troika. This has echoes of what happened with Greece. The ten-year closed at a yield of 8.89% last night. One factor which is again troubling investors is this which I mentioned on the 20th.
4. There remains talk of derivative losses sitting on the books of the Irish banks and this needs to be addressed apart from having echoes of AIG/Lehman Bros from 2008.
Investors have looked at the agreement between Ireland and the troika and spotted that the liability for any such losses seems to now reside with the Irish nation. Added to this Allied Irish Bank placed more than 9 billion Euros with the bad bank Nama leading the blogger Jagdip Singh who has a good track record to question if AIB is solvent. So we are back to Ireland being under pressure and at this moment the rescue plan looks as likely to suceed as the one for Greece.
Other Euro zone nations: Contagion for Spain and Italy
These two nations have become increasingly affected by the contagion effects of what has happened in Ireland and Greece and what looks likely to happen in Portugal. We can illustrate this by looking a their respective ten-year government bond yields and comparing them with a month ago and if we do this we get for Spain 5.55% and 4.74% and for Italy 4.71% and 4.21%. As I type this these are problems but not a crisis as whilst Spain has recently had to issue some shorter-dated paper at a higher cost than before this is so far relatively small fry. You see in 2011 both nations have quite a lot of debt to issue both to finance their deficits and to replace existing debt. Indeed we will see this start in January and if you start issuing substantial amounts of debt at higher interest-rates, then your solvency arithmetic can change quite quickly. One of the flaws of the Euro zone rescue system is that it will be issuing debt too so there is the danger of it crowding out sovereign nations.
If we look at the recent effort by the European Central Bank with its Securities Markets Programme to buy debt in Ireland Greece and Portugal to try to prevent contagion we can see that at best it is only delaying the spread. As I wrote when the SMP was beefed up after the ECB meeting earlier this month this particular phase may have been tactically astute but it was also strategically unsound. The recent plan for an addition to the ECB’s capital was rather eloquent on this subject I thought.
The UK’s economic growth in the third quarter
This morning this has been revised down from 0.8% to 0.7% in terms of growth in our Gross Domestic Product. This is well within the margin of error and accordingly is a shame (as we need every scrap of growth we can get) but is not particularly significant. Even with this slight downgrade our economy grew by 2.7% over the past year which if we went back a year and asked people they would have been very happy with. However linking this news with yesterdays disappointing fiscal deficit figures only reinforces how disappointing they were.
There had been a lot of debate over the construction figures which had shown extraordinary growth. In the event they were only revised down from 4% to 3.9%. However sneaked away in the detail was an update to growth for the construction industry in the second quarter where it was cut from 9.5% to 7%. Partly because of this economic growth for this quarter was revised down from 1.2% to 1.1%.
Austerity versus Stimulus
This was one of the debates/themes of 2010 and over the past few days I have been revisiting it. For many places I have come to the conclusion that it was not as important as it has been represented. For example if we look at Ireland it looks as though the collapse of her banking sector would have derailed any economic strategy. So my point is not that it was not an issue but that in fact economic policy is sometimes less significant than we would like to believe. I would be interested to hear others thoughts on this subject.