The final weeks of the September quarter of 2008 and the month of October will go down as one of the most extraordinary and tumultuous periods in the history of financial markets. The bear market which began in the middle of last year has reached almost unprecedented ferocity in the past two months; few assets have been spared but leading the falls have been credit markets and equities where declines of 30-50% over the past three months are widespread. In the month of October alone, at the very lowest point in markets, which occurred on the 27th of the month, the MSCI World Equity Index had fallen by a staggering 29.5% and the MSCI Emerging Markets Index had fallen by 42.3%. Markets then had a sharp rebound from these heavily oversold levels but for October as a whole markets experienced one of their worst ever monthly performances; full monthly returns for most asset classes and currencies are shown in the tables below.

There is now little doubt that there is no-one left in Washington who thinks the decision to let Lehman Brothers collapse was correct. Within weeks, the ensuing shock to the financial system and collapse in confidence brought the global banking system to the very brink of a systemic failure, with all the unthinkable consequences that would bring for economic activity and living standards throughout the world. The bail out packages announced by governments to rescue the banking system now total around USD2 trillion, and we have seen the progressive melt-down of financial companies, currencies and countries which are perceived to have unstable 'balance sheets' and excess debt, much of which has become impossible to re-finance. The list of banks and insurance companies which have either failed or been bailed out by governments looks almost like the 'who's who' of the great and the good: Lehmans, AIG, Washington Mutual (the largest banking failure in US history), Wachovia, Fortis, Dexia, HBOS, RBS, the list could go on.

Despite this obvious trauma and the well publicised mess in which the world has slipped, there is now greater clarity in financial markets and the outlook for the global economy than for some time. The key points are as follows:

1. The action to bail out and stabilise the banking system, which reached its greatest intensity in the middle of October, is working; confidence is being very gradually restored as evidenced by the steady falls we have seen in LIBOR, the interest rate at which banks lend to each other. The banking system, staring at the abyss only a few weeks ago, will not be allowed to fail. If conditions deteriorate further it is inconceivable that governments and central banks will walk away from the problem, having already committed USD2 trillion. In effect all necessary action will be taken to shore up the system and ensure the continuing life blood of the global economy, namely credit and a smoothly functioning banking system.

2. The crisis is now moving away from the credit crunch and its impact on the finance sector towards the real economy and the inevitable recession which will follow the credit crisis.

3. That there will be a global recession is no longer in doubt, it is simply a matter of its length and depth. Profits in many sectors will be severely hit, an outcome which is rapidly being reflected in share prices.

4. There is ample room for strong policy responses in many countries. Interest rates will be cut further and substantially around the world, especially in Europe and the UK. Inflation is last year's problem, not today's. By the middle of next year it is highly likely that cash will be earning very little in all the major economies.

5. We are currently in the midst of a wholesale and massive process of deleveraging right across the capital markets. Banks, proprietary traders, market participants with high leverage and hedge funds are all closing positions as capital has become scarce. This process is on a huge scale and is happening irrespective of underlying values; it will clearly end in due course (you only have to deleverage once!) but it is impossible to know exactly when.

6. The decoupling theory that was so popular in the past couple of years, to which we never subscribed but which led many forecasters to believe that the growth in emerging markets (and especially the 'BRIC' countries) would offset any slowdown in the developed world, has proven to be without foundation. Emerging markets have fallen further and faster than the developed markets as the onset of recession in the US, Europe and Japan has hit the exporters and manufacturing industries of the developing world very hard. At the same time, commodity markets, on which so many emerging markets critically depend, have collapsed, debunking another popular theory of recent years, the commodity 'super-cycle' (another one to which we did not subscribe). As the global economy has slowed, so demand for commodities has fallen sharply, and, as they always do, when demand falls so do prices. One of the most notable features of the past few weeks has been the huge falls in emerging market stocks, virtually all commodities (agriculture, metals and oil) and all related materials companies share prices.

Unprecedented times in capital markets invariably give rise to unprecedented opportunities. The markets are already discounting a steep recession and fall in earnings, and are overlooking the positives ahead, especially the very sharp cuts in interest rates to come. Furthermore, markets always turn well before the real economy reaches the nadir.

The root cause of the crisis has been excessive and unsupportable levels of debt. It is logical therefore that the epicentre of this crisis has been the credit markets. Credit spreads have ballooned out to historically extremely high levels, in some sectors, notably bank capital, to levels which have never been seen before. It is equally logical therefore that this will be the area with the earliest and strongest recovery prospects. The very high yields available relative to government bonds more than compensate for the extra risks and the rising defaults which will occur as the cycle plays out. We have therefore been building up positions in the credit sector.

The second area of huge recovery potential is large capitalisation blue chip companies with strong balance sheets, good cash flow and defensive characteristics in a tough environment. Valuations in this area have been decimated along with everything else, and while it might still be premature, the long term opportunities are now exceptional. Having reduced equities earlier, our funds are well positioned to capitalise on further weakness to repurchase equities for their long term recovery prospects.

Currencies have been almost as volatile as equities in recent weeks and have had a material impact on portfolio returns. After a number of years of weakness the US dollar had a major rally against most major currencies, rising by almost 10% in October alone against both the Euro and Sterling. The yen was even stronger, rising by 7.9% in October against the strong dollar as the carry trade, in which investors such as hedge funds borrow in low yielding currencies such as the yen to re-invest in higher yielding currencies, were rapidly unwound during the process of deleveraging and scaling back of risk positions. Our portfolios are diversified across a spread of currencies which mitigates against the potential damage caused by sudden and sharp movements such as those of recent weeks, and ensures a broad spread of risk and opportunity.

Source: RMB Asset management / Bloomberg. October 2008

Important Notes

Disclaimer:
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Prospective investors should inform themselves and if need be take appropriate advice regarding applicable legal, taxation and exchange control regulations in countries of their citizenship, residence or domicile which may be relevant to the acquisition, holding, transfer, redemption or disposal of any investments herein solicited.

Any opinions expressed herein are those at the date this material is issued. Data, models and other statistics are sourced from our own records, unless otherwise stated herein. We believe that the information contained is from reliable sources, but we do not guarantee the relevance, accuracy or completeness thereof.  Unless otherwise provided under UK law, Wealth management Group Ltd does not accept liability for irrelevant, inaccurate or incomplete information contained, or for the correctness of opinions expressed.

We caution that the value of investments in discretionary accounts, and the income derived, may fluctuate and it is possible that an investor may incur losses, including a loss of the principal invested.  Past performance is not generally indicative of future performance. Investors whose reference currency differs from that in which the underlying assets are invested may be subject to exchange rate movements that alter the value of their investments.

Our investment mandates in alternative strategies and hedge funds permit us to invest in unregulated funds that may be highly volatile.  Although alternative strategies funds will seek to follow a wide diversification policy, these funds may be subject to sudden and/or large falls in value.  The illiquid nature of the underlying funds is such that alternative strategies funds deal infrequently and require longer notice periods for redemptions.  These Investments are therefore not readily realisable. If an alternative strategies fund fails to perform, it may not be possible to realise the investment without further loss in value. These unregulated funds may engage in the short selling of securities or may use a greater degree of gearing than is permitted for regulated funds (including the ability to borrow for a leverage strategy). A relatively small price movement may result in a disproportionately large movement in the investment value. The purpose of gearing is to achieve higher returns associated with larger investment exposures, but has concomitant exposure to loss if positive performance is not achieved. Reliable information about the value of an investment in an alternative strategies fund may not be available (other than at the funds infrequent valuation points). 

Under our multi-management arrangements, we selectively appoint underlying sub-investment managers and funds to actively manage underlying asset holdings in the pursuit of achieving mandated performance objectives. Annual investment management fees are payable both to the multimanager and the manager of the underlying assets at rates contained in the offering documents of the relevant portfolios (and may involve performance fees where expressly indicated therein).

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Wealth Management Group 2009