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Broadgate: Weekly Briefing

9 December 2011

Asia – Asian shares fell on Thursday as doubts set in about whether European leaders can agree on a plan to tackle the euro zone’s two-year-old debt crisis at a summit meeting on Friday.

Shares in the euro region were expected to rise, after stuttering in the previous session, amid hopes of further support measures for strained money markets from the European Central Bank (ECB).

With important meetings looming, the ECB’s final monetary policy meeting of the year later on Thursday and the E.U. summit on Friday, investors were unwilling to commit new funds, leaving riskier assets such as commodities and emerging market currencies subdued.

“We aren’t expecting any great resolution,” said Su-Lin Ong, senior economist and fixed income strategist at RBC Capital Markets. “Markets are quite hopeful but we’ve had plenty of E.U. summits and they tend to disappoint … There are no silver bullets here.”

China – China’s equities will rally in the first half of 2012 as the stock market is among the cheapest in Asia, according to Michael Kurtz, chief Asian equity strategist at Nomura Holdings.

He favours Chinese financial, energy and material companies in a market that is trading at a 33 percent discount to its long-term average, the strategist said. Nomura was ranked No. 1 for China research in a 2010 poll by Institutional Investor magazine.

“A lot of the pain in the first and second quarters appears to have been already embedded into equity prices,” Kurtz said. “Investors should be opportunistically taking advantage of the weakness in the market to add risks to their portfolio earlier in 2012.”

Nomura joins Royal Bank of Scotland and UBS AG in predicting gains for the Shanghai Composite Index after the benchmark measure slumped 17percent in 2011. Stocks have fallen for a second year after policy makers raised interest rates and banks’ reserve requirement ratios to curb inflation.

Europe – German Finance Minister Wolfgang Schaeuble has said Standard & Poor’s (S&P) threat to downgrade eurozone countries is the “best possible incentive” ahead of Friday’s summit.

S&P put almost all eurozone countries on “credit watch” on Monday, meaning that six countries with top AAA ratings now have a 50percent chance of a downgrade.

S&P added on Tuesday that it was placing the AAA rating of the European Financial Stability Facility (EFSF) bailout fund under review. “Depending on the outcome of our review of the ratings on EFSF member governments, we could lower the long-term rating on the EFSF by one or two notches, if any,” S&P said in a statement.

Italy – Italy’s implied cost of borrowing in financial markets has fallen after new Prime Minister Mario Monti unveiled his austerity plans over the weekend.

A sharp rise in Italian and Spanish borrowing costs to levels seen as unsustainable in the long run, as well as a broad collapse of market confidence in Europe’s banking system, has raised fears that the countries may ultimately be forced to exit the single currency.

Australia – Australia’s economy grew more than expected in the third quarter, driven by building and mining activity.

Gross domestic product (GDP) rose 2.5percent in the three months to the end of September from the same period a year earlier, the statistical bureau said.

Despite the stronger growth, there are fears about coming quarters with a slowdown expected in Europe and China. The weaker outlook is what prompted the Reserve Bank of Australia on Tuesday to cut interest rates by 25 basis points, to spur domestic demand.

U.S. – The U.S. economy may have achieved a sustainable pace of growth that eases pressure on the Federal Reserve to buy more bonds while giving it time to fine tune how it informs the public about the outlook for interest rates.

“Recent economic data takes away some of the urgency for the need to engage in a new round of quantitative easing,” said Michael Feroli, a former Federal Reserve economist who is now chief U.S. economist at JPMorgan Chase & Co. in New York. The Federal Open Market Committee “can say, ‘Let’s wait and see if this is going to build on itself.'”

Since the Federal Reserve’s last meeting early in November, reports on employment, manufacturing and retail sales have dispelled concerns the world’s largest economy may slide back into recession. Signs of economic strength, along with coordinated central bank action to alleviate the European debt crisis, last week helped drive the biggest rally in the S&P 500 Index since March 2009.

Spotlight on: the continued role of Credit Rating Agencies

Once again, the integral role and influence of Credit Rating Agencies (CRA’s) has been pushed into the spotlight, following the announcement by S&P this week that France, Germany and four other countries could lose their AAA credit ratings. The news sent global markets down and made already nervous investors even more wary over the Euro-debt crisis.

It is a well-known fact that many commentators within the financial industry place little faith in the announcements from CRA’s these days, with many still mindful of the 2008 financial meltdown, for which CRA’s were accused of being “key enablers” by the U.S. Financial Crisis Inquiry Commission 2011 (Moody’s downgrade of 83percent of the USD869bn in mortgage securities it had rated triple-A in 2006, being central to the argument).

Still though, the ratings of CRA’s move markets. Last week when S&P down-graded almost every major U.S. bank, it sent shares of Bank of America, Citigroup, Morgan Stanley, Goldman Sachs, Wells Fargo, JPMorgan Chase, Bank of New York Mellon down in after-hours trading, even though the downgrades were widely expected and already priced into stock values.

The obvious question that this prompts for some is ‘why do the agencies that blessed toxic assets with AAA ratings for several years leading up to the crisis still carry so much influence in the markets?’

A key criteria, one would assume, is that CRA’s remain completely impartial and subjective when conducting their research and applying their ratings. However, it is the fact that the various companies and governments that CRA’s rate, actually pay them for their services, that brings their role into further question. Some might suggest that this is akin to a student paying his teacher for a report card.

However, the absence of CRA’s would, ultimately, result in investors having to spend time conducting their own in-depth analysis/due diligence; ‘time’ being a commodity that the rapidly moving world of investment doesn’t allow.

Jeffrey Stibel, Chairman and CEO of Dun & Bradstreet Credibility Corp, explains it this way: There is way too much information out there which causes a lot of people to shut down. So what markets, governments and investors need is someone to distil that information into a single conclusion.

“For better or for worse the information overload requires someone to make sense of it all and that’s what these agencies do. If it wasn’t S&P, Moody’s or Fitch doing the job then another company would be,” Stibel says.

The scariest part about this necessary yet questionable industry, according to Stibel: It’s likely they’ll make another big mistake again.

Conversely, some are of the opinion that CRA’s are being incorrectly targeted as a cause for recent events, with other fundamental factors such as the ‘fantasy trading’ practices engaged by investment bankers being overlooked. As Frank Partnoy, a law professor at the University of San Diego neatly explains “…we cannot blame the CRA’s themselves that the structure has become so dependent on them, we must blame the structure itself”.

The information set out herein has been obtained from various public sources and is sent to you by way of information only. Broadgate can accept no liability of any sort in relation thereto and readers should obtain their own verification of any statement before making any decision which may have any financial or other impact.

Neither the information nor the opinions herein constitute, or are they to be construed as, an offer or a solicitation of an offer to buy or sell investments.

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