Quarter Ended 31 December 2008

Equity Markets

All major equity indices suffered negative returns for Quarter 4.  The S&P 500 recorded falls that bore comparison with the stock market performance of 1931 as other indices reached multi-year lows.  Hedge funds came under pressure from investor redemptions and the withdrawal of credit lines from banks.  Hence, markets continued to see indiscriminate selling in all asset classes as hedge funds attempted to create liquidity.  The financial sector was particularly weak as the fall out from the Lehman’s bankruptcy continued to reverberate.  The Irish Government, fearing a run on domestic banks, issued a Government guarantee on deposits.  The UK Government initiated a rescue package for its banks and similar practices occurred with other national Governments.  The initial belief that Emerging Markets could decouple from the developed world has proven to be a fallacy and whilst these countries have strengthened their balance sheets since the Crises of 1997/98, they will suffer significantly as the US slows down.

Monetary and Fiscal Stimuli

Global Central Banks initiated co-ordinated rate cuts for the first time since September 11th 2001.  Continued aggressive rate cuts should be expected.  Focus on the woes of the financial sector transferred to the deteriorating environment in the real economy.  Within the real economy, unemployment increased dramatically and retail sales declined significantly.  Fears of deflation came to the fore as Governments initiated massive expansionary fiscal policies and Central Banks were encouraged to operate quantitative easing procedures.

Falling oil prices and corresponding inflation figures proved one of the few economic benefits of the slowing global economy for the indebted consumer.

Property

Property markets continued to remain depressed, with indicative falls of between 40%/50% for 2008 in the Commercial and Residential sectors.  US metropolitan house prices, according to the Case/Shiller Index, fell 18% in 2008.  A plateau in US house prices is a necessary precursor for any possible renewal of US growth.  We continue to avoid property either directly or through equity markets.

Exchange Rates

Volatility in exchange rates continues. This has been a reflection of individual countries’ dramatic changes in interest rates and fiscal deficit concerns.  Sterling was particularly weak against the Dollar and Euro, based on a straining of two significant sectors for the UK economy, the Oil and Financial sectors.  This is of particular concern to the Irish domestic economy and more specifically for Irish exports to the UK.  There may be a significant weakening of the US Dollar, based on the substantial economic stimuli created, but this needs to be balanced against the perception of the US Dollar as the global reserve currency.

2009

Fiscal and monetary stimuli are expected to create inflation in the medium to long term.  However, in the near term, recessionary forces and deflation are at the forefront of policymakers’ concerns. The introduction of a new US President in association with financial experts from the previous Democratic Administration would indicate that post the extensive stimuli and a subsequent return to reasonable growth, a re-balancing of the US national accounts will be sought.  This will entail a re-balancing of the global economic equation that has existed for much of this decade.

There have been two main engines of growth in the Global Economy.  The US consumer has provided the necessary demand, whilst Emerging Markets, particularly China, have ensured adequate supply.  As we have mentioned in previous correspondence, the US consumer has benefited from historically low interest rates and significant tax cuts.  In addition, an asset bubble within the property market has allowed the US consumer to extricate equity from their home values.  Appian believes that the US consumer will attempt to strengthen their personal balance sheets via saving.  A significant slowdown in US consumer spending will have obvious implications for exporting countries such as China and Germany, who, as part of the re-balancing process, will need to encourage domestic consumption.