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Quarter Ended 31 March 2009 Global equity markets continued their decline in the first quarter of 2009, with particular pressure felt in the banking and insurance sectors. There were significant write-downs of toxic assets for year-end accounts for financials. This resulted in extensive Government support for the banking sector. In the UK, the Government became a significant shareholder in Royal Bank of Scotland and Lloyds and there were fears initially that the entire UK banking sector would be nationalised. In the States, Bank of America received an increased injection of capital as a result of their takeover of Merrill Lynch and the subsequent write-downs associated with that acquisition and Citigroup welcomed the new Administration as a significant shareholder. A significant amount of work has been done to eradicate the issue of toxic assets. Of more concern to Appian at this present juncture are the deteriorating economic cycle and the bad debts associated with that for banks. US Economy Tim Geithner, the US Treasury Secretary, introduced the public-private investment programme in an attempt to increase liquidity within the financial sector. In short, this programme allows the purchase of toxic assets by a private and public partnership, the finer details and the prices of which these toxic assets are to be bought at are still to be defined. However, the market took the announcement initially as encouraging news. The US Federal Reserve cut interest rates to between 0% and 0.25% and spoke explicitly about initiating quantitative easing (QE). QE is a process that has been undertaken by nearly all global monetary authorities in this quarter in an attempt to encourage the flows of capital within their domestic economies. The US Metropolitan property market as reflected by the Case Schiller Index is down year on year 19% and 29% from its peak. It continues to indicate that the bottom of the US property market has yet to be reached. Unemployment in the US increased substantially over the first quarter with some commentators suggesting that unemployment could be at mid-teens post the accumulation of discouraged workers. Based on these poor economic fundamentals, the US is unlikely to recover in the short term with consumer sentiment so negative and a necessary increase in the savings ratios. Eurozone Economy The ECB cut interest rates to an historical low of 1½% and indicated to the market that further interest rate cuts would be open for discussion. Each individual European country has put in place their own specific model for re-capitalising their domestic banks. In some cases, this has involved the discussion of a bad bank whilst the alternative most often mentioned is an insurance scheme for the bad assets associated with banks’ balance sheets. Since the start of the year, Germany, considered by many analysts to be the locomotive for economic growth within the Eurozone, has slowed dramatically. Some commentators are suggesting a contraction in German GDP of between 5% - 7% and the German Government has come under significant criticism, particularly in the recent G20 Summit for a lack of a fiscal stimulus. Not only does the Eurozone have to take account of slowing exports and a decline in property values, but the exposure to Central and Eastern Europe is a very real threat to many banks within the Eurozone. The Irish Economy Irish Government bonds have come under significant pressure, with fears within the market that the Irish Government may default on their obligations. This is reflected in the spread of Irish bonds, over their German equivalents and the recent downgrade by Standard & Poors from AAA to AA+. Unemployment is going to significantly increase, with Appian’s estimates that it will reach 14% by the end of 2009 and 16% by the end of 2010. A lack of diversification of economic growth for the Irish economy has ensured an over-exposure to the property market and the generation of tax revenue associated with that sector. Whilst we can expect contracting GDP for this and next year, we can hope for, at best, sub-par growth from 2011 onwards. Appian believes that the reduction over recent years in our debt to GDP ratio allows the Government and the NTMA considerable room in offering a stimulus to the economy. Ireland, whilst undergoing a painful re-diversification of its growth, remains an open economy with significant amounts of flexibility but one that is ultimately reliant on the recovery of the global economy. Of immediate importance is a solution to Irish banks. In Appian’s opinion, the Swedish (bad bank) model seems most appropriate for resolving these issues, notwithstanding the fact that there are several significant concerns with regard to the structure of the bad bank and its associated acquisition of the toxic property assets that presently inhabit Irish bank balance sheets. Final Thoughts Appian, whilst encouraged by the significant importance placed by Government on the re-capitalisation of the financial sector, remains pessimistic with regard to the economic fundamentals associated with the global economy. At this moment in time, an increase in unemployment, dramatic falls in earnings and negative consumer sentiment point to a significant contraction in global GDP. We maintain a relatively low weighting in equities and remain comfortable with the security that cash provides despite, based on recent interest rate cuts, the low yield associated with that asset class. Whilst the economic fundamentals remain negative, there will come a time where the significant stimuli enacted by Government and monetary authorities will ensure that the global economy will recover and that inflation, rather than deflation, may become a more pressing concern, but this scenario is not one for the immediate future. Name Change We have recently changed our name from Appian Wealth Management to Appian Asset Management which we believe better reflects our modus operandi as a manager of assets that takes special cognisance of the risks associated with investing in financial assets.
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