Fund Performance Review (October 2008): From global failure to rescue by unification

the vortex. Similar scenarios performed on stage include the forced bailout of HBOS by takeover of Lloyds TSB, and the crisis of the Fortis and Hypo Real Bank. The series of subsiding major financial institutions across the Atlantic has carried forward into October a catastrophic risk that demands strong inter-governmental attempts for coordinating a comprehensive rescue plan to solidify the fragile, if not disintegrating, confidence of every participant in the markets.

A concerted plan – not an easy one
The road to a rescue plan is a meandering one. From the very beginning, policy makers in the US and Europe demonstrated their inadequacy in alleviating the situation by simply doing nothing, which was causing a demoralizing effect in the market. When the US was taking the lead to doing something – in the manner of Troubled Asset Relief Programme (TARF), the market was, however, further unnerved by having the TARF rejected by the politicians initially. In early October the senate finally convened and passed the amended bailout plan of $700 billion, and its strategic partner over the Atlantic, the UK, echoed by revealing a ₤50 billion rescue package for the banking industry.

It cannot be denied that it is indeed a great and unprecedented achievement among the sovereignties, by having a coherent recognition on the seriousness of the financial market's condition, as well as a consensus to resolving the crisis altogether. Nevertheless, the likelihood, also the painful truth, is that the GDP in the last quarter will still look awful for both US and most other countries in view of the continued malfunctioning of the financial markets.

There has been a concerted rate cuts announced across all countries, which injected stimulus to the market. Nonetheless, even the authorities can cut funding rates aggressively, they cannot force banks to lend and thus the chain of freeing liquidity is curtailed. The need to address these issues and to activate the liquidity cycle will be a very major challenge for the governments across the globe. While that will be the crucial criterion in order to justify the success by their unionization, such capability of resolving that problem by the new US Administration led by Barack Obama will be particularly in the spotlight.

Equities within recession
The equities continued to see falling off as weak economic data being published throughout the month. In particular, lately in October the US announced GDP fell at 0.3 percent annualized rate in the third quarter, which is the worst since the 2001 recession. Consumer spending, being the biggest component of GDP and accounting for as much as 70% of economic activity, plunged 3.1 percent, which is the steepest fall since 1980.

Albeit stronger and more articulated bailouts could be expected from different governments, under the fear of the coming recession the responses of investors in the equity markets are universal. In October the U.S. Large-Cap Blend Equity lost 17.91 percent, with US Small-Cap Equity posting a deeper loss of 22.42 percent. The Global Large-Cap Blend Equity slipped 20.63 percent while the Global Small/Mid Cap Equity dropped 23.75 percent during the month. In terms of sector performance the Sector Equity Health Care is the best performer despite still falling 13.83 percent, and that relative performance is mainly arising from the expectation that it has a lower correlation with the global health. The plunge of Sector Equity Precious Metals further magnified to 34.74 percent in October, making it the worst performer.

Bond
Throughout the month the government bond markets have found support as the flight out of equities supported prices. Economic data are generally felt to be bond positive in so far as the recession will have a dampening effect on inflation and whilst investors prefer to avoid equities the bond markets are likely to receive more support. However, there is a potential risk to this expectation. Firstly, the increasing risk aversion of investors will make bonds looking more expensive in a relative sense. Secondly, both the government and corporate borrowings are expanding, their more attractive yields are imposing pressure on the existing bonds. Lastly, in view of the worsening economy and the frozen liquidity for enterprise operations, corporate credit is deteriorating and that brings a detrimental effect on the bond prices.

In October the Dollar Government Bond posted a 2.05 percent loss. The Dollar Corporate Bond and Dollar High Yield Bond registered a deeper loss of 7.97 percent and 18.60 percent respectively. Its counterparty over the Atlantic was performing in a similar pattern. The Euro Government Bond posted a milder loss of 8.88 percent while the Euro Corporate Bond and Euro High Yield Bond lost 13.37 percent and 25.01 percent respectively.

Outlook
Looking ahead as the year draws to a close, the current market environment is not a promising one. Without a hint of convergence to stabilization, it is hard to anticipate the current market condition would start reversing. With the effect of the financial crisis spreading over the globe, the confidence of investors in all regimes is largely undermined, and this makes their risk appetite at very low levels towards all investments. In this respect the outlook for equities is particularly gloomy: the current valuation of equity market looks low compared with historical levels but this presupposes corporate earnings targets are achieved. While economic indicators announced are kept disappointing, forecasts for company profits in 2009 need to be reduced, perhaps significantly.