Between a rock and a hard place

"Significant Downside Risks"  were the three key words from last night's Federal Reserve Open Market Committee statement that investors appear to focusing on, despite the headline announcement that Federal Reserve announcing a purchase programme of longer dated Treasury securities, with a corresponding sale of shorter date securities. Dubbed "The Twist", this manoeuvre is designed to reduce the cost of longer term borrowing, with the hope of stimulating demand in the housing market by reducing the burden on mortgage payers.

The Fed's action was expected by the market; however, whether it will have any impact remains to be seen. The decision was carried on a majority vote only, and three dissenters within the ten member committee indicates that both on Capitol Hill and within the Federal Reserve itself, there remains indecision as to the best course of action to stimulate demand, reduce unemployment and boost the flagging housing market.

But the Fed's statement, in particular the language used, was deeply negative. There does seem to be little light at the end of tunnel right now, with the Fed's statement coming on top of the International Monetary Fund's downgrading of growth expectations for the US, UK and Eurozone on Tuesday.

I have been expecting a further weak patch for most Western economies for some time, and in my view, policymakers now have a real fight on their hands to keep the US, UK, Eurozone from plunging into a double dip recession. Equities markets remain nervous and I believe that a Greek default and the potential fallout is far from priced in. If Equities markets fall further this will only exacerbate the problem facing Central Banks.

The Federal Reserve and Bank of England face a difficult dilemna. They have both eased policy by reducing interest rates as far as they can go, and embarked on asset purchase programmes to promote lending and stabilise the monetary system. These were put in place in 2008/9 and staved off a potentially crippling seizure in the banking system. Fast forward two years, and banks again face a liquidity crisis, amdist a sea of downgrades from credit rating agencies. Should the Fed and BoE act again, and invoke another round of Quantitative Easing? It is a difficult call. They are both fast running out of ammo, and the move could spark panic rather than calm fears. Who would be a central banker? In my view, they are stuck between a rock and a hard place.

How not to trade....

In this blog, I try very hard to stay politically neutral, and I endeavour to report the facts rather than opinion clouded by any political leaning. Of course, Government policies affect the economic backdrop in which investment markets operate, and politics and markets are intrinsically linked.

However, at the M&G "Meet the Managers" Conference, speaker Steven Andrew presented a slide showing a graph of the price of Gold and overlayed a marker as to when Gordon Brown - then Chancellor of the Exchequer - decided to sell 1/2 of the UK's Gold reserves. Cue much derision from the massed audience.

I decided to dig a bit deeper, and discovered that Brown sold the Gold in a series of auctions between 1999 and 2002 - the sheer quantity sold meant that the sales had to be "drip fed" through the market to avoid destabilising the price of Gold too much. The average price obtained was $280 an ounce. The monies raised were used to diversify into foreign exchange, particularly the Euro.

The spot price of Gold closed yesterday at $1833 an ounce some 654% higher than the average price achieved between 1999 and 2002. If Brown had of hung on, and sold now, the UK would be £13 billion richer.

And the trade could look even worse, as the fundamentals look in place for Gold to move towards the $2000 an ounce mark in the next few months. There is always the risk that Gold could retrace given its' stellar run since 2008, but market momentum is certainly in its' favour at present.

Bonds set to outperform once again

Over the past two years, Corporate Bonds - debt issued by companies - have been one of the best performing asset classes, and one that I have used extensively in client investment portfolios since 2008. They are naturally defensive investments, that have become increasingly attractive as the Base Rate freeze at 0.5% becomes ever longer.

I attended the M&G "Meet the Managers" Conference in London yesterday, and after listening to the conference, I managed to grab a quick chat with Richard Woolnough, manager of the M&G Corporate and Strategic Corporate Bond funds, and one of the most respected managers in the industry. I asked Richard what the prospects for the next twelve months were, particularly in terms of credit risk and rising default rates that could occur if we returned to recessionary conditions.

Richard's contention is that default rates - that is to say those companies that fail to repay their debt - will remain low, as many of the weakest companies have already fallen by the wayside during the 2008/9 recession, and he believes that Corporate Bond holders are being compensated well for the risk. I agree, and as Base Rates are unlikely to increase before 2013 and corporate profits remain relatively stable, I expect Corporate Bonds to continue to be an attractive investment.

Another factor to consider is that research indicates that companies are not looking to raise capital at this time, so issuance of new Bond issues is low. This could well increase the "scarcity" factor, which may further support Bond prices.

As ever, before taking any investment decision, always take independent professional advice tailored to your circumstances.