In this week’s bulletin:

  • Irish bailout talks continue as both sides try to finalise detail, with the rates of corporation tax very much the area of debate
  • Ireland’s main banks see significant outflows from institutional investors 
  • Are there opportunities within European equity markets amid all the turmoil? 
  • The dangers of market timing are highlighted with research showing how much can be lost by getting it wrong.

Irish bailout talks continue
Going into the weekend, the Irish government was still hammering out the final details of an emergency financial programme to stabilise their economy, paving the way for the eurozone’s second bailout of 2010. According to The Financial Times, the plan will involve at least €15 billion of spending cuts and tax increases from 2011 to 2014, which is equal to around 10% of the Irish annual economic output. Experts from the International Monetary Fund (IMF) and the European Union (EU) have combed through the balance sheets of the banking sector, as well as the public finances, to determine the size of the bailout but it is thought to be €80–90 billion, slightly less than the €110 billion rescue received by Greece in May. However, it is likely that the bailout will not be announced until mid-December, as it was warned that it will take weeks to finalise the minute detail involved in any deal.


It is hoped that the announcement of a convincing IMF/EU plan will drive down Irish government bond yields, allowing Ireland to return to debt markets and avoid the perceived humiliation of drawing on emergency foreign loans. The initial news of the talks helped narrow the yield spread between Irish bonds and German bonds by 19 basis points by the end of the week, and Irish ten-year yields tumbled by 90 basis points on Thursday and Friday alone. In the currency markets, the euro was buffeted to a six-week low as the drama played out, but managed to scrape back some losses before the end of the trading week, particularly against the dollar.


Although Brian Lenihan, the Irish finance minister, has indicated that the country’s 12.5% corporation tax rate (the lowest in the eurozone) will not be raised, a number of factions within the European Union are known to have pushed for it to be raised in return for the bailout. This was denied by such luminaries as Nicholas Sarkozy, the French president, but he was quoted as saying, “It’s obvious when faced with a situation like this, there are two levers to use, which are spending and revenues. Why not use them? They have a greater margin for manoeuvre than others, with their taxes being lower than others.” Other governments have long criticised the rate, and argue that it is unsustainable and distorts the market for attracting large corporations. But even as late as Friday, Ireland’s Deputy Prime Minister, Mary Coughlan, declared that the rate was “non-negotiable”.


The Sunday Telegraph reported that Ireland is facing a mass exodus from some of the biggest American companies, as executives at Microsoft, Hewlett-Packard, Bank of America, Merrill Lynch and Intel spoke of the “damaging impact on Ireland’s ability to win and retain investment” should the corporation tax rate be raised. As well as these US behemoths, FTSE groups such as advertising giants WPP, magazine publisher United Business Media, and Shire Pharmaceuticals have all relocated to Ireland recently to take advantage of the lower rates.


The British government is keeping a very close eye on the situation, according to The Independent on Sunday, and the UK economy has a high level of exposure to Ireland. Royal Bank of Scotland, for example, was owed billions according to the latest data in June of this year. Britain’s Chancellor, George Osborne, declared, “It’s in Britain’s national interest that the Irish economy is successful and we have a stable banking system.” The UK is set to provide around £7 billion towards the rescue deal, though a Treasury spokesperson was at pains to insist that Ireland had not yet requested any aid.


Banking outflows
The effect of all this debate on the future of the Irish economy is being felt by the nation’s banks, as The Times reported, as Allied Irish Bank (AIB) has suffered €13 billion in withdrawals this year, with €12 billion of that coming since June as companies and large investors withdrew funds that weren’t covered by the state’s guarantees of €100,000 on retail deposits. Last week, its larger rival Bank of Ireland signalled a €10 billion outflow of corporate deposits in the third quarter, which amounted to roughly 12% of its deposit base. AIB also revealed that its planned rights issue would raise €6.6 billion, up from the expected €5.4 billion. The government will convert €2.9 billion in preference shares after the rights issue, leaving it with a stake of around 95%.


Problems in the Irish economy and banking system have put the security of savings back in the spotlight. As highlighted in The Mail on Sunday, savers are being warned once again to check that their money is protected by compensation schemes. Post Office accounts, where savings are provided by Bank of Ireland, have recently been moved so that UK savers are under the wing of the Financial Services Compensation Scheme. Until the start of the month, deposits were covered by the Irish government. But with many brands being owned by the same banking group, it is up to savers to ensure they have not exceeded the limits within one group.


Does opportunity knock?
Global equity markets rallied late in the week after initially being rocked by both the Irish debt crisis and the Chinese government trying to limit inflation by tightening its banking reserve requirement for the fifth time this year. The FTSE 100 closed the week at 5732.83, down 1.1%, after battling back with gains on Wednesday and Thursday. Amid all the negative sentiment within the eurozone, The Sunday Times put its head above the parapet to suggest to investors that they could use the situation to their advantage by scooping up European stocks that have failed to rally with other markets, and may well “present a real opportunity”. The FTSE Eurofirst 300 Index, which fell 2.3% on Tuesday when it appeared any bailout would be rejected, did actually make up some ground by the end of the week to close just 0.16% down. The difficulties in Ireland, as well as Greece and Portugal, have held back European equity markets throughout the year relative to the rest of the world.


Stuart Mitchell of S.W. Mitchell Capital recently reported, “Even if one chooses to see the glass half-empty, and we are in the half-full camp, European shares are good value and trading on some ten times prospective earnings. European markets also continue to trade at significant discounts to the US market despite their corporate sectors being just as profitable. Equities are as cheap as ever relative to bonds and cash. Our meetings with companies continue to confirm that many traditional institutions, such as insurance companies, still have scant exposure to equities.


“It is to our mind encouraging that so many investors remain cautious, if not downright pessimistic. Nevertheless, following on from the sovereign jitters earlier in the year, we draw a clear distinction between business and economic conditions in the southern periphery of the eurozone, labouring under the burden of higher cost structures, and its northern ‘core’ tier. For the south (roughly Greece through Portugal) currency devaluation is not an option, and it will see relative deflation, which will doubtless be painful. But the reverse of this is the prospect of rather better growth rates in the northern tier. This will provide a backdrop for northern European companies altogether more benign than that of the last year or two, further enhanced by the steep euro devaluation relative to the dollar since the autumn of last year.”


Costly Errors
The dangers of trying to time equity markets were highlighted in The Financial Times, as they published research showing that UK investors are losing out because of market timing errors. Over the 18-year period from 1992 to date, investors attempting to time their investments were typically 20% down on the return they would have had if they had kept their money invested in the market. This figure rises to 2.27% per year when trying to time global equity markets, which were generally more volatile, meaning that investors who tried to time the market were missing out on extreme bounces. This theory is backed up by separate research from Fidelity, which shows the impact on returns over the long-term if just a few good days are missed in equity markets. It found that investors who placed £1,000 into the FTSE All-Share in October 2000 would have seen their investment grow to £1,330 by October 2010. However, if they had missed the ten best days during that 10-year period, their value would actually show a loss and would be worth just £720. If the best twenty days were missed, then the value dropped to £475. The article went on to cite research from Blue Sky Asset Management which suggested that a more relevant lesson for retail investors was to look at the effect of sitting in cash for a year after a market low – a more likely response of investors spooked by equity market lows. The research, using analysis of UK bear markets since 1972, found that this could cost investors up to 75% over the following four years. Whichever research is deemed most relevant, it is clear that over the longer term, resisting the temptation to switch between asset classes depending on short-term performance increases the chances of delivering long-term returns.


Key week for UK exporters
Critical growth figures this week will tell the Bank of England whether exporters are finally using the fall in sterling to rebuild their foreign markets, reported The Mail on Sunday. Despite a 25% drop in the UK currency since the summer of 2007, which makes British goods cheaper in overseas markets, there have only been muted signs of an export-led recovery. Wednesday’s second official estimate for the size of gross domestic product in the third quarter of this year will coincide with public speeches from the two members of the Bank’s Monetary Policy Committee (MPC) with the most divergent views. On Tuesday, Adam Posen, who wants an increase in quantitative easing, will speak in Sweden, while on Wednesday Andrew Sentance, who wants a rise in the official interest rate, will make a speech in Belfast. Posen fears a return to recession, while Sentance is worried by inflation. Both men are, at present, alone in their views within the MPC but the public remarks are likely to highlight the committee’s three-way split.

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