Why this isn't another 2008

Prudential’s head of portfolio management group John Betteridge explains why recent market turbulence should not be compared with the crisis of three years ago.

Financial markets have been extremely turbulent in the past week or so and the media is full of stories about the renewed financial crisis.

While there are some similarities with the crisis of 2008, there are important differences. The share prices of financial stocks have been hit hard but so far, there is very little evidence of the sort of liquidity strains that beset the system three years ago.

Central banks and regulators are much better prepared and can arguably act more decisively to alleviate any such strain. The credit markets have been much better behaved than in 2008, partly because the corporate sector balance sheet is much stronger.

At Prudential, our portfolios are much more defensively oriented. In with-profits funds, we have an equity exposure substantially lower than in 2008 and have sold nearly all of our holdings of subordinated bank debt. In annuity funds too, we are much more defensively positioned and retain substantial credit reserves. Direct exposure to the US downgrade is small.

Bad time for a downgrade

Unfortunately, S&P’s downgrade of the US (long-term) sovereign debt status, from AAA to AA+, did not come at a great time. It was a case of a rating agency action having a severe effect upon sentiment.

The direct impact of this action is likely to be limited, particularly on the status of the securities of quasi-government bodies. In fact, the prices of US government bonds actually moved higher after the downgrade, reflective partly of the view that government bonds of the world’s reserve currency are the best place to be invested in a crisis. It is also reflective of fears about future growth.

European sovereign debt issues have been troubling the markets for some time, mostly because of the inability of policymakers to take decisive action to address the issues. Most damaging of the news was the aftermath of the monthly meeting of the European Central Bank (ECB) on Thursday.

Markets had been expecting more concerted action than had hitherto been the case to address the deteriorating fiscal situation of the European periphery. ECB president Jean-Claude Trichet made it perfectly clear that while the institution was willing to support the bond markets of Ireland and Portugal he would not be doing likewise for Italy and Spain, which have been the focus of the markets’ concerns for a while.

Rather unsurprisingly, that did not ‘please’ the markets – to the extent that their reaction has caused the ECB to have second thoughts. At the start of last week (8 August), after a weekend of crisis meetings, the ECB announced it would be buying Italian and Spanish bonds in the open market and it promptly began to do so.

Italian and Spanish cash yields have fallen almost a point. This is good news but it needs to be followed up.

Political concerns

We have been worried for some time about the potential impact of policy error on economies and markets. At a time of financial stress, it is more likely that politicians and regulators will do the wrong thing, or fail to do the right thing quickly enough.