“The market should be wary of short-term palliatives”

Rathbones’ chief investment officer Julian Chillingworth gives his thoughts on the Chancellor’s Autumn Statement.

Investors’ response to Chancellor George Osborne’s speech was muted, understandably, as the main points had already been fed to the press.

Much was made of the additional £111bn of borrowing, but the reality is, as far as the market is concerned, that no-one ever truly expects anyone to repay the debt in its entirety; it’s more about the servicing of the interest. As far as government yields go, gilts are favourable.

EU concerns

The bigger story has to be whether France and Germany will make an alteration to the EU Treaty, and bring about greater fiscal union.

In recent days, we have seen euro finance ministers agree to leverage the European Financial Stability Facility, and investors have also become rather excited about the ECB’s failure to sterilise a bond purchase. Essentially, this allows for money to slosh around the system via the ‘back door’. The first sign of QE or a mere technicality? At this stage, your guess is as good as ours.

However, the market should be wary of short-term palliatives, both in terms of their 
development and impact.

At the time of writing, the market’s positive reaction is symptomatic of the now entrenched risk-on, risk-off trade, but it would not be surprising if we see another rabbit pulled out of the hat ahead of the EU Leaders Summit, to placate markets during what will be a tense week.

In theory, the seeds of a credible solution are at hand, and there is the potential for a ‘Stability Union’, whereby a core group of eurozone members will commit to strict budget and debt limits, which would include national bond issuance.

These would be underscored by punitive measures if they are flouted. However, the EU leaders have to be careful. The last bout of ‘cooperation’ was signed and sealed in four months, and look where we are now.

Placating the markets is one thing, but addressing the underlying structural issues is another, more painful process. We watch that space over the next 12 to 18 months.

Redefining recession

Meanwhile, what is more certain is that any failure in Europe’s plans still has the ability to floor ours, and the Chancellor’s speech needs to be viewed in that context. Fears remain that the debt crisis could still spread to the core nations, leading to downgrades.

For more than 20 years, the West has lived under an illusion of sustainable affluence.

We need to develop an acceptance of greater volatility, shorter cycles and even inflationary spikes ahead – these are factors for which we should be positioning our portfolios. Indeed, the term ‘recession’ will have to be redefined in time, while a period of prolonged, tepid growth here in the West becomes the norm, and the emerging markets break out and flourish.

That is not to deny that, for many, the downturn here in the UK will feel like a recession, but there is an inevitability to this new, albeit, painful rebalancing.

The Chancellor’s autumnal plans should provide some temporary relief, but only time will tell if gilt yields at current levels are a sign of confidence in the UK or a distinct lack of confidence in other G7 nations.