Didier Le Menestrel

Back to basics

Since summer 2007, this editorial has reflected what we have all experienced: a lot of finance and not enough real economy. However, the weight of finance in GDP has never really depended directly on growth in the real economy. Major periods of momentum in the financial system have often coincided with extensive upheaval notably railways at the the end of the 19th century, electricity at the start of the 20th century and internet at the end. The financial boom at the end of the 2000s was original in that it was self-propelled and created its own steam. In the US, the finance sector accounted for more than 30% of overall corporate profits over 2006/2007 compared with an historical average closer to 15% since the Second World War.

The time has come for the weight of the finance sector to move back into line with its economic utility, although global finance cannot just light-heartedly or spontaneously go on a diet. Like a Phoenix of modern times, it is barely just rising from its ashes while enthusiasts are already delighting in prospective future bubbles and erratic price changes which provide a source of exceptional profits. By stating “we have done God’s job”, Goldman Sachs’ chairman clearly lacked humility !

Instead he provoked the ire of an authority not particularly inclined towards leniency. President Obama has just firmly given a reality check to the more naïve in finance by announcing the rules he would like to impose on financial institutions present in the US. These rules are based on three focuses namely, new taxes, a limit on the size of banks and on their scope of intervention. In order to add weight to his message, Barack Obama is accompanied by former Fed chairman, Paul Volcker, the man who “broke” inflation in the 1980s and spontaneously mentioned a redeeming rigour.

Irration caused by pessimists should nevertheless not mask the fact that we are witnessing what is probably the least harsh solution to this crisis. A few months ago, the priority was to put out the fire. Let’s not accuse those that have managed to do this of getting the carpet wet! Rescuing savers was necessary and seen as such, whereas rescuing investment banks is now considered as an unbearable charge imposed on tax payers. Today, those who called on the population are paying back rapidly and the fire has been put out.

So Yes, implementing new rules is urgent in order to avoid (and better control) a prospective future fire. However, it is just as urgent to rejoice in the restored global economic balance. By constantly only treating the hottest subjects, we risk overlooking what’s essential. Money now needs to recirculate serenely in the economy.

Serenity and stability is not damaging to our universe of stock pickers, which has been sending out positive signs in recent months. Indeed, if there is one category of players that has not failed overall, it is clearly that of corporate heads, who have been far more reactive than in previous crises and maintained more than respectable margins (6.8% for the DJ Stoxx 600 in 2009 vs. 4.5% in 2003) and, like good helmsmen in rough weather, have rapidly restored balance sheet quality. A quarter of the top 200 European companies boasted a positive cash pile at the end of 2009 and are starting 2010 ready to brave all bad weather.
After months of very (overly) finance-based editorials in our Letter, let us bet that these coporate heads will make the most of a more advantageous backdrop and will find an increasingly large place in the minds of savers, that they never should have left.