By GRAHAM FROST 13/09/2010
Stock markets around the world had risen in the week leading up to last weekend’s Basel III announcement. The Swiss based Basel Committee for Banking Supervision got agreement from the world’s banks on how they should be capitalised. Bank capital requirements were hiked to 7% of assets from 2% but banks have nearly 5 years to comply with minimum requirements, and until 2019 to meet the full requirements. Stock markets responded positively to the news, despite the fact the changes will impact on the banks ability to lend money and in turn reduce their profits. Furthermore, capital can come from retained earnings, which may reduce dividends, or new capital issues, which may dilute returns. Bank debt rallied on the announcement as it provided reassurance whilst improving the buffer between bond and share holders. Bank shares, and the rest of the market, rallied presumably because the announcement was less draconian than feared. For us mortals, the target was to ensure that the credit crunch/banking crisis of 2008 doesn’t happen again. This won’t do it so we can expect more regulation later.
Providing extra cheer to stock markets was China’s weekend announcement that August industrial production was ahead of expectations, growing 14% year on year with exports up 34% and imports up 36%. There had been fears that efforts to stop the economy overheating might have been overdone, risking a plunge in the economy. Better activity in China reinforced earlier data from the US that employment is picking up modestly.
Sentiment has picked up for the time being, but in the long run it is valuations which drive markets. We continue to believe markets will remain volatile as economic data swings one way then another.