Weekly market bulletin by John Greengrass

Going for Growth

2011-03-29T08:22:00.002+01:00

In this week’s bulletin:

Going for Growth – George Osborne outlined his plan for UK growth in last week’s Budget – alongside the latest OBR growth forecasts which were reduced for 2011.
Carry On Regardless – Fixed-income manager, John Hamilton of Jupiter gives his thoughts on the Budget and implications for government debt markets.
Inflation ‘Blip’? – Despite UK inflation jumping to a 28-month high of 4.4%, the Bank of England’s MPC have made no move to increase interest rates. One of their Regional Agents explains why.
Confidence Rebounds – Global financial markets demonstrated extraordinary resilience last week by rising sharply, despite the welter of poor news. The FT investigated why this might be.
Back in Westminster - George Osborne takes the axe to 43 outdated and irrelevant tax reliefs.

Going for Growth
The Chancellor’s message was pretty succinct last week. “This is a Budget built on sound money. A Budget for making things, not for making things up. Britain has a plan and we’re sticking to it. But stability is not enough,” announced George Osborne. The crucial part centred around the ‘sticking to it’ bit because if there had been the slightest hint that the government’s plan to cut the UK’s deficit had veered off track, then the financial markets – specifically the gilt market – would have been swift to punish Mr Osborne. Economist Roger Bootle, writing in The Daily Telegraph, opined that, hemmed in by circumstance, the Chancellor made the best of a bad job. Mr Bootle went on to say that with the fiscal position so tight, there was never going to be much to ‘give away’; even though it looks as though this year’s borrowing numbers will come in a bit below previous estimates, there was no scope left as the Office for Budget Responsibility (OBR) raised its forecast for borrowing. “When £100m on potholes is being trumpeted, you know the Chancellor hasn’t got much dosh,” was his summation.

According to the OBR, Mr Osborne should, by the tax year 2015/16, have come close to meeting the government’s fiscal mandate of eliminating the current structural budget deficit. This was challenged though by independent groups such as the Institute for Fiscal Studies, which said that the Chancellor was “uncomfortably dependent on the judgements of the OBR” and that the forecasts used were too optimistic. Even before this dissent amongst forecasters, Mr Osborne had to admit that the previous forecasts for UK growth were being revised down, but managed this adroitly saying, “We are publishing the plan for growth. Although average growth this year is to be set higher than was previously forecast, the annual forecast for 2011 has been revised [down] to 1.7%.” Economists will be waiting anxiously for initial estimates for growth in the first quarter of this year following the surprise decline in Britain’s GDP in the last quarter of 2010.

Carry On Regardless
According to fixed-interest manager John Hamilton of Jupiter it was business as usual for the UK bond markets following last week’s Budget. “This week, despite higher inflation and slower growth, Chancellor George Osborne confirmed that he would stick to his guns and carry on reducing the deficit. The 2011 Budget therefore did not deviate from the aim of tackling the deficit within the life of one Parliament and did not upset the gilt market where any slippage would have caused alarm.

“Instead, it was very much business as we saw it last June, when the emergency Budget of fiscal tightening (supported by a fingers-crossed policy of ultra-low interest rates) was introduced to stave off a sovereign debt crisis similar to that experienced by Greece, Ireland and soon possibly Portugal. Faced with two unpleasant alternatives, the coalition government decided it was better to risk growth faltering than to allow an escalating debt crisis.

“So, whereas the US chose to stimulate its way out of recession, the UK embarked upon one of the most significant budgetary tightenings of any developed economy. This begins next month and will run for four years. However, by confirming that he aims to contain the deficit with a year to spare, the Chancellor has retained a small amount of wriggle room should growth falter, which it might well do. But if the economy were to suffer a further year of weak growth, then the government would need to demonstrate that it had an alternative plan. Any such plan would be unlikely to involve fiscal stimulation, for fear of leading markets to doubt its main strategy, so the onus would largely fall upon monetary policy.

“The yield on ten-year gilts barely reacted to the OBR’s lower growth forecast, as the big recent news was another large jump in inflation. CPI for February was 4.4%. And with RPI inflation at 5.5%, the highest since July 1991, real interest rates remain extraordinarily stimulatory at -5%. However, this economic ‘fuel’ is unable to get from the pump to the tank as bank lending remains constrained by the need to bolster their weakened balance sheets. Meanwhile, consumers continue to see their real incomes squeezed tightly. With the British economy remaining vulnerable to the health of its overseas trading partners and mindful that the current externally induced burst of inflation might begin to subside, the Bank of England is likely to ‘ease off the accelerator’ cautiously. It will not fully normalise interest rates until certain that recovery is on a firm footing and the worst of the coming fiscal retrenchment is over.”

Inflation ‘Blip’?
News that the UK’s official inflation rate – the Consumer Prices Index – had shot to a 28-month high of 4.4% last month surprised economists on the upside last week. The jump signalled that inflation is running at more than double the 2% target and well above the average pay deal. But it could get worse, according to the Bank of England, which warned in its February Inflation Report that there was a significant risk that inflation would exceed 5% in the near term. But notwithstanding the deteriorating numbers, the BOE’s monetary policy committee (MPC) continues to vote to keep interest rates on hold. The traditional monetary response to higher inflation is to raise the cost of borrowing to choke off demand. This time, though, it’s not happening and many independent observers believe the Bank is underestimating the problem.

So why has the BoE not increased interest rates? At a recent briefing, one of the Bank’s regional agents explained why, for now, the majority of the MPC’s members were sitting on their hands. The BoE’s rationale seems to be like this. Within the 4.4% figure, 1% is down to the one-off increase in VAT in January. Another 1% is attributable to the spike in energy costs and perhaps a slightly lesser amount to other, one-off, commodity price rises. Once these fall out of the equation, in around a year’s time, then CPI should fall back close to the 2% target, in which case interest rates do not need to be ratcheted up now. The BoE accepts though that ultra-low rates can’t remain forever and is forecasting that base rates will rise slowly, to around 3% sometime in 2014. With weaker economic growth also anticipated because of austerity cuts, it is unlikely that the Bank will want to exacerbate the situation by piling more pressure on consumers – according to the Council of Mortgage Lenders, some 70% of current mortgages are on variable rates which means they would rise in line with base rate increases.

Confidence Rebounds
Away from the UK there was no shortage of worries for international investors. Ongoing geopolitical issues in the Middle East meant that oil prices remained elevated – the price of a barrel of Brent crude rose to $116; just a whisker away from its twelve-month high. The US$ plumbed to its lowest level since late 2009, gold hit another all-time high of $1,447 per ounce before falling back somewhat and there were ongoing worries about Japan’s struggle to contain leaking nuclear reactors. And finally, the eurozone’s sovereign debt woes re-emerged as the price of Portuguese government bonds slumped following the collapse of its government. This toxic cocktail of bad news should have normally sent global investors scurrying to the sidelines. Instead and rather perversely, as is often the way, equity markets swept aside these concerns to enjoy one of their best weeks for three months. “The market is ignoring all the bad news as it prolongs the era of cheap money from central banks,” was the view of one analyst at TD Securities.

This aspect was discussed by The Financial Times as it mulled over recent market reaction to what appears to be a string of bad news. As the paper said, there was one word on the lips of everybody in the market last week – resilience. Financial markets responded to the sight of US aircraft bombing Libya and the resignation of Portugal’s prime minister with equanimity; hardly blinking. The numbers are pretty impressive – most major equity markets advanced 3% last week, leaving them up on the year, and even Japan is down only 7.6% this year after the strong rebound from the recent sell-off. America’s ‘fear gauge’, the increasingly watched (and traded apparently) ‘Vix’ index, had its largest weekly fall since the Lehman crisis in 2008 and ended the week at 17, down 42% from its recent high. So what lies behind this strength? Traders say the resilience of global asset markets has been largely underpinned by the efforts of central banks around the world, led by the US Federal Reserve, to pump unprecedented amounts of money into the financial system.

The paper went on to say that as inflation picks up, real or inflation-adjusted interest rates are either negative or very low. This makes the returns on cash appear unattractive. “One reason is the power of cash. There is still a lot of cash on the sidelines. With negative real interest rates in many countries that pushes cash into risk assets,” was the view of J.P. Morgan. In any event, argue the equity bulls, in spite of all the turmoil, profits and growth numbers look healthy. “Shares are still cheap after the falls since mid-February, the global recovery remains on track, global monetary conditions have actually become easier following the Bank of Japan’s easing and investor sentiment readings are now a lot more sober, which is normally a positive sign,” thought analysts at AMP Capital.

So, even though Portugal is likely to seek a bail-out of around €80bn from the Eurozone’s new €700bn Stabilisation Mechanism some time soon and data shows America’s housing market sales plunging further, investors shrugged off the news. Helping confidence in the world’s largest economy though was news that unemployment claims were down, signalling that lay-offs are slowing and that employers may be ready to hire soon. The 5,000 fall brought the four-week average down to 385,000 – its lowest level since July 2008.

Back in Westminster
After speaking for nearly 20 minutes, Chancellor Osborne began to warm to his subject, according to The Daily Telegraph, and announced his first policy – a promise to consult on the possible merger of income tax and National Insurance contributions. But he also went on to say that, “I can announce today that this Budget abolishes no fewer than 43 complex reliefs. This Budget at a stroke removes over 100 pages from our tax code and begins the work of simplification.” One of the 43 reliefs will be Millennium Gift Aid which, Mr Osborne noted, “we won’t need for another 989 years”. However, from an environmental point of view, the paper also pointed out that the accompanying notes and press releases detailing the 100-page cuts numbered some 147 in total.

Japan dominated the headlines all week

2011-03-22T09:00:00.001Z

This week:

The issues of Japan dominated the headlines all week, as the effects of the tragic events were felt around the world
The G7 group of leading industrial nations took steps to weaken the yen by selling a significant amount of the Japanese currency
It was very difficult for investors to understand the possible implications, so markets were driven downwards by emotion and fear
Andrew Green, manager of the SJP/GAM Managed fund, gives his views over the impact to long-term growth in Japan
George Osborne, Chancellor of the Exchequer, delivers his second Budget this week with changes to National Insurance expected to be high on the agenda

Week in summary
Thinking about the financial and commercial impact of such an event as the recent earthquake and tsunami in Japan can appear insensitive given the scale of human suffering being endured, and the impact on those affected is unthinkable.

Japan is the third-largest economy in the world. The tragic situation caused the most turbulent week in the markets since 2008, as Japan’s post-earthquake nuclear crisis created a week of volatile swings. However, risk appetite improved in the wake of the first co-ordinated international intervention into the currency markets for 10 years. The G7 group of leading industrial nations took steps to weaken the yen after it hit record highs on Wednesday (the exact amount of capital involved will remain secret for two months). This helped revive global stock markets and stemmed gains for ‘safer’ assets such as government bonds. The G7 and Japanese Central Bank each sold billions of dollars’ worth of yen in response to the frenzy of currency buying that had taken place earlier in the week, with the Japanese blaming speculators for the dramatic rise which at one point had the yen at its strongest since World War II. Authorities stressed that the reason for targeting the yen was purely to maintain stability in exchange markets and avoid the derailment of the global recovery.

Just as in 1995, after the Kobe earthquake, the yen has surged. This may seem strange but, as The Sunday Times explained, currency markets foresee cash repatriation following large sales of Japanese assets overseas by insurance companies, who will have to pay enormous amounts for reconstruction.

During the immediate aftermath, financial markets followed the usual emergency drill of buying safe-haven assets such as US Treasuries, but if Japan starts cashing in its $980 billion of American government debt, this could cause the price of these to take a serious fall and the borrowing costs of the US government would escalate, along with that of other Western nations. While the Japanese government is no doubt grateful for the intervention, it is clear that there is a benefit to both parties, not least to the G7.

Driven by fear or knowledge?
Over the last few years, as each financial crisis has unfolded, traders and analysts have been able to draw on their own knowledge of economic issues in order to make investment decisions, but very few were able to immediately call on experts on the risks of atomic power. The Financial Times opined that words such as ‘meltdown’ and ‘going critical’ incite investor fears, however unlikely the worst-case scenario may be. Traders relied on industry sources and academics, although these expert views on the likely outcome provided little guide to the direction of the market. As one Japanese minister pointed out, “Every time smoke rose from one of the reactors, share prices fell, even though the smoke itself meant very little.” Historically, the paper continued, financial markets are terrible at pricing highly unlikely disastrous events. It took investors days to figure out the ramifications, while the prospect of nuclear catastrophe continued to be played out on rolling news channels, leaving an information gap that the market couldn’t fill.

The outcome of this lack of understanding was perhaps shown best in the wild market swings. At its worst, the Nikkei 225 was down just over 20% but finally ended the week down 10.2%. The country’s credit risk shot up: at one point Japan was deemed less credit-worthy than Mexico and Panama. Elsewhere around the world, the FTSE 100 closed the week just 1.9% down, with France and Germany falling slightly more as they were also affected by the European Central Bank stepping in to buy Portuguese government bonds in the secondary market.

Economic effect
As pointed out by The Sunday Times, whilst not yet recovered from its long-term malaise, the Japanese economy was in good shape with GDP growing by 3.9% in the third quarter of last year. However, towards the end of the year, growth collapsed and the economy contracted by 0.3%. The four parts of Japan most affected by the disaster – Fukushima, Iwate, Miyagi and Ibaraki – together account for around 6.5% of the country’s GDP, and across these regions factories have been closed as the effects of damage are assessed. It is estimated that the country is now producing just 90% of the electricity it requires, which will also undermine economic activity, even in areas away from the affected north-eastern regions.

Longer-term view
The combined impact of the Japanese disaster and hostilities in Libya made it a nervous week for investors. However, as pointed out by The Daily Telegraph, history tells us that markets behave erratically in the immediate aftermath of a crisis, and also that markets tend to recover quickly after a sudden shock. David Schwartz, a stock market historian, told the paper, “When these big drops happen, they always shock the hell out of everybody, but we’ve seen a lot of them. Since the FTSE 100 was launched in 1984, we’ve had 32 falls that were in excess of 4%. A decline of last week’s magnitude is a relatively common occurrence and is not in the big league.”

Looking back, the UK stock market reacted negatively to the United Nations’ ultimatum to Saddam Hussein to exit Kuwait in 1991 – the FTSE All-Share fell in the build-up to the deadline but then rose more than 20% in the next two months. After the 9/11 tragedy, shares globally fell 14% over the following two weeks but by October 24th the losses had been regained. It is impossible to predict what will happen in the short term, but the key is not to panic and to remain focussed on the longer term.

One fund manager who takes the long-term view on his investments, and has held around 25% of his portfolio in Japanese stocks for several years, is Andrew Green of GAM, manager of the St. James’s Place Recovery Unit Trust and SJP/GAM Managed funds. He reported last week, “The earthquake and subsequent tsunami in Japan is likely to leave a tragically deep and permanent human toll in the areas affected. However, the economic cost of such events should prove to be more transient, especially in a country as resilient and industrious as Japan. Hence there is reason to believe that over the medium term the economy can rebound, aided by a very material reconstruction programme, despite an undoubted impairment to growth in the short term. Since the ongoing nuclear crisis retains the very real potential to further compound the severity of the situation, making more specific predictions about short-term market movements seems futile. We will operate on the basis that unless the nuclear situation deteriorates, the quantum of the economic damage is significant but manageable over the medium term.

“Most large listed companies should be able to survive this event without permanent franchise impairment, with the apparent possible exception of specific utilities. Corporate Japan is renowned for the strength of its balance sheet and low gearing, suggesting that in the main companies should be able to ride out the short-term downdraft. Longer-term impacts are still difficult to determine, as suggested, but there could be a long-term opportunity for Japanese banks over a prolonged time horizon. This is because the substantial reconstruction effort will require financing, and Japanese banks have experienced for some time a notoriously weak lending environment. The Government should in theory be eager and willing to accelerate private sector involvement in hitherto public sector projects, given their own stretched balance sheet and the need for a huge post-crisis reconstruction effort. At this stage however, this is still little more than being a conceptual possibility. We don’t anticipate making any substantive changes to the composition of our Japanese investments, nor the overall scale of them, as we don’t believe this event negates the fundamental long-term case for investment in Japan.”

Budget debate
This week’s Budget is expected to take some focus away from Japan and the Middle East. The Mail on Sunday reported that George Osborne may throw middle-income families a lifeline by cancelling next month’s 4.5p a gallon fuel duty rise and raising personal tax allowances. The paper opined that the Coalition could commit to raising the allowance from the current £6,475 to possibly as high as £10,000 over the next few years. With soaring oil prices already squeezing motorists, the cancellation of the 1p per litre increase would cost the Chancellor around £500 million, but this would be funded by the £800 million raised through the increased bank levy announced last year. With the average price of a litre of petrol now reaching 132p, the cost stands 20% higher in real terms than in September 2000 when the country was brought to a standstill by protests and blockades. The Times suggested that Mr Osborne is very conscious of risking such a scenario happening again.

The Sunday Telegraph proposed that the speech could be double-edged for many in the City, as George Osborne reduces the amount of tax paid by British companies on foreign profits, but tightens up regulations and taxes on non-domiciled businesses. The development would be seen as a major concession to some of Britain’s biggest companies, including HSBC, which has been in discussion with shareholders over moving its headquarters to Hong Kong because of what it sees as the onerous tax burden on its operations.

Changes in National Insurance contributions were the focus of The Daily Telegraph – all employees will pay an additional 1% from April, with the main rate increasing from 11% to 12%. This is currently paid once earnings exceed £110 per week, but this will change to £139. The top rate of National Insurance will also change from 1% to 2% on earnings over the Upper Earnings Limit which is currently £844 per week, but will reduce to £817. Lowering this threshold to the same level at which people start paying higher rate income tax means more people will pay this increased rate although it will benefit those who earn between £42,000 and £44,000.

This week also sees publication of the latest economic forecasts. With the government’s austerity measures yet to be felt fully, as well as the recent surge in oil price following turmoil in the Middle East, The Sunday Times reported that it is highly likely the Office for Budget Responsibility will downgrade its 2.1% forecast for growth in 2011 to around 1.7%. It may lower its forecast for 2012 as well, which currently stands at 2.6%.

Events in Japan have traumatised its people and global investors

2011-03-14T14:56:00.000Z

In this week’s bulletin:

The terrible events in Japan have traumatised its people and global investors are assessing the financial impact
In the short-term, Japanese stocks have fallen sharply to reflect the likely economic cost to the country – Many large exporters have shut down plants, which will hamper recovery
Elsewhere, though investor response has been muted, most leading markets are trading little changed or flat so far
Global markets had to contend with other issues too last week – Oil prices remained elevated as worries over Libya continued
And the spotlight was focused on the eurozone sovereign debt problem following debt-rating downgrades for Spain and Greece
Whilst geopolitical and other issues are impacting short-term, the longer-term outlook for global recovery looks to remain in place
Professional investors are looking to the long-term and rarely allow short-term shocks to change their strategy. Hugh Young of Aberdeen explains his approach of ‘buy and hold’ and gives his views on the events in Japan
Private investors should adopt a similar approach and remain focused on their longer-term aims and objectives

Wealth Management Awards: Just to let you know that the Financial Times has received an overwhelming number of votes for this year’s wealth management awards.
This means that the competition is likely to be stronger than ever.
Voting closes on Friday 18 March 2011 and, if you wish, you can vote online at www.icwealthawards.co.uk/voting.

Japan Quakes
As the catastrophic earthquake in Japan continues to take its terrible human toll, it was only a matter of time before global financial markets started to conduct their seemingly clinical audit of the likely impact of this huge natural disaster on the country’s growth prospects. In a truly global world though, the ramifications are also being assessed not just in the Far East but also in the West. Writing in The Sunday Telegraph, Fidelity fund manager Tom Stevenson succinctly explained the markets’ conclusions. The most recent parallel was the 1995 Kobe quake which incurred heavy human and economic cost: estimated at some $100bn. This time the area affected has a smaller share of GDP but the outlook is far less clear because of the added dangers of the failing nuclear plant.

Regardless, the short-term impact for the Japanese economy will be negative; in part due to physical damage but also because of the psychological trauma. The reaction from Japanese industry was swift, with the country’s three largest motor manufacturers – Toyota, Honda and Nissan – announcing they would stop production at almost all of their domestic assembly plants. The firms cited health and safety reasons as the cause. Electronics giant Sony also said it would be shutting down production. Economists warned of temporary price stagflation and economic contraction. “The timing of the disaster could not have been worse” was the view of Capital Economics, pointing to Japan’s economic contraction in the last quarter of 2010.

But whilst the immediate effects are certainly negative, in every aspect, further out Mr Stevenson took the view that rebuilding and associated expenditure would stimulate the economy. Last time around the economy followed a V-shaped performance curve, with the initial downward fall followed by a strong rebound as policy stimulus and private spending returned. The Bank of Japan was quick to promise support, saying “The bank will do its utmost, including the provision of liquidity, to ensure stability in financial markets and to secure smooth settlement of funds in the coming weeks”. Some economists are taking the view that the BoJ may well embark upon another round of quantitative easing when it next meets.

The immediate reaction of investors has been both understandable and predictable – the Japanese stock market fell sharply when it opened today, with the leading Nikkei Dow 225 Index closing down some 6%, although it had been down over 7% at one point. Again, using Kobe as guidance as to what might happen to the stock market in the slightly longer term, Tom Stevenson pointed out that the Japanese market underperformed the S&P500 for a number of months - with the latter achieving a relative outperformance of around 30%. The other aspect is the knock-on effect for overseas markets. Foreign assets tend to be liquidated first when there is an urgent need for capital and this happened in 1995 when Japanese insurance companies sold US Treasury bonds in order to meet claims by their Japanese customers. This in turn saw the yen appreciate sharply which, if repeated this time, will hit the country’s big exporters. Jim O’Neill, chairman of Goldman Sachs Asset Management said “Most of Japan’s recovery is driven by exports so the key is to make sure the yen doesn’t strengthen”.

Clearly it is too soon to be definitive about the final outcome, but in the meantime investor reaction in the Western markets has been relatively calm.

What will it mean?
The terrible events in Japan will be long-lasting but their immediate timing added further pressure to the world’s financial markets, which were already enduring a pretty torrid time last week. A toxic cocktail of bad news sent equity and commodity markets into reverse – mid-week the cost of borrowing for Portugal, Ireland and Greece hit euro-era highs amid concern in the markets that European leaders will fail to take concerted action to dispel fears of sovereign debt defaults. Attention was focused particularly on Spain following debt-rating agency Moody’s decision to downgrade the country’s rating – later in the week the agency did the same for Greece. The rise in 10-year bond yields for the so-called peripheral eurozone countries has been inexorable over the past five months as investors have taken an increasingly cynical view on any likely action to be taken on the part of policymakers. “It looks like the authorities aren’t going to do anything particularly aggressive” was the view of Deutsche Bank.

But there were tensions elsewhere too. Geopolitical concerns continued to drive the markets as Libya’s descent into civil war – and the threat of possible NATO military intervention – kept oil prices elevated. Nervous investors headed for the perceived traditional safe haven of gold, which hit a record high of $1,437 per ounce, before falling back on the week. The price of oil was little changed on the week with Brent crude closing at $115 per barrel. There was some good news for the energy sector as it was announced that other influential members of the oil cartel OPEC are joining Saudi Arabia in raising output to cool soaring prices and allay fears of a supply crunch in the West. The behind-the-scenes move by Kuwait, the United Arab Emirates and Nigeria, reflects growing unease among OPEC members over the threat to global recovery from the runaway rise in crude oil prices.

Testing Time for Global Recovery
The aspect of higher energy costs and implications was mulled over by The Financial Times. The paper opined that the level of confidence is the key outcome, following data from the University of Michigan which showed that: its index of US consumer confidence fell from 77.5 to 68.2 last month. “All the good news in the labour market has been wiped out by rising oil prices” commented Standard Chartered Bank. Developing its case, The Financial Times analysed the separate and different implications for the key players in the global economy. It took the view that the oil producers are less likely to spend all their increased revenue as it causes inflation at home so they tend to invest short term in safe areas such as US Treasury bonds. This in turn helps finance the US government but not global private consumption and spending. America itself should be able to cope quite well, according to Goldman Sachs, who estimate that a sustained $10 rise in oil prices will lower US growth by just 0.2% for each of the following two years. Current estimates for US GDP this year are a very respectable 3.5% - somewhat above its long-term trend rate of 3%.

It is the developing world that is likely to be hit hardest because overall, incomes are lower and oil makes up a far larger share of total consumption. The higher ensuing inflation could therefore cause interest rates to rise but the positive news is that government finances are in good shape and allow them to fund subsidies. UK and Europe, who are amongst the most efficient users of oil, are well-placed to withstand higher prices, although the backdrop of government austerity measures mean that consumer spending is likely to be squeezed thus potentially hurting short-term growth prospects. So the crucial question for investors is the extent to which the global economic recovery could be derailed by a combination of man-made and natural disasters.

Stepping Out
There was some good news last week which gave an insight into the longer-term prospects for the global economy. According to the latest data, American households stepped up their spending at the country’s shopping centres and superstores last month in a sign that the recovery in the world’s largest economy is gathering momentum. Retail sales grew by 1% - the highest for four months as job prospects improved and a payroll tax boosted incomes, according to the US Commerce Department. The numbers arrived in time for the latest meeting of the US Federal Reserve which will mull over its current, ultra-loose monetary policy – some members of the Fed, such as Kansas City Fed chairman Tom Hoenig, are worried that inflationary threats are building and interest rates should rise. But US Fed chairman Ben Bernanke has remained relaxed about the risks, leaving open the option of yet more money-printing.

The economic picture is more mixed here in the UK where, unlike the US, retail sales have slowed to a crawl – up 1.1% last month compared to a 4.3% rise in January, according to British Retail Consortium data. The figures reflect that the increase in VAT and higher prices are causing fewer shopping trips. Conversely, Britain’s trade deficit experienced its sharpest monthly decline in more than 30 years in January on the back of booming exports, according to data from the Office for National Statistics. Foreign demand for British goods – including food and drink, chemicals, cars and oil – has surged as UK manufacturers capitalised on global demand. The figures will bolster hopes of an improvement in overall GDP in the first quarter of this year, following the 0.6% slide at the end of 2010.

It’s the Long-Term that Counts
Irrespective of short-term events – however traumatic – it is the longer-term that really matters. This is the view held by many leading fund managers, including top performer Hugh Young of Aberdeen, who manages Far Eastern equities. Talking to The Daily Telegraph he said “We’re not terribly good at predicting market fluctuations but we think we are good at identifying the long-term winners. We see ourselves as investors, rather than speculators. Ideally we want to hold a stock forever”. With an average holding period of nine years, he will have seen many of his holdings experience significant volatility but he has remained resolute and this is reflected in his enviable performance record.

This morning, he commented specifically on the recent tragedy. “Toyota is suspending production at all domestic factories through Wednesday. Chemical company Shin-Etsu has temporarily lost three plants. Convenience store operator Seven & I has reported about 5% of its stores are out of action. More tellingly, many companies do not know themselves how they are affected because of outages and communications failure. If there are any gainers, cynically opportunistic though that may sound, they are likely to lie among resource companies such as Rio Tinto and BHP. Japan will need thermal coal and iron ore to boost non-nuclear power alternatives. With China slowing, the demand here and for other commodities needed for reconstruction may be timely”.

Morning Round-up
As mentioned, the sharpest reaction to the latest events were, as expected, felt in Japan. Elsewhere the reaction of investors has been muted with the prices of stocks trading higher in Hong Kong and India and small falls in some of the European bourses. In London the market has, at the time of writing, reversed earlier small losses to stand up a few points. For private investors the key is to maintain, as ever, a well-diversified portfolio; by asset class, by geography and by fund manager. This approach has in the past reduced both risk and volatility, allowing clients to focus on their longer-term goals and objectives.

Two Way Pull

2011-03-07T08:45:00.000Z

In this week's bulletin:

Two Way Pull – investors were encouraged by strong manufacturing data from the UK, Europe and US but continued to fret over rising oil prices. For the most part, global stock markets ended the week flat.
Powering Ahead – with global growth strong, inflationary pressures are building and central banks appear to have broken ranks. The Fed has said low rates will remain but the ECB is saying that eurozone rates may rise as early as next month.
Back to Work – strong employment numbers and a falling headline unemployment rate boosted confidence in the US last week.
China’s Chatty PM – during an on-line ‘chat’ with his country’s citizens, China’s premier promised to tackle rising inflation by slowing growth over the next five years.
Tax-efficiency – savers are being reminded not to miss out on this tax year’s ISA allowance and to make use of other tax-efficient wrappers.
The Long and Short of it – fund manager Mark Lyttleton of Blackrock explains his ‘Absolute Return’ strategy and how he can produce positive returns with less risk and lower volatility.

Two-way pull
Global financial markets ebbed and flowed last week as investors juggled the dichotomy of better-than-expected economic data with worries over oil prices which continued to be stoked up by the Libyan crisis. The net outcome by the end of the week was that stock prices finished little-changed in the developed economies whilst those in the East played catch-up – share prices in China and India have struggled so far this year despite their booming economies. But behind the short-term noise there are some clear lines of engagement being drawn up by investors focused around possible stagflation or, on the other hand, continued recovery in the global economy with inflationary pressures a mere blip on the path to progress.

Most immediately, the unravelling of some of North Africa’s incumbent political leaders is, unsurprisingly, causing tension in the oil markets – driven for the most part by the potential for a larger disruption of energy supplies rather than what is actually happening at present. Libya accounts for around 2% of global supply which could easily be replaced by Saudi Arabia upping output, yet crude oil prices are still edging closer to the $120-per-barrel level again – they were up around $3 on the week. The ramifications are clear – higher petrol pump prices and more pressure on the consumer who may need to make cuts in spending elsewhere, which could impact upon economic recovery. Will higher oil prices slow the global recovery? “I am concerned,” says the IMF’s managing director. “The hike to something which is between $110 and $120 a barrel is something which may affect [growth] if it lasts too long.” But Mr. Strauss-Khan added that oil prices are unlikely to be hitting growth yet. “We are not there today.”

Economists believe that with oil consumption accounting for about 5% of the world’s GDP, the recent 20% increase in prices is likely to raise total expenditure by 1% – with a corresponding reduction in demand for goods and services. This would not affect global growth if the oil producers spent their extra revenue, said The Financial Times, but it seems that they have less of a propensity to spend than their oil-consuming customers, meaning a possible slowdown in recovery. This needs to be put in context, though – the IMF reckons that global growth is close to record levels of around 5%, so it is more a slowdown than reversal.

Powering ahead
Here in Britain, the manufacturing sector’s renaissance is continuing – several of the UK’s best-known exporters reported booming profits last week, including GKN and Cookson. They are not alone, fortunately – last week the closely watched PMI Index (which measures confidence in the sector) remained steady at 61.5, with any number over 50 being positive. It’s a similar story elsewhere around the world – in the US its own corresponding ISM Index rose to its highest level since 1983 and in the eurozone the index jumped to 59, with strength beginning to broaden out to include Italy, Ireland and Spain.

However economists said the recent data highlighted Britain’s ‘two-speed’ economy; while exporters are thriving, consumer demand remains muted amid a rapidly rising cost of living. Citigroup commented that, “The data highlight the extremes of Britain’s two-speed recovery – strong growth in manufacturing but sluggish trends in money and credit. We expect this to continue.” If you want evidence of consumers under pressure, you need go no further than your local branch of Primark. Last week, one of the UK’s retail success stories told investors that its bargain-basement clothes stores have suffered a sharp drop in demand over recent weeks, adding to fears that the recovery here at home may be faltering. The rise in VAT, amongst other things, is being blamed for consumers turning more cautious.

Back to work
One of the strongest US payroll reports in months raised hopes last week that the economic recovery is finally leading to steady growth in jobs. Non-farm payrolls rose by 192,000 in February, with hiring spread across a broad range of industries; and figures for previous months were revised up. Crucially, the unemployment rate fell again from 9% to 8.9%. But the better job numbers are unlikely to push the US Federal Reserve towards early interest rate rises because wage growth, which feeds through to inflation, was slow.

Signs of sustainable job creation make it highly unlikely that the US Federal Reserve will expand its ‘QE2’ programme of asset purchases due for completion at the end of June. The Fed’s chairman, Ben Bernanke, also made it clear that it would keep interest rates at near-zero for much longer than its Western counterparts. Mr. Bernanke said that the bank would keep rates “exceptionally low” for an “extended period”. This was not good news for the US dollar which hit a 13-month low of $1.63 against the pound as investors took the view that interest rates are likely to rise sooner in the UK and eurozone. Indeed, the ECB surprised the markets towards the end of the week as it warned that interest rates may rise as soon as next month to combat rising inflation. Its president, M. Trichet, effectively called time on two years of ultra-loose monetary policy, saying that an “increase of interest rates in the next meeting [April] is possible”.

China’s chatty PM
But if inflation is not seen as a problem in the US, the same cannot be said for China. In an online ‘chat’ with his nation’s citizens, premier Wen Jiabao said the world’s second-largest economy can no longer “blindly” pursue unsustainable expansion. Mr Wen reduced China’s annual growth target from 8% to 7% for the next five years in an effort to curb soaring food and house prices. He acknowledged that the gap between the country’s official rate of inflation of 5% and the cost of food and housing (food prices are climbing at a rate of 10%) is making life difficult for hundreds of millions of Chinese people. Not that many believe growth will fall back in line – last year it was 10.3%. “The road map is clear but the extent to which the political will and power is sufficient, remains to be seen,” said China analyst, Alistair Thornton.

Whilst the Far East has been one of the most dominant investment themes of the last decade, as savers look to tap into the Chinese growth story, not all investors in the region are as bullish on China. Veteran fund manager Hugh Young of Aberdeen is a good example – his concern about the country’s inflation problem has meant that he has limited his funds’ direct exposure to China to just 5%. Hugh Young adopts a long-term buy-and-hold strategy which has served his investors well, as The Daily Telegraph pointed out, saying that, whilst he typically lags his peers in sharply rising markets, he better protects capital in downturns.

Tax-friendly
With the end of the tax year rapidly approaching, investors are being reminded not to waste their annual allowances across a number of tax regimes. FT Money reminded its readers to utilise their annual £10,200 Individual Savings Account (ISA) allowance and also highlighted the benefits of specialist arrangements such as Enterprise Investment Schemes. As a reminder, ISAs are free of CGT and can provide income free of any further tax liability from a wide-range of investments, whilst an EIS offers income tax relief, CGT deferral and offset plus CGT-free returns; although it must be remembered that EISs are classified as being higher-risk.

The Long and Short of it
Few investors need reminding about the stock market volatility witnessed in recent years. One of the traditional approaches to managing this issue has been to diversify a portfolio across a number of different asset classes; by geography, by fund manager style and also by risk. One type of investment that has become increasingly popular with investors is the ‘Absolute Return’ fund which aims to produce, but not guarantee, better-than-cash returns in all market conditions. Fund manager Mark Lyttleton of BlackRock Investment Management is recognised as a market leader in this specialist investment field.

“I see the role of this type of fund as about reducing volatility and controlling risk. The aim of the fund is to create a positive return over all meaningful periods – by that I mean 12 months – or in other words, whilst the fund may fall in value, making money for clients whatever the market conditions. It’s about slow, consistent returns with low volatility. If you take the period 2007–09, the market returned zero whilst the fund produced 19.5%. It’s important to remember, though, that if the market is very bullish we are likely to underperform; but for investors who want lower risk and to be able to sleep at night, then this is a solid place to put your money.

“The way we can achieve this involves three components. Firstly by going long – in other words buying shares we like, to make money. Secondly we can short stocks: selling shares we believe are overvalued and likely to fall in price. We also combine the two strategies, which is known as pairing: buying one share and selling another share, usually in the same sector of the market. For example, pharmaceutical stocks where you could buy GSK but sell AstraZeneca. This takes out both the market and sector risk. Lastly, the fund can hold cash – up to 100% if we want to.

“Currently we have a mixed approach in terms of themes. We believe there is a solid global recovery taking place with signs of the US recovery being stronger than expected. The stock market as a whole – using all measures including profitability – is in rude health, with companies having cut costs early on and enjoying high profit margins. The question is how much of the good news is already priced in; and that’s my job to identify the opportunities. So the fund currently holds many cyclical stocks which are benefitting from the current environment. Wolseley is a good example – a company operating in Europe and the US which embarked upon an aggressive acquisition strategy but was wrong-footed during the recession. Today it has a new management team which has been actively cutting waste, has improved its balance sheet, and is able to grow its market share as recovery takes place and to operate more efficiently.

“So the current positioning of the fund is very diverse, from real estate and asset management to industrials and energy stocks. The fund is currently ‘net’ long – in other words after offsetting the short positions we are in a positive position. I am confident the fund will continue to meets its objectives of delivering steady returns with lower levels of risk.”

2011 FT/Investors Chronicle Wealth Management Awards
You may like to know that you can vote for this year’s FT/Investors Chronicle Wealth Management Awards, to identify the best wealth and investment managers in the UK. By doing so you will also be entered into a prize draw (sponsored by the FT) for the chance to win £1,000. Simply visit www.icwealthawards.co.uk/voting.

Monday 28th February 2011

2011-02-28T17:26:00.000Z

In this week's bulleting:

The Libyan crisis caused sharp volatility in equity and commodity markets this week, as investors sought less risky assets
Trading on the London Stock Exchange was halted for four hours as problems arose with the new trading platform, which had only been in use for two weeks
Lloyds Banking Group announced a profit for 2010, but the City was unimpressed
The dangers of structured products were highlighted, outlining the amount of protection offered by the Financial Services Compensation Scheme
An overview of the power of dividend income was once again offered, with comments from Neil Woodford

Libyan unrest sparks sell-off
Savage swings in the oil price dominated market action this week, as fears that supply disruptions in Libya could spread across the Middle East triggered a broad flight from risk. The Financial Times reported that these concerns were largely played out in global equity markets where volatility rose 30% on the VIX Index; but base metals, copper in particular, and the credit market also suffered. Emerging markets equities slipped to their lowest levels in three months as nervous investors sought safety in US Treasuries (the yield of which fell 16 basis points to 3.43%), gold and ‘safer’ currencies such as the Swiss franc and the Japanese yen. Crude oil prices rose to two-and-a-half-year highs of around $120 a barrel on Thursday. their highest level since August 2008, but subsequently eased after Saudi Arabia signalled that it was prepared to increase supplies to make up for the Libyan shortfall. The Sunday Times warned that this crisis was driven by fear rather than fundamentals of supply and demand, pointing out that the International Energy Agency has enough reserves to cover the Libyan shortfall for a number of years as the country makes up only around 2% of daily consumption. This steadier tone to end the week allowed equities to recoup some of the losses, with the FTSE 100 closing just 1.3% down for the week at 6,001.20 and the S&P 500 closing the trading week down just 2%.

However, it was warned that, for as long as the Libyan turmoil continues, it is Britain and Europe which will feel the most pain as European refineries are built to process their particular crude oil rather than the sulphur-heavy Saudi Arabian version. Andrew Ovens, chairman of Greenergy, one of Britain’s biggest fuel suppliers, said, “We are going to see prices rise more in Europe than in North America or Asia, but once that happens, demand will haemorrhage just like last time.” As The Independent on Sunday highlighted, it is Italy which will suffer most from the shortfall as more than 25% of its oil imports are affected, followed by France and Spain. Britain relies on Libya for less than 10% of its supply, and is likely to have to bid for replacement supplies on the open market.

With speculation over the possible spread of dissent across the region, The Financial Times pointed out that the last five global recessions have all followed sharp jumps in oil price, so it is perhaps understandable that analysts would be concerned over the weekly rise of 16%. However, the increase is not as large as those seen during previous oil supply shocks. During the first Gulf War in 1990–1991, oil prices rose by 150% in three months, whereas in the 1970s, when oil supply was hit by a series of events including the Iranian revolution, prices increased by 200% in a matter of months. Despite the continued uncertainty over the future of oil prices, most analysts agree that volatility would continue to be high since the removal of the Libyan supply reduces the market’s buffer against further shocks.

Away from the obvious effects on the oil price, what effect does the unrest have on UK companies, was the question posed by The Sunday Telegraph. The paper advised that there are several major business projects that would be affected, involving household names such as HSBC, Standard Chartered and GlaxoSmithKline. Up until the crisis in Libya erupted last week, the companies were part of the 120 members of the Libyan British Business Council which were trying to grab a share of the £102 billion of infrastructure investment that the Libyan government had committed to over the next two years. While the likes of HSBC and Wood Group are reducing exposure to the country, GlaxoSmithKline may find this difficult due to the nature of its business supplying medicine to the country’s people.

Millennium bug
Just to add to the uncertainty, it was made impossible to trade last week as dealing on the London Stock Exchange (LSE) was halted for four hours on Friday morning. Shares in companies listed on both the main market and the AIM market could not be bought or sold on the Stock Exchange Electronic Trading Service, and market-makers were unable to conduct their business; therefore no prices could be set. Traffic typically worth a total of around £4.5 billion each day ground to a standstill as, just before the open, the LSE announced there were problems receiving real-time data from its new Millennium trading platform which launched two weeks ago. Overall, the trading volumes for the day were down over a third and, according to The Times, this had leading stockbrokers describing the situation as “a shambles”, and claiming that it had cost their individual businesses significant revenues.

Lloyds fails to impress City
Lloyds Banking Group announced its 2010 results, showing a £2.2 billion profit for the year after the £6.3 billion loss in 2009. However, investors were disappointed as Britain’s biggest retail bank indicated that profit margins would be lower than expected because of funding costs, and because the company has already enjoyed most of the benefit of increasing prices on mortgages and other products. Lloyds’ shares fell 4.5% on the day of the news, closing at around 62p; while for the government to be in profit, the price needs to reach 73.25p. As pointed out in The Daily Telegraph, these results risk heightening public anger after the state-owned lender admitted it will not pay any corporation tax in the UK until it makes another £15 billion of profits. Lloyds, which is 41% owned by the taxpayer, is able to avoid corporation tax as it has billions of pounds of deferred losses that it can write off against tax liabilities. Barclays was criticised the week before after revealing it had paid only £113 million in tax in 2009, despite making pre-tax profit of £11.6 billion.

This coming week sees HSBC expected to unveil the largest profit generated by a British bank since the start of the financial crisis, reported The Sunday Times. HSBC is expected to announce a £13 billion pre-tax gain for 2010, just 20% less than its record profit for a calendar year. The company makes about 80% of its profits overseas, and with a market valuation of £126 billion, HSBC is worth more than RBS, Lloyds and Barclays combined. The UK’s fifth largest bank, Standard Chartered, which performs most of its business in the Far East, is also expected to announce a record profit this week and because it is not part of the Project Merlin deal with the government, is expected to reveal a rise in bonuses paid to top employees.

No guarantees
The dangers of investing in structured products were highlighted by The Sunday Times, pointing out that savers often invest in the belief that they get the same security as with a deposit account, but that they do not have the same protection from the Financial Services Compensation Scheme if the bank underpinning the scheme goes bust. The protection offered is different due to banks using complex financial instruments to provide the ‘guaranteed’ market-linked returns, and as such, the promise to return your money is only as good as the financial strength of the institution that guarantees it. Thousands of investors lost money when Lehman Brothers collapsed in 2008, while more suffered in 2009 when Keydata went bust. Despite this chequered history, structured products are still being released and described as ‘guaranteed’, ‘protected’ and ‘secure’, and investors should make sure they fully understand the product in which they invest their money.

Hot topic
At a time when corporation tax is being widely discussed, The Sunday Telegraph reported that BP is suing the Government for almost £300 million plus compensation, claiming for tax it paid “by mistake” more than a decade ago. The oil giant is accusing HM Revenue & Customs of wrongly charging stamp duty reserve tax when it took over a US rival in 1999, and the company is already expected to pay much less tax over the next four years as it meets the costs of the Gulf of Mexico oil spill. Before the events of last summer, BP paid worldwide tax at the effective rate of 33% on profits of £15 billion, and of the total tax paid in 2009, more than £900 million was to the UK government. The tax paid in that year was worth as much to the UK as from its entire transport and communications industries combined.

Dividends still the key
It is not news to any investor that income seekers have had a torrid time over recent times with cash delivering very little, and UK dividends falling in 2010 as a result of the BP oil spill in the Gulf of Mexico. However, as highlighted in The Sunday Telegraph, if you take BP out of the equation, then dividends actually rose by 7.5% over the full year. The latest Barclays Equity Gilt Study shows that £100 invested at the end of 1899 would have been worth just £180 in real terms at the end of 2010, but when dividends are reinvested, then that figure is boosted to £24,133. While there has been an element of criticism that 38% of all UK dividends came from 5 companies last year, and 61% from the top 15 companies, the paper highlighted the tactics used by the top income managers in the UK. One of the highest-rated managers in the sector is Neil Woodford of Invesco Perpetual. He said, “I look to invest in businesses that can provide sustainable long-term dividend growth. If I can invest in a business when its growth potential is not reflected in the valuation of its shares, this not only reduces the risk of losing money, it increases the upside opportunity. In the short term, all sorts of influences buffet share prices, but over longer time periods fundamentals shine through. Dividend growth is the key determinant of long-term share price movements; the rest is sentiment.”

2011 FT/Investors Chronicle Wealth Management Awards
You may like to know that you can vote for this year’s FT/Investors Chronicle Wealth Management Awards, to identify the best wealth and investment managers in the UK. By doing so you will also be entered into a prize draw (being sponsored by the FT) for the chance to win £1000. Simply visit www.icwealthawards.co.uk/voting.

Markets shrug aside Middle East tensions on mounting recovery optimism

2011-02-22T08:30:00.001Z

In this week’s Bulletin:

Markets shrug aside Middle East tensions on mounting recovery optimism
Investors’ appetite for risk continues as interest rates on US high-yield debt hit an all-time low
G20 seeks solutions to global inflationary pressures and the threat of protectionism
Latest RPI figure means not a single savings account in the UK pays a real return
Speculation continues over whether, or when, the MPC will raise interest rates
ISA season in full swing as investors are reminded of inflation-proofing options

Markets weather sandstorms
The turmoil in the Middle East intensified during the week, with a brutal crackdown in Bahrain and Libya’s Colonel Gaddafi reminding the world that he is no soft touch either. Investors appeared to shrug aside these escalating tensions and focused on mounting optimism about the prospects for economic recovery, prompting global equities to continue their march higher. US equities recorded a third successive weekly advance; the S&P 500 set a sequence of 30-month highs and hit a level twice the cyclical low of March 2009. The FTSEurofirst 300 Index reached a 29-month peak and the Nikkei 225 Stock Average managed a gain of 2.2% to record its highest level for more than nine months. The UK market also registered a third straight week of gains, despite the FTSE 100 being dragged down on Friday by sharp losses for mining stocks, and ended the week up 0.33%.

Elsewhere, there was evidence that markets were becoming troubled by geopolitical risks, as the traditional safe havens of precious metals and the Swiss franc gained ground. Gold hit a five-week high above $1,390 per troy ounce and silver prices followed suit to reach their highest level since 1980. Amongst other commodities, copper hit a record high of $10,190 per tonne earlier in the week before falling back after China tightened its monetary policy, and Brent crude oil breached $104 per barrel – its highest level for two-and-a-half years. The result was more misery for motorists, with The Times reporting that the average petrol price had hit a record high of 128.8p per litre.

Analysing further the rise in the US equity market, The Financial Times studied the speed and extent of the climb and compared it to previous bull markets to see what lessons could be learned from history. The S&P 500 index took just over 500 trading days to rebound from the lows of March 2009; faster than in any comparable rally in the last 75 years. The developed western markets are also currently the beneficiaries of money being rotated out of emerging markets – last week saw developed market equity funds enjoy their biggest inflow for 30 months, according to data provider EPFR. Needless to say, in terms of how much further the rally might have to go, history throws up arguments supporting both the bulls and bears. One statistic suggests it should last at least until October: that is when the third year of the US presidency ends: a year which almost without exception has delivered strong gains. The S&P 500 is up 17% since 1st October. Chris Blum of J.P. Morgan Asset Management counselled that it will last as long as the economy is improving: “Follow the data. As long as it continues to get better, it is hard to bet against.”

The price of junk
Another indication of investor belief that a US recovery is under way came with news that interest rates on US high-yielding debt, or ‘junk’ bonds, have hit an all-time low of 6.8%. The Financial Times reported that investors’ continued appetite for riskier assets saw a record inflow of $1.4bn into US high-yield funds in the first week of February, driving yields lower. This has been helped by a sharp reduction in corporate default rates – the global rate fell to 2.8% in January from 12.6% a year ago. January also saw no new defaults, the first such month since June 2007. The strong demand for this debt has meant that even the riskiest of companies have been able to borrow money at historic low rates of interest. However, the drop in yields means investors have a smaller cushion against rising interest rates or an economic shock, although the spread to benchmark treasuries remains well above the lows reached at the height of the credit crunch.

However, a stark reminder of the dangers to the US recovery came in news over the weekend that an all-night session in the Republican House of Representatives had agreed to slash the federal budget by $61bn. The Sunday Telegraph reported that US Treasury Secretary Tim Geithner immediately condemned the news, speaking at the G20 summit in Paris, “The continuing resolution as passed by the House would undermine and damage our capacity to create jobs and expand the economy.” On the other side of the argument, the House Speaker, John Boehner, said the legislation was part of Republican efforts “to liberate our economy from the shackles of out-of-control spending”. President Obama pledged to veto the aggressive cuts package and the proposal will now be debated by the Senate, where Democrats hold a slim majority. If a compromise short-term spending deal cannot be struck the government will be forced to close; something which last happened in 1995 in a budget row between President Clinton and House Speaker, Newt Gingrich. Such paralysis is likely to damage US economic prospects and therefore the chances of a continuing global recovery.

Groundhog week
As The Sunday Times reminded its readers, inflation is the world’s most pressing economic problem and the factor which continues to dictate the thoughts and actions of policymakers, corporations and consumers around the globe. Price rises are being driven by big macroeconomic factors and the commodity price boom risks crushing the global recovery. So were the warning words of the Chancellor, George Osborne, at the G20 conference, who went on to advise fellow ministers that soaring food and fuel prices are the biggest menace to growth after the public debt crisis that has afflicted nations around the world. The G20 countries together account for 85% of world economic output and at the two-day meeting France was leading a call for greater transparency and regulation of commodity prices and derivative trading to stop markets being driven by speculation rather than demand. There was also pressure to agree measures to monitor and so begin unwinding the huge trade imbalances that have built up in the world economy and pose a significant threat to stability. In a week which also saw China overtake Japan as the world’s second largest economy, the globe’s biggest exporter was baulking at measures which would increase the pressure on it to let its currency appreciate significantly, thus making its exports less competitive. However, a last-ditch Chinese deal enabled the G20 nations to agree a first step towards greater co-operation, with “indicative guidelines” to be agreed by April. In spite of this, Capital Economics was amongst those organisations fearing that progress on this issue will move at glacial speed, increasing the likelihood of a serious escalation in protectionism in 2012.

On Friday, China intensified its crusade against inflation by raising the banks’ required reserve ratio (RRR) another 50 basis points, in a move designed to drain the equivalent of £34bn from the financial system. The RRR forces banks to deposit a fixed proportion of their wealth with the central bank, which can be touched again only if the ratio is lowered.

Feeling the squeeze
Back in the UK, the Office for National Statistics announced that inflation, as measured by the Consumer Price Index (CPI), had jumped to 4% in January, double the 2% target. The Retail Prices Index (RPI) rose to 5.1%, which for many is the more realistic gauge of how prices are rising. Mervyn King, the Governor of the Bank of England, stated he had “enormous sympathy” for people whose household income was facing the biggest squeeze since the 1920s, but that the squeeze “was going to happen one way or another – it’s the price we are all paying for the financial crisis.” He also cautioned that Britain will have to get used to slower growth if people want to avoid longer-term rising inflation. As The Daily Telegraph opined, it is not just income but also savings which are losing their spending power. According to Moneyfacts, not one savings account in the UK pays sufficient interest to earn a real return after tax and inflation (as measured by the RPI). For a basic-rate taxpayer, just 23 accounts make the mark against the CPI measure, of which 21 are cash ISA accounts, into which only a limited amount can be deposited.

The news sparked renewed speculation about whether, or when, the Monetary Policy Committee (MPC) should raise interest rates and, as The Times reported, prompted MPC hawk Andrew Sentance to openly dismiss the Bank of England’s latest inflation forecasts as “too optimistic” and claim that rate increases were “overdue”. Mervyn King went as far as to acknowledge that, “It is clear that at some point the Bank rate will have to go up”, but otherwise left the markets guessing – the interest rate futures market is implying three quarter-point rate rises in the next 12 months.

Inflation-beating ISAs
Inflation and ISAs shared the headlines of the weekend press – The Sunday Telegraph suggested ways to combine the two to your advantage by investing in the reinvested dividend potential of equities, which has historically provided the lion’s share of returns. The paper pointed out that one way to beat inflation was to invest in what was causing it by buying energy and food-related shares and funds. This theory helps explain the current popularity of equity income funds amongst ISA investors, as a route to generating tax-efficient growing income that can keep ahead of inflation. With the bank base rate stuck at 0.5%, the average yield of more than 4% on equity income funds looks quite attractive. Other sectors that came under the spotlight for ISA opportunities were pharmaceuticals and financials. Sanjeev Shah of Fidelity commented, “The drugs sector is cheaper relative to the broader market than at any point in the past 15 years and valuations are underpinned by strong cash generation”; meanwhile, financial stocks had “not been so cheap in the past 25 years”.

Continuing the ISA theme, The Telegraph provided a reminder of the potential folly of chasing performance when making your ISA selection. It reflected on the fact that the most popular funds currently tend to be those with decent recent performance, yet there are many examples of winners one year becoming also-rans the next. These observations are backed up by a study from Cass Business School and Barclays Wealth, which found that timing decisions by private investors since 1992 had lost out on returns averaging 1.2% a year because they had chased performance. The message was that, if your decision to invest in a fund was only down to what it had done in the past, then it was wise to think again.

2011 FT/Investors Chronicle Wealth Management Awards
You may like to know that you can vote for this year’s FT/Investors Chronicle Wealth Management Awards, to identify the best wealth and investment managers in the UK. By doing so you will also be entered into a prize draw (being sponsored by the FT) for the chance to win £1000. Simply visit www.icwealthawards.co.uk/voting.

2011-02-14T15:25:00.001Z

In this week’s bulletin:

The clamour over inflationary threats once again dominated markets last week – along with ongoing geopolitical concerns and the eurozone sovereign debt issue.

Whilst central banks in the developed markets are resisting the pressure to raise interest rates, government bond investors are exerting pressures, causing yields to rise. Last week the BoE announced it was leaving rates unchanged despite CPI rising to 4%.
One clear theme is a move by investors to reduce their exposure to Emerging Markets as concerns over monetary tightening grow and to favour developed equities over government bonds.
More positive news on US unemployment and the departure of Egypt’s President Mubarak gave markets a late fillip, enabling Western bourses once more to trade around 2 and a half-year highs.
Equity Income fund manager Nick Purves of RWC explains how his approach can deliver prospects of both a rising income and capital growth.

Blowing Hot and Cold

Inflation is proving to be a thorny issue for both consumers and economists alike. Last week was no exception, with a continuing flow of data highlighting rising costs and prices – with more to come it seems. In a recent speech, Mervyn King, Governor of the Bank of England (BoE), warned that UK inflation could spike to 5% before falling back: the Bank’s argument is predicated on the belief that a number of one-off factors – such as the VAT increase – will ultimately drop out of the numbers. This week, economists are of the view that the Consumer Price Index (CPI) will jump to 4% when figures are released tomorrow. “Petrol prices rose 5.1% in January – that alone is enough to push CPI 0.1% higher. The price of food and heating oil also increased. The VAT rise will also be crucial,” was the view of Société Générale. There was similar news from the Office for National Statistics, which said that factory price inflation had risen twice as quickly as forecast last month, with producer prices up 4.8% – a direct result of soaring energy and metal costs.

The causes of higher commodity prices are self-evident – rising demand in emerging and developing economies is being fuelled by rapid economic development as countries like China pump billions into building their infrastructure, added to the impact of a burgeoning number of middle-class consumers. Last year, China used more concrete that the US, UK, Germany and France combined as it pressed ahead with its breakneck pace of growth. This demand is in turn pushing up the cost of raw materials including soft commodities. Not that everyone is a loser of course – last week mining company Rio Tinto announced that it had reduced its debt pile by £21.5bn in just two years thanks to very strong price increases for iron ore. So successful has it been that it is buying back some $5bn of shares. The numbers get bigger. BHP Billiton is set to reveal profits of more than $15bn this week, putting the resources company on track to generate one of the largest ever profits by a UK company in a single year, thanks to the commodities boom.

Borrowing Costs Edge Up

The ramifications of higher inflation could be far-reaching. Robert Smithson of THS Partners, which manages funds for St. James’s Place, commented, “We expect higher inflation globally over the next few years and for interest rates to rise in response, albeit at a slow pace. Equities are, on the whole, likely to fare better than other assets, as companies are usually able to pass rising costs down to their customers, thereby protecting profitability. One of our themes – Changing Diets – has led us to invest in companies that will benefit from increased food prices and higher calorie consumption in the emerging world, for example Bungey and Yum Brands. Our Deep Value Opportunities theme centres around us owning a number of insurance companies, such as Allianz and Aegon, which stand to benefit significantly from higher inflation and rising long-term interest rates.”

The point about rising interest rates as a tool to combat inflation is particularly pertinent. Last week a number of UK mortgage lenders rushed to pull their best fixed-rate deals and replace them with those bearing higher rates. In the government bond (essentially IOUs) market, the yields on longer-dated paper have been rising – including in the UK gilt market as investors begin to price in higher interest rates. For yields to rise it means capital values have to fall and this is having a knock-on effect for the BoE which, according to The Times, is at risk of recording billions of pounds of losses on its money-printing quantitative easing (QE) scheme. QE was introduced almost two years ago to help boost recovery and involved the Bank buying up gilts with its new money to keep interest rates low. It now owns £200bn of gilts and whereas the scheme was in profit to the tune of £26bn last August, this figure has fallen to £10bn as gilt prices have retreated in recent weeks. Higher interest rates would therefore exacerbate the situation. Coincidentally, the BoE’s Monetary Policy Committee met last week to review its interest rate policy and, in the face of a worsening inflation outlook, held its nerve and decided to keep rates on hold. The decision came as no surprise to the 62 economists polled by Bloomberg who all expected this outcome.

Full of Import

The emerging markets’ remarkable growth boom has created an interesting and yet delicately balanced dichotomy. On the one hand it creates huge opportunity for the developed economies to export more of their goods to the likes of India, Russia and China but, on the other hand, as mentioned previously, the flipside consequences are higher and inflationary raw material costs. And for the UK, therein lies the problem it seems. Economist David Smith, writing in The Sunday Times, mulled over the fact that whilst Britain’s companies are exporting more – goods and services have risen more than 10% in the past year – unfortunately Britain’s importers have also been working overtime: imports have grown 14.5% over the same period. As Mr Smith points out, it’s impossible to have true, export-led growth if that growth is exceeded by imports. As ever, it’s cause and effect – specifically the 25% devaluation of sterling during the financial crisis which has helped make exporters more competitive but also pushed up the cost of raw material et al. Helping things along are the UK’s consumers who proved they are still capable of spending – retail sales jumped 4.2% last month as Britons flocked to the high street, snapping up non-food items such as clothing and electronic goods. So, for now, it looks like we’ll just keep on running an ever-growing trade deficit.

Meanwhile . . .

. . . over in the financial markets, investors endured a choppy week. Disappointing corporate earnings, renewed tensions over eurozone sovereign debt and mounting confusion over the situation in Egypt ensured some volatile trading. Lower-than-expected earnings figures from the likes of Cisco Systems and Credit Suisse rattled investors, sending shares into retreat, with those in emerging markets faring worse as growing inflationary fears raised worries about monetary policy (interest rates) tightening. Last week, China increased its benchmark interest rate by 0.25%, the third move since October. Over in the eurozone there were suspicions that the European Central Bank had intervened heavily to support Portugal’s bond market following revived fears that the country might be forced to seek international financial aid. An economist at ICAP said, “It would appear, at face value, that the ECB is back in, buying aggressively.”

Investors took heart from comments made by US Federal Reserve Chairman, Ben Bernanke, who gave a slightly more optimistic assessment of the US jobs market, although he did warn that unemployment remained too high for comfort. During the week, data released showed that new claims for jobless benefits in the US dropped to a 30-month low, suggesting a strengthening labour market. The US Labor Department said initial claims fell 36,000. A welcome end-of-week boost came in the form of Friday’s news that Hosni Mubarak, Egypt’s president, had finally stepped down, which enabled equity markets to shake off earlier losses and rally sharply. So, on balance, the week reflected a shift in sentiment away from emerging market stocks and into developed market equities, together with increased wariness over inflation. The Financial Times summed up when commenting that with inflation now also a concern for some (developed market) central banks, it is not surprising that markets are choosing the inflation hedge of equities as opposed to the nominal returns on offer from bonds. By close of business on Friday the Frankfurt Dax Index topped the leaderboard, up over 2%, followed by Wall Street and London – heading south were the Hang Seng and Bombay Sensex indices.

Income Outlook

One well-tried and tested strategy to combat the threats of inflation has been to invest in equity income funds which offer the opportunity of a growing income via rising dividends. The Sunday Times reminded its readers that over the long term equities have performed better than cash and gilts after adjusting for inflation. In its latest review of the performance of UK shares and bonds, the just-released Barclays Equity Gilt Study showed that over the 30 years to 2010, UK equities returned 8.3% a year after inflation. Within these figures, of course, some sectors do better than others, as figures from the London Business School highlight. For example, £1 invested in the UK stock market in 1900 would have grown to £23,335 but the same pound invested in the 50 shares with the highest yield (the ‘value stocks’) would have grown to an impressive £100,160.

One of the UK’s leading equity income managers, Nick Purves of RWC, which manages funds for St. James’s Place, explains his approach. “High-yielding stocks are by definition lowly valued – sometimes for good reason but often because the market has overlooked them. I concentrate on finding good quality companies that are essentially sound with strong balance sheets, but are seen as unfashionable. The next step is to be patient – it can be a slow process waiting for the fundamentals to be recognised but when they are, a value stock can become a growth stock. So the portfolio currently has 30 stocks with solid dividend yields which are covered by earnings several times over, which makes them less risky. I think the outlook for income is very positive at present, with many companies increasing dividends at a faster rate than could have been hoped for a year or so ago, so I feel confident about the prospects for my income investors.”

Time is Ticking Away

As we approach the end of the tax year, investors are being reminded not to waste valuable tax breaks – from Individual Savings Accounts to pension contributions. The latter took pole position with The Daily Telegraph as it told its readers that there are only six weeks left before the new pension reforms kick in. These will see significant reductions of the pension contribution allowance as well as likely cuts to income under the drawdown rule changes. The paper recommended that if you’re unsure as to whether you will be affected then seeking advice is an imperative.

2011 FT/Investors Chronicle Wealth Management Awards

You may like to know that you can vote for this year’s FT/Investors Chronicle Wealth Management Awards, to identify the best wealth and investment managers in the UK. By doing so you will also be entered into a prize draw (being sponsored by the FT) for the chance to win £1000.

Simply visit www.icwealthawards.co.uk/voting.

In this week’s bulletin

2011-02-08T08:22:00.001Z

Financial markets were led by the bulls last week - equity and commodity prices raced ahead on the back of good economic data and high demand as investors set aside the previous week's geopolitical worries
UK economic data was particularly strong as manufacturing and construction bounced back
In the US, lower job growth was overshadowed by a fall in headline unemployment to 9% and comforting words from US Federal Reserve Chairman Ben Bernanke
With the tax year-end ever closer, the press reminded people to maximise use of available tax breaks, including ISAs
Dividend income is once more on the rise again with increased payouts outstripping inflation and acting as a good hedge against inflationary pressures
The commercial property sector is back on track according to fund manager Duncan Owen and for cash buyers, there are plenty of opportunities around

Onwards and Upwards
The bulls were out in force last week, sweeping aside any concerns caused by political unrest in Egypt and other parts of the Middle East, preferring instead to focus mainly on a swathe of positive economic data. Even potential disruption to oil supplies through the Suez Canal was seen as positive, enabling traders to mark up the price of Brent oil to just over $100 per barrel. With global demand for raw materials running at record levels it was no surprise that any threat to production caused by Cyclone Yasi hitting Australia saw copper and tin prices hit record highs – $10,000 and $30,790 per tonne respectively. News that China’s manufacturers appeared to pause for breath last month is unlikely to give commodity markets any respite though: a solid flow of new orders and a rising backlog of work mean the rapid pace of expansion has not cooled.

Higher commodity prices continue to feed through into inflation but its impact is felt more keenly in the developing economies, where people spend a greater proportion of their income on food staples. In China, consumers are complaining about day-to-day increases in the cost of familiar items – even fast food outlets have had to succumb by increasing prices, including the likes of KFC whose crispy chicken burger is apparently a must. Is the impact of higher food, raw materials and energy prices a ‘blip’ as suggested by some central bankers? Maybe, but not everyone is convinced. Fidelity’s Tom Stevenson, writing in The Sunday Telegraph, pointed out that the demographics of the developing world suggest price rises might be here to stay. According to the UN’s World Population Prospects database, between 1950 and 2050 the population of the developed world will have increased from 800m to 1.3bn while that of the developing world will have risen from 1.7bn to 7.9bn. The World Bank says food demand will rise by 50% from current levels by 2030 – a key driver is increased meat consumption primarily because it takes seven kilos of grain to produce one kilo of beef.

Economy Watch
After the shock news that the UK economy contracted in the last quarter of 2010 owing in part to poor weather, data showing that manufacturing, construction and the key services sector had once again resumed growing last month was well received by the market. Sterling hit a near three-month high on the news that the Purchasing Managers’ Index, a closely watched measure of economic activity, jumped to 62; the highest level since records began in 1992. Manufacturing companies reported rising demand from domestic and overseas markets, with new export orders rising sharply. “UK manufacturing steamed ahead in January. This is the much-needed kick-start to 2011 everyone in the sector was hoping for,” commented David Noble of The Chartered Institute of Purchasing and Supply. Construction has bounced back too, according to the latest Markit/CIPS survey with all the main areas of activity – housing, civil engineering and commercial construction – growing. The only downside to a stronger recovery is that economists believe the Bank of England may take action to tackle rising inflation by raising interest rates sooner than expected. The markets are now pricing in a quarter-point rate increase in May.

Small Gains
Snow and statistical revisions left economic policymakers struggling to judge the health of the US labour market last week following a confusing January jobs report. The Bureau of Labor Statistics estimated that the US economy managed to create only 36,000 jobs last month – well down on the 146,000 expected – but, oddly, the unemployment rate plunged from 9.4% to 9.0%. Investors decided the glass was half-full. “On balance we’d take it as a positive, – although with some caution,” said Standard Chartered, with their economist adding, “The labour market as a whole is definitely looking better.” Wall Street agreed, with the Dow Jones index rising smartly. But the numbers will, thought The Financial Times, create a dilemma for the US Federal Reserve because the current second phase of its $600bn programme of quantitative easing depends, in part, on the health of the labour market. Fed chairman Ben Bernanke was quick to reassure though, saying, “Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established.” The US bond market, however, read between the lines and decided that a rise in interest rates is now closer than ever, so Treasury yields rose to their highest level since last May.

Large Gains
By the close of business on Friday, it was self-evident that investors felt in buoyant mood and positive about the outlook for the global economy. Most of the major indices advanced on the week – London was up 2% and the S&P 500 even more. With the eurozone sovereign debt issue assigned to the backburner, European equity markets gained momentum, led by the financial sector. Whilst many Asian markets were closed for much of the week for the lunar new year, Tokyo rallied almost 2% as investors returned to the equity market. On the currency front, the pound attracted most of the attention in response to positive economic data and enabled the Sterling Index to jump more than 1%. Taken together, the FTSE All-World Index reached a 30-month high for a 1.7% gain on the week.

Taking the Offensive
Investors are currently battling on two fronts – trying to avoid rising taxes and also to combat the threat of rising inflation. With the end of the tax year approaching fast, the press is urging people to maximise the use of as many tax-breaks as possible by boosting their pensions, crystallising capital gains to utilise the Annual Exempt Amount (currently £10,100) and to ‘max-out’ their Individual Savings Account (ISA) allowance of £10,200. You might even go for a double whammy by using the ‘bed-and-ISA’ strategy, which enables tax-free capital gains to be sheltered from CGT and income tax going forward.

On the inflation front, equities have historically helped investors maintain the real, inflation-adjusted value of their capital and income. The Daily Telegraph reminded its readers that dividends are often overlooked as a component of the returns from equities. But receiving and investing dividends is by far the largest source of investors’ return over the long term. If you do need income then the good news is that company dividends are on the up once more following the cuts seen in 2008–09. Data from the Dividend Monitor shows that dividends from the FTSE 250 rose 16.3% last year whilst those from the FTSE 100 rose 6.8%. Whilst both beat inflation, it also illustrates the need to diversify your income portfolio across a broader number of shares. In total, some £56.5bn was paid out in dividends by British companies during 2010 and this year the figure is expected to rise 11% to £63bn, which will be good news for those seeking to protect their income from inflation.

Property Matters
It’s not just shares and commodities that have been enjoying rises in the last couple of years – commercial property has also been in recovery mode. Fund manager Duncan Owen, of Invista Real Estate, last week explained why he is feeling a lot more confident about the outlook. “The UK commercial property market has experienced a remarkable polarisation post the financial crisis. At its worst point the asset class had fallen some 44% – an unparalleled event and worse than the early 1990s. Since the low point about eighteen months ago, there has been a recovery in prices as buyers return to the market but most of this activity has been confined to the very top or prime end of the market.

As a result of keen interest from foreign investors and sovereign wealth funds, ‘trophy’ properties have been bid up to the extent that they are now back to, or have exceeded, 2007 prices, driving some rental yields down below 4%. West End London offices are a good example; values have soared and rents are probably double where they were just a few years ago. In contrast, the prices of property perceived to be less glamorous have remained virtually unchanged, with risk-averse investors avoiding this secondary part of the market, despite the extraordinary high yields of close to double digits. So, unlike the equity markets, there has been no ‘dash for trash’ whereby investors have been happy to snap up distressed but fundamentally sound companies again.

So, where we are today is that the ‘shiny’ property is very expensive and the ‘less shiny’ is still languishing. In amongst the latter are some very good properties which, whilst not ‘trophy’, are attractive with good tenants and income streams, so we have spent a significant amount of time and resource searching for these. The strategy for your fund has always been to concentrate on owning prime property with blue-chip tenants. Today, with substantial cash levels within the fund, now is a good time for us to deploy some of the war chest, picking up some of these overlooked properties, often at a significant discount. We are able to do this because, with banks still risk-averse, it means their lease/yield criteria remain very strict, precluding about 50% of potential buyers from being able to participate, leaving cash buyers a clearer playing field. Our recent purchase of the Novotel Hotel in Bristol is a good example; Accor is a blue-chip tenant and the property yields 7.2%. Another example is a retail development in Plymouth, which yields 9%.

Overall, the market has stabilised and we do not have the problems of over-supply that plagued the asset class back in the 1990s. There is another aspect to the asset class that is often overlooked – the ability of commercial property to act as a part-hedge against inflation, which is now becoming increasingly worrying for investors. All of the properties within your portfolios are on ‘upward-only’ rent reviews, which enable us to link these to inflation, thus helping protect the income in ‘real’ terms.”

2011-01-31T15:02:00.000Z

In this week’s bulletin:

Investors’ went from ‘risk-on’ to risk-off’ last week as the positive earnings outlook and success of the eurozone bail-out fund’s bond debut were replaced by economic and geopolitical concerns.
Mid-week markets were shocked by news that Britain’s economy had shrunk by 0.5% in the final quarter of 2010 although the impact was muted by the view that most of this was down to December’s poor weather and growth would rebound.
In contrast the latest data showed the US economy powering ahead in 2010 as consumers and businesses benefitted from President Obama’s economic stimulus.
Worries about America’s burgeoning budget deficit were placed on the back-burner unlike in Japan where the country’s credit-rating was down –graded to AA- by S&P in response to worries over current debt levels.
Investor worries over a possible bond market ‘bubble’ are discussed by Paul Read of Invesco Perpetual
The Financial Times told its readers that with returns from with-profit bonds less than many cash accounts investors might think about taking advantage of any penalty-free exit opportunities available.

Risk-Off
Market strategists have had a full-time job over the last year trying to gauge the best course of action as investors’ mood vacillated, but finally came up with the ‘risk-on, risk-off’ solution. Early on, it was risk-on, with US and European stocks pushing back towards recent two-and-a-half-year highs: the FTSE 100 flirted with the 6,000 level once more with investors buoyed by the corporate earnings outlook. “One of the more compelling reasons for us still being in the risk-on part of the cycle remains the still-strong earnings backdrop,” was the view of Deutsche Bank. The mood was not quite so positive in emerging markets, though, with political concerns unsettling Bangkok and Moscow and leading some strategists to take the view that emerging markets stocks were beginning to look expensive. “Tightening monetary conditions in emerging markets should lead investors to rotate away in favour of developed market assets,” thought Lombard Odier.

But, as The Financial Times noted, the risk-off button was soon pressed with news that the UK’s output went into reverse in the last quarter of 2010, coupled with investor disappointment at the latest batch of US corporate earnings and caution about the US Federal Reserve’s latest meeting. The scene was set following news of a 0.5% contraction in Britain’s economy – a genuine shock to most economists – although some comfort was taken from the view expressed by the Office for National Statistics that much of the drop was linked to December’s appalling weather. Even so, the ONS said that the overall picture looked “flattish”, although few believe there is any danger in the economy going back into recession. With household incomes under pressure from rising inflation and no real wage growth, the Governor of the Bank of England, Mervyn King, defended the Monetary Policy Committee’s (MPC) decision not to raise interest rates in the face of rising prices.

The Governor went on to say that real (inflation-adjusted) wages were unlikely to be any higher than they were back in 2005. Economists are hoping that, against a backdrop of planned government expenditure cuts, the private sector will take up the slack to keep the economic recovery on track. The ONS figures were mixed on this front, with construction falling once more and slippage in the service sectors. The one bright spot was a robust effort on the part of manufacturing as exports rose strongly, helped by the relative weakness of sterling. The discussion about the impact of higher inflation and whether the BoE should raise interest rates continued last week and, whilst expectations of higher rates over the next six months or so are now higher than a few weeks ago, it is not clear-cut. Coming out strongly against more costly borrowing was economist Roger Bootle who said there was no real evidence that the gilt market is getting alarmed – ten-year bond yields remained little-changed. Mr Bootle argued that any rise in rates now would imply the BoE had been wrong so far and also set expectations that the rate cycle had changed.

Spend or Save?
With many European governments having embarked on a huge programme of austerity cuts, the US has been resisting pressures to do likewise, with the Obama administration insisting that this is not the time to save but to spend more to engender a strong economic recovery. In the short term, Mr Obama’s decision to put expenditure cuts on the back-burner has been vindicated. Figures out last week showed that the American economy powered ahead at the end of last year as the US continued to spend its way out of recession, with government stimulus money helping create a surge in consumer spending. US economic growth advanced to 3.2%, according to official figures, as Americans spent at the fastest pace in four years and companies sold more goods and services overseas. But the current administration’s reluctance to put together a long-term strategy for cutting the massive budget deficit – it’s set to hit a record $1.5 trillion or 9.8% of GDP this year, according to credit-rating agency Moody’s – is worrying many observers, including the IMF. Whilst many recognise the need to make savings, there are some who are cool on cutting the deficit; mainly US businesses, said The Financial Times. American bosses are worried that they could end up footing the bill when it comes to redressing the country’s public finances. Government spending cuts would hit private sector profits and tax reforms would likely cut corporate tax breaks currently enjoyed.

Japan Slips
Against this outlook, Moody’s did say that it might have to downgrade America’s premier AAA rating if no plan was forthcoming: although, for now, international investors are not worrying unduly; and this is reflected in the ten-year Treasury bond yield, which remains close to recent lows. Not that the same could be said of Japan. Last week the country’s long-term sovereign debt rating was cut by Standard & Poor’s for the first time since 2002. The cut from AA to AA- reflects increasing investors’ concerns about events in what was, until recently, the world’s second-largest economy.

Fund manager Dan O’Keefe of US-based Artisan Investment Management summed up the consensus view, saying, “Like many developed countries, Japan is in a perilous fiscal position, running large deficits with significant debt relative to GDP. It stands out however for the inability of both its government and corporate sector to mount any meaningful response to the economic challenges they have long faced. As a result, we have always found it very difficult to find attractive investments in Japan. So, while it is easy to find cheap stocks, rarely do we find true value, hence our small portfolio weighting. We have been especially cautious of late as we believe that the recent strength of the Japanese yen is not justified given the structural issues mentioned. The downgrade by S&P certainly brings the issues of Japan into clearer focus but it does not reveal anything new.”

Geopolitics Intrude
As the week drew to a close there was one final twist for investors to think about: the resurgence of geopolitics in the form of political unrest in Egypt. With the escalating unrest in the region’s anchor state, it was no surprise that some investors sought their usual flight into bonds and gold as a short-term haven; but it also caused Brent oil prices to rise within a whisker of $100 a barrel too. Analysts were quick to comment that some had underpriced the risks of emerging markets, saying that whilst it was right to focus on the improving fundamentals of developing countries, politics mattered, particularly in sovereign states with unstable systems. So it was no surprise that the heady mix of economic, corporate and political news meant that global markets endured a choppy week, although in some respects the final outcome was perhaps surprising. Japan ended the week up, Shanghai rose to prevail over a falling Hong Kong market and the Bombay Sensex fell over 3% as the market reacted to higher Indian interest rates. Strong demand for the eurozone bail-out fund’s debut bond issue – it was ten times oversubscribed – eased concerns about the region’s periphery and in turn acted as a support for equity markets. Wall Street and London may have seen earlier gains reversed but both stock exchanges ended the week little-changed.

Investing for Income
One asset class that has served those investors seeking income well over the years has been corporate bonds – effectively IOUs issued by companies. With all the talk of interest rate rises because of higher inflation, some investors have expressed concerns about the longer-term merits of owning what is primarily an income-producing investment. Paul Read of Invesco Perpetual is recognised as one of the sector’s most successful managers and co-manages two of the St. James’s Place corporate bond funds. Here he gives his view of the current environment. “There has been widespread discussion about the possibility of a ‘bubble’ in bond markets. Investors’ concerns over valuations stem principally from the low level of government bond yields that reflect the extremity of the current economic cycle. However, we believe that both the policy and low yields are appropriate for the circumstances we face.

The central view of the MPC is that inflation will fall back as the impact of temporary factors wane. We agree that it is hard to be too bearish about inflation unless there is strong improvement in aggregate demand. With low growth and inflation expected to fall, we expect interest rates to be low for years. Given the characteristics of the fixed-interest asset class in which investors receive a fixed coupon [income] and return of principal, the main risk is of negative ‘real’ returns if inflation is persistently higher than the income received. Repricing is also a risk as market interest rates rise. Most investment-grade corporate bonds are issued by well-established blue-chip companies with strong balance sheets, low gearing and a history of low default. Global growth expectations are improving and the threat of deflation has receded – conditions that should see yields rise further. We therefore expect corporate bonds to outperform government bonds in this environment.”

Window of Opportunity?
One investment that regularly comes under the scrutiny of the personal finance press is that of with-profit bonds. The Financial Times drew its readers’ attention to the fact that investors in with-profit bonds should take advantage of opportunities to exit their investments without penalty as new figures (source: Money Management) show that the annual bonus rates on nearly 100 with-profit bonds are less competitive than returns on cash savings. The paper said this coincided with news that Friends Provident announced it was freezing most of its regular bonus rates in spite of improved returns. Figures show that 90% of with-profit bonds paid an average bonus rate last year of just 1%, although the article did say that not all funds are poor performers. Apparently there are a number of funds which this year will offer a penalty-free exit on the tenth policy anniversary.

2011-01-25T08:45:00.001Z

In this week’s Bulletin:

The ‘big news’ story for the week was the latest economic data from China, showing the country’s economy recording a huge spurt in the final quarter of last year and achieving GDP of 10.3% for the year as a whole.
The data raised fears that Beijing is losing control of its rampant economy and will be forced to take aggressive counter-action in the form of higher interest rates – as a consequence global equities sold off as investors moved to the sidelines.
There was better news from the US where an improvement in the housing market and jobs sector helped sentiment, coupled with better-than-expected earnings from bellwether stock General Electric.
In the UK the economic picture remains mixed albeit on a positive uptrend – the economy is expected to have grown at 2.3% last year although there is some evidence of a slowdown in the last quarter of last year.
Higher UK inflation data has spooked some large institutional investors - as a consequence their appetite for government bonds is likely to wane. On the flip side, investors are reminded of the ability of equities to shelter against inflation.
Finally Cato Stonex, a principal of THS Partners explains their current investment strategy.

So Good, It’s Bad
Good news! Your economy has grown faster than expected during the last quarter of 2010 – up by 9.8% and way ahead of everyone’s expectations. This means that when added together with the rest of the year’s growth, the economy has grown by a dazzling 10.3%. As one of the world’s largest economies you are contributing to almost half the globe’s total economic growth and you’ve helped create some 14m jobs worldwide. Sound’s like a great success story. And that, it seems, is the worry – China’s continued explosive growth has now become so good that international investors are concerned that Beijing has lost control of one of the world’s most dynamic economic stories: a bubble waiting to burst. The latest economic data released last week showed that China’s rate of growth in the final quarter of last year increased rather than slowed – defying expectations that the People’s Bank of China’s tightening of monetary policy, by increasing interest rates and raising liquidity requirements for the banks, would act as a brake to the red-hot economy.

China’s thriving economy has fuelled significant commodity price rises in the last few years as its factories suck in ever-greater amounts of raw materials and the country’s growing middle classes change their diets from rice-based to a more protein-based one – to say nothing of their appetite for BMWs and the like. So the latest news has increased fears amongst some investors that, in response to what appears unchecked growth and rising inflationary pressures, monetary policy will be tightened further. “The solid growth outlook suggests that inflation is likely to remain uncomfortably strong in the months ahead. We continue to expect more rate hikes – and risks are skewed to more aggressive action,” was the view of RBC Capital Markets. If the Chinese authorities do decide to take more robust action, the fear is that this will have a significant impact on global growth. Hence the reason that global equity markets fell sharply on the better-than-expected economic data, with most major indices ending the week around 2% lower. The Financial Times made the point that with mining and energy companies accounting for around a third of the value of the FTSE 100, it was no surprise that the UK blue-chip index was disproportionately impacted.

Looking West
Meanwhile, back here in the West, there are some promising signs that our own developed economies may be back on the road to sustained recovery, albeit patchy. Despite China’s elevation to near top of the GDP table, the US remains the world’s largest and most important economy. Last week there were some signs that the two areas most troubling for investors – housing and jobs – offered some scope for optimism. Existing home sales jumped 12.3% in December and ahead of forecasts, while the number of new jobless claims fell to 400,000 last week, the largest drop for almost a year. Sentiment was also given a boost by better-than-expected fourth-quarter earnings figures from behemoth General Electric – the company is seen as a bellwether for the global economy. GE’s chairman told investors that “the economy gets stronger everyday. The environment continues to improve. It is broader and deeper as we look across our portfolio”. The news helped boost Wall Street which bucked the global trend and helped the Dow Jones Industrial Index to end the week almost 1% higher.

Over in the eurozone there is somewhat of a dichotomy. Whilst the Mediterranean economies continue to struggle, the region’s heavyweight economies continue to bear the load comfortably – particularly Germany. Last year the country enjoyed stellar growth of 3.6% and, according to economists, both the German and French economies continue to power ahead. Whilst last year’s recovery was export-led there are hopes that the two countries could be less dependent on overseas exports as they are each other’s largest export markets. The optimism seems to be well-founded with data from France, Germany and Belgium all showing sharp rises in business confidence – the German Ifo index hit an all-time high of 110.3 this month.

Not that investors see just blue skies ahead – the eurozone sovereign debt crisis continues to lurk in the background, although even here there are signs that European leaders are set to get to grips with the issue as a whole, rather than dealing with it incrementally, as it has thus far. In Brussels, European leaders are considering a plan to allow the region’s €440bn bail-out fund to lend money to struggling peripheral countries, so they could buy back their own distressed bonds. But, notwithstanding its economic success, Germany has made clear to the rest of the zone that it is not prepared to see an increase in the size of the bail-out fund.

The Flip Side
Whilst the residents of India and China are among the most optimistic about the way things are going in their country, it’s rather a different story in Mexico and Spain, where people are the most dissatisfied with the outlook. Neither outcomes of a recent MORI survey are surprising given the respective economic backdrops. Here in the UK it’s a mixed picture. Whilst the New Year has opened with a surge of optimism – consumer confidence jumped last month as people became more upbeat about the outlook for our own economy – sentiment among small businesses fell. Whilst the property market in London continues to do well, a different story emerges in the shires, with the latest figures revealing that mortgage lending slumped to its lowest point for a decade last month. Unemployment numbers have resumed their upward trend with a near 50,000 increase in the last quarter, with the construction industry still mired in recession according to the Federation of Master Builders. But whilst an ill-wind blows for some, hundreds of new jobs will be created by Siemens’ decision to build a huge wind turbine factory in Hull. Overall the UK economy is expected to have grown a respectable 2.3% last year, although figures due from the Office for National Statistics are likely to show a slowing of growth in the final quarter of 2010.

Overblown?
It seems, according to The Financial Times, that some of the world’s leading investors have become increasingly concerned about the growing danger of inflation. Data released last week showed the UK’s Consumer Price Index (CPI) hitting 3.7% last month (the Bank of England’s target is 2%) and the Retail Prices Index rising to 4.8%. For followers of The Daily Telegraph’s ‘real inflation’ index, the level is 5%. Last month petrol prices rose at the fastest pace on record, reflecting a surge in oil prices over the last year to almost $100 per barrel. There is plenty of anecdotal evidence of inflationary pressures and the CBI warned in its latest survey that “domestic prices are set to rise strongly over the next three months”, as the upward pressure on raw materials for manufacturing remain “intense”. Higher inflation has two potential impacts – firstly, it puts pressure on the BoE to raise interest rates and, secondly, investors tend to eschew government bonds, a point made by Bill Gross who runs the world’s largest bond fund at Pimco. To date the BoE has resisted pressure to raise interest rates as this could potentially derail Britain’s economic recovery, insisting that the latest rise in inflation is down to one-off factors such as the raising of VAT. This is the view taken by other well-known institutional investors such as Anthony Bolton who told The Financial Times that “My central view is that the current concern [about inflation] will die down somewhat over the coming months”.

So what choices do private investors have and what actions can they take to protect their wealth from inflation? Advice from the weekend personal financial columns, including The Sunday Times, was diverse but the overall message was one of the need to review existing strategies and to ensure one had a diverse portfolio, invested across a number of different asset classes. If emerging markets have become too expensive in the short term, then switching into Japan for example, which has lagged for many years, might offer some opportunity, opined the paper. One of the key things to remember is that historically, according to data collated by Barclays in its Equity Gilt Study, dividend income has risen at a faster rate than inflation. Looking at it another way, the real return (adjusted for inflation) for cash has been 1.6% pa over the last twenty years. The report also showed that the real return from UK equities (with income re-invested) was 5.9% pa over the same period. Currently, the FTSE index of the UK’s top 350 high-yielding companies yields 4.2% – and remember that this figure is net of basic rate tax.

A Strategy for 2011
So what are the professionals doing? Cato Stonex, principal of THS Partners, shared his views on THSP’s current strategy. “We continue to like equities for valuations and fund flow reasons; we think the European situation will improve and we are cautious about emerging market valuations. Although we believe the emerging market story is real and durable, some slowing in China could occur, with pressure on the resource sector. But we remain enthusiastic about our other themes: consumption and credit growth in the emerging world, a recovery in the US housing market, a transfer of value in media towards content owners, the rising value of oil production in the safer parts of the world, the value of specialist data and information technology businesses and increasing spend on healthcare in the West.

“We are keeping a watchful eye on inflation – at the very least high inflation should direct some flow into equities from [government] bonds. Inflation has been running ahead of the UK target for two years; is now ahead of the ECB’s target within the eurozone and is a more pressing problem in many emerging markets with fast-growing economies starting to apply the brakes. Erratic and unpredictable inflation is no panacea to economic concerns, but strong companies with the ability to raise prices will provide better earnings protection than fixed-income securities in an inflationary scenario. Our portfolios will continue to be built in the same way as we have constructed them in the past. We now have a portfolio of global equities which collectively have a prospective price/earnings ratio of 11.3, with a dividend yield [net] of 3.4%. Indeed, valuations for the market as a whole are towards the lower end of their 15-year range. After a period of higher markets, we now believe it is particularly important to focus on both valuation and growth; and the portfolio displays these underlying characteristics.”

2011-01-18T08:30:00.000Z

In this week's bulletin:

The first major takeover tussle of 2011 started as Smith & Nephew were rumoured to be of interest to US company Johnson & Johnson
BP announced a deal with Russia that results in new shares being issued amounting to 5% of the company.
The impact of increasing global food prices is discussed
Interest rates in the UK were held, but analysts are starting to see signs that a rise could be imminent
Hugh Young, manager of the St. James’s Place Far East funds, gives his opinion on the outlook for Asian markets

Activity picks up

After a relatively quiet first week of the year for the FTSE 100, last week saw an increase in trading activity and market rumour. The leading UK index retreated late in the week from its 31-month high as commodity stocks were undermined by China’s decision to further tighten monetary policy, causing the index to close the week at 6002.03, still an increase of 1.7% since the start of 2011. Elsewhere, the US and Europe also saw gains of over 1% as, overall, equity markets concentrated on encouraging quarterly earning reports from the likes of Intel and J.P. Morgan, rather than less impressive economic data such as an increase in US unemployment.

Last week also witnessed the beginnings of the first major takeover tussle of the year, according to The Sunday Times. One of

America

’s biggest healthcare companies, Johnson & Johnson, is understood to be examining a fresh takeover approach for Smith & Nephew, the

maker of hip and knee replacements, with the

firm looking to put together a revised bid worth at least 800p a share, valuing the

company at around £7 billion. Not only has this news put the Smith & Nephew board on alert, with it stating “we are not engaged in any discussions which could lead to a merger or takeover involving the company”, but this would also test the coalition government’s determination to scrutinise bids by foreign companies; since after the sale of UK confectioner Cadbury to the American foods group Kraft last year, Vince Cable announced a review into the “short-termism” of the City.

Johnson & Johnson, which has a market value of £109 billion, has been encouraged by market reaction to the reports, with shares in Smith & Nephew rising to 750p on the first trading day after the news was leaked; and with massive cash levels of around $6.5 billion at its disposal, the US company certainly has the financial firepower to launch a formal bid. It remains to be seen whether a formal offer will be forthcoming but Richard Oldfield, manager of the St. James’s Place High Octane funds, sees it as a good acquisition for the US firm. “A company like Johnson & Johnson continues to look greatly undervalued, and it is odd that there should be such valuation anomalies at the larger end of the market. Within equity markets, waves of enthusiasm and gloom sweep through different parts at different times, but we can see with reasonable confidence that this company will provide good returns over several years. While by no means finalised, the deal with Smith & Nephew would increase worldwide sales, but if it doesn’t go through as planned, it shouldn’t change the long-term prospects of the stock at all. There is no real downside to the attempted acquisition.”

‘British’ Petroleum

On Friday, BP unveiled a $16 billion share-swap that will see the company issue new shares equivalent to 5% of its stock, in exchange for a 9.5% stake in Rosneft, the Russian oil giant. The deal would potentially make the Russian company, which is 85% controlled by the Kremlin, BP’s largest shareholder. The deal is part of a wider alliance between the two companies that will see them explore for oil in the Kara Sea in the Russian Arctic (an area the size of the North Sea), as Bob Dudley, BP’s chief executive, hailed it as a new model for co-operation between publicly traded companies and government oil companies. Looking to the future, Mr. Dudley has not ruled out Rosneft adding to its 5% stake if the project goes well, though it is important to remember that should everything go to plan, production from the region would not begin for another ten years. It is unclear how existing investors will react to the deal, which will see their shares diluted by the Russians’, but the size of the issue means that no investor vote is required. The deal has been seen initially as a coup for the British oil company and a blow to US rivals such as ExxonMobil, especially as it is believed that Vladimir Putin has promised BP the “most favourable tax treatment” during the project. The announcement brought mixed responses globally as the share price rose 4%; but environmentalists slammed the move into new exploration areas, while the reaction from the US was for politicians to express concerns; while The Sunday Times reported that Michael Burgess, a Republican congressman from Texas, said, “The national security implications of BP America being involved with a Russian company requires scrutiny”.

The Sunday Telegraph opined that the planned Arctic exploration will allow BP to regain its global prominence following the Gulf of Mexico oil spill which saw half of the company value lost in the space of months, although the share price has recovered around 70% since then. The paper reported that, nine months after the incident, this partnership is seen as a statement that the company still has friends in the world and does not intend to give up its position at the forefront of deepwater drilling in the face of US hostility. The outlook for BP in America has improved slightly, but remains uncertain. The publication of Barack Obama’s oil-spill commission report savaged BP for “failure of management”, but spread the blame among its partners as well. The likelihood of BP having to pay out several tens of billions in damages has diminished as a result, but the company’s brand in the US remains tarnished in a market that was central to its growth plans, and it remains unclear as to whether it will be granted new licences in the Gulf of Mexico.

Any salvation for savers?

This week, the Office for National Statistics is due to announce its Consumer Prices Index figure for December, which was 3.3% for the previous month. It is fully expected that the inflation rate will rise even higher due to the increasing price of petrol and utility bills, with economists believing that it will rise above 4% within months. According to The Daily Telegraph, savings rates are now so low that, taking these inflation figures into account, there are only three instant access accounts paying a real rate of return, with the average account paying just 0.23%. However, data from the financial markets indicated last week that interest rates could rise by early summer, following surprise at the steep rise in inflation. Most economists had not expected an increase until the end of the year, and a rise in the Bank of England base rate would end a two-year period of stability of rates at 0.5% aimed at rebuilding the flagging UK economy. Mortgage companies are already beginning to pull their best fixed-rate deals, with analysts seeing this as another sign of anticipation of a rate rise; but some leading economists are warning that the Bank of England must hold its nerve. According to a report in The Sunday Times, Ernst & Young is suggesting that inflation is being temporarily affected by rising commodity prices, and that the Monetary Policy Committee should “keep base rates where they are until it is clear that the economy is taking the fiscal adjustment in its stride”.

A global problem

With inflation talk high on the agenda, The Independent on Sunday felt it important to emphasise that this was a global issue, and not just confined to the UK. While we are all too aware of rising oil prices, it was also announced last week that global food prices are now on average 32% higher than they were six months ago. In a developed country such as the

, food generally accounts for around 15–20% of household spend, whereas in most of the emerging world the figure reaches the heights of 50–75%; therefore a rise in food prices is felt much harder. This is one of the factors that has already caused civil unrest in parts of North Africa, with several governments in the region taking steps to control food costs. The Indian government has already placed a ban on certain vegetable exports,

China

has had to cut road tolls for food transportation, and the Korean government has actually had to take the steps of distributing emergency stocks of meat, fish and vegetables. There are a number of reasons to believe this trend will continue, including a rising global population, a global shift towards more meat-eating, and the higher costs of fuel and fertiliser. While globally we are highly likely to adapt to increasing the food supply, the paper warned that with the emerging world having more impact on global prices, food inflation may not be a short-term trend. It is difficult to see an increase in

interest rates as a solution to this global phenomenon.

Global inflation concerns seem to have taken over from worries over the eurozone in global markets, with commodity prices rising again last week. The Financial Times reported that several agricultural prices are now at 30-month highs and oil is pushing back towards the $100 per barrel level once again. Within Asia, South Korea and Thailand raised their benchmark interest rates, while China increased its reserve ratio requirement for banks for the fourth time in two months. Closer to home, Jean-Claude Trichet, president of the European Central Bank, felt the need to comment on the inflation problems (2.2% in the eurozone), which the markets interpreted as increasing the chances of a rise in eurozone interest rates. This had the effect of pushing the single currency to a one-month high and its best week for a year.

But what does this necessarily mean for equity markets, particularly in the less developed regions of the world? Hugh Young of Aberdeen Asia, manager of the St. James’s Place Far East funds, is relatively positive on the shorter-term outlook, reporting recently, “Economic growth in Asia appears well underpinned in the next 12 months, having rebounded last year to pre-crisis levels. Although inflation has risen steadily since mid-2009, it has stabilised in recent months. However, many central banks have been slow to normalise monetary policy and their reluctance is due partly to the huge capital inflows into Asia that have caused regional currencies to appreciate. Policymakers also seem doubtful about the region's robust recovery, concerned perhaps that the US and Western European economies remain vulnerable. To us, it appears that Asia is decoupling from its developed counterparts, finding its own sources of supply and demand. Corporate sentiment is upbeat, which reflects not only the strength of their balance sheets but also those of Asian consumers. With corporate profits well supported and real interest rates remaining low, the outlook for regional stock markets appears reasonably positive.”

2011-01-10T16:27:00.000Z

In this week's bulletin:

Banking bonuses were in focus again, as RBS and Lloyds TSB are expected to pay large bonuses to senior employees
The Bank of England continues to be put under pressure to curb inflation
The major players in the retail sector report this week, with excuses being given in advance for poor profits
Problems in the eurozone continue to be of concern, particularly Portugal’s levels of debt
Andrew Green gives his view of current market conditions

New year, same news
The change in year does not necessarily mean a change in news as it was reported that Stephen Hester, the chief executive of Royal Bank of Scotland, is to be paid almost £7 million this year in bonuses, salary and other payments. These annual earnings come just two and a half years after the state-controlled bank was bailed out by UK taxpayers to the tune of £45 billion, and the bank is still 84% owned by the government. After foregoing his expected £1.6 million bonus last year, Mr Hester is expected to accept his cash and shares bonus of £2.5 million when it is allocated to him by the board next month while, overall, the bank will pay £950 million to senior employees. The Sunday Telegraph reported that the announcement is expected to cause controversy at a time of government austerity measures, particularly as there have been signs that ministers are unlikely to take any action to curb bonuses. Vince Cable, the Business Secretary who is one of the most vocal critics of large bonuses, has been unable to persuade George Osborne that a crackdown is necessary.

The coalition government is poised to allow Britain’s five biggest banks – RBS, Lloyds TSB, Barclays, HSBC and Standard Chartered – to allocate as much as £7 billion in bonus payments over the next two months. Despite most top executives foregoing some, or all, of their 2009 bonus, with some donated to charity instead, it is understood that the likelihood is for full bonuses to be accepted this year, including by Eric Daniels, the outgoing chief executive of Lloyds. As The Financial Times opined, there is a feeling in the City that these previous gestures were unappreciated by politicians and the general public, and bankers have been emboldened by the apparently fading influence of the Liberal Democrats after veiled threats from both Vince Cable and Nick Clegg came to nothing.

Away from the UK banks, amongst the global banking institutions there is also an increasing appetite to return to the much-maligned bonus culture. It is expected the 6,000 London staff at J.P. Morgan will receive in excess of £1.2 billion, while Goldman Sachs, Citigroup and Morgan Stanley are expected to announce similar remuneration within the next two weeks. The Sunday Times reported that, despite an expected 40% drop in profits, Goldman Sachs will announce that it has paid staff more than $13 billion, an average of $370,000 for its 35,000 employees around the world.

Eyes on inflation
A critical 12 months kicks off this week for the Bank of England’s Monetary Policy Committee. With inflation expected to continue to run above target and having done so since November 2009, there is pressure for action to be taken, with the living standards of millions being squeezed, reported The Mail on Sunday. At every monthly meeting since October, the MPC has been split three ways, with votes for both tighter and looser monetary policy, and the majority voting for no change. Analysts suggest that it is these mixed messages that is undermining the MPC’s position. The Bank has also said inflation, as measured by the Consumer Prices Index, is likely to stay above target for the whole of this year, pushed up by the increase in VAT to 20%, and higher import prices resulting from the fall in value of sterling.

Snow excuses for retail sector
Figures to be released this week are expected to show that retail sales in December 2010 were only 1% lower than in 2009. As reported in The Sunday Telegraph, the minor impact that the snow has played will cast doubt on chief executives’ claims that the weather caused havoc with sales in the run-up to Christmas. HMV Group, Next and Mothercare were among the high-street names to have issued dire trading updates in which they were attributing blame to the snow for poor sales. However, experts believe that the bad performances could be more to do with deeper-rooted structural issues at some chains rather than the weather. The stock exchange announcement from HMV Group that the company was not going to meet profit targets, and may break banking covenants, caused the share price to fall 20% within half a day of trading. While the chief executive, Simon Fox, was quoted as saying that HMV “remains a profitable and cash-generative business”, the debate soon began over whether the company had a long-term future. With over 50% of music sales now being transacted online, and book sales increasingly going the same way, the management team are keen to establish the business as more of an “entertainment brand”, moving more of its product range into electrical products such as iPads and MP3 players, a product area which made up around 9% of total product sales last year.

This week, in contrast, some of the UK’s largest retailers including Tesco, Marks & Spencer, J Sainsbury and Debenhams will report on Christmas trading, with sales for most expected to actually increase. Retailers that have already reported positive data include John Lewis, Waitrose and Majestic Wine. The pre-emptive excuses from some companies have drawn criticism from analysts, according to The Independent on Sunday, with many pointing out that there are high-street retailers claiming record profits, and the snow may have simply given investors the chance to pick the winners from the losers in the retail sector.

While 2011 will no doubt be tough for all retailers, with consumer spending cut back by the VAT hike and higher unemployment, the good businesses will survive. However, exactly how tough was speculated upon by The Mail on Sunday which discussed the possibilities of major retailers adopting a round of savage job cuts to combat rising costs and the threat of commodity price increases, particularly in food, cotton and fuel. Both Tesco and M&S have said they have not confirmed spending plans as yet, but with a series of senior management changes at major retailers due in coming months, new bosses are expected to review operating and staff costs.

Investors still moving away from relative safety
While diversification is the key to steady long-term returns, the start of the year is traditionally the time when investors are drawn to thinking about asset allocation, according to The Financial Times, and judging by the first week of trading in 2011, decisions are being guided by “a delicate mix of fragile economic optimism and financial fear”. Market movements and trading data shows that equities and commodities continue to be the most popular areas, while investors are clinging less to the relative safety of bonds and gilts. Certainly for the first week this looked a good decision as UK equities returned 1.4% and European equities increased in value by more than 2%.

Over the last quarter of 2010, there was seemingly a dramatic change in investor sentiment as stock markets have rallied, with the overwhelming opinion from analysts that equities are heading higher in 2011. The majority of equity strategists have year-end targets for the FTSE 100 in excess of 6,500, with some venturing into the record 7,000 levels. However, there are two areas in global markets that continue to be of concern to investors. Firstly, in emerging markets, the key issue is whether developing markets can successfully rein in inflationary pressures without curtailing growth. China raised interest rates over the Christmas period, and is now attempting to curb its fastest inflation in two years. Secondly, closer to home in the eurozone, the cost of insuring the debt of peripheral European governments continues to rise, with Citigroup believing there is further debt restructuring to come throughout the year, claiming Portugal the most likely to be the next to approach the EU cap-in-hand. According to The Times, Citigroup has described the country as “quietly insolvent” after Lisbon’s costs of borrowing rose to a prohibitive 7.38% (rising 0.59% over the week) amid signs that the flurry of activity from last year has given way to wrangling and uncertainty, pushing Portugal to the rates seen by Greece and Ireland before they sought rescues. Jose Socrates, the Prime Minister, insisted last week that his country would hit its goal of cutting its 2010 deficit, but the country still has to raise up to €20 billion on bond markets and there are serious concerns that it will struggle to refinance the €9.5 billion of debt maturing in April and June.

As pointed out by The Telegraph, diversification is vital to creating a portfolio which limits the shocks that will inevitably occur within each and every asset class, and it is crucial that your portfolio suits your attitude to risk and your overall objectives. Without regular reviews, your portfolio may well be taking too much or too little risk based on the original allocations being distorted by performance over a number of years.

Expert view
The truth is that no-one knows what will happen in the coming year within the eurozone, or when the economic and monetary stimulus is withdrawn from the system. Andrew Green recently reported, “Markets have continued to climb the wall of worry accompanied by the requisite hand-wringing and declarations of doom-laden scenarios. Even recent fears that the equity markets have been getting ahead of themselves have been assuaged by the US Congress approving the continuation of tax cuts for another year, with little regard for what such a move means for fiscal stability longer term. The background of eurozone fragility has kept pressure on financial stocks in Europe, and German machismo has created a stand-off that somewhat impedes a market-friendly solution. Strong corporate profitability has enabled the equity market to maintain conviction in the economic recovery thesis.

“There is an assumption of better growth prospects for 2011, but this will result in more competition for capital than previously assumed. Markets may continue their upward move, since equities are the default beneficiary of current economic conditions, at least whilst bond yields remain low by historic standards. However, different alternatives may beckon if inflation and higher bond yields combine to reveal that future growth has already been discounted. In such circumstances, stock selection will be key and, as a result, our portfolio will continue to focus on situations where visible growth is undervalued or there is a strong internal restructuring or recovery theme.”

2010-12-23T09:41:00.003Z

In this week's bulletin:

Debt concerns for the eurozone reasserted a hold over markets
Shares in RBS, Lloyds fell late last week pushing the FTSE 100 down from a two and a half year high
Stories surfaced regarding the amounts of bonuses to be paid to RBS employees
AstraZeneca experienced a significant fall as one of its key drugs failed to get approval for the US market
The weekend press focussed on reviewing the various asset classes from 2010, and took a look ahead to 2011

No Christmas Spirit
With Christmas approaching, debt concerns for the eurozone reasserted a hold over the bond markets this week, as the recent sell-off in US Treasury bonds showed signs of slowing, and worries about Chinese policy tightening faded. Early in the week further evidence of accelerating economic growth in the US and Germany bolstered optimism over global recovery, with the UK market reaching its highest level in two and a half years. However, it was the renewed uncertainty about the eurozone periphery that provided the key price driver later in the week. Investors focused on rating agency actions after Moody’s issued an unprecedented five-notch downgrade on Ireland’s government debt to the same level as Trinidad & Tobago and Russia. The credit rating agency also warned of a possible downgrade in Spain, while a summit of EU leaders in Brussels saw the markets take little comfort from an agreement to establish a permanent crisis management mechanism from 2013 onwards. According to The Times, Germany ruled out adding to the interim €750 billion rescue fund, leaving markets to fret that existing resources could be inadequate to cope with the crisis should it spread to Spain.

Shares in Lloyds and RBS fell sharply on Friday pushing the UK market down, as the Bank of England warned of the threat to Britain’s banks of a continued euro crisis. As reported in The Mail on Sunday, Lloyds Banking Group also announced a sharp rise in its likely losses in Ireland. Lloyds, which is 41% owned by the taxpayer, has already taken a £1.6 billion hit to its profits from its portfolio of loans to Irish businesses and households, but on Friday they announced a further £2.7 billion in losses, blaming the sharp cuts in public spending which will slow the country’s economic recovery.

This announcement knocked the RBS share price down 6%, as the company has exposure of £53 billion in Irish loans and owns Ireland’s third biggest lender, Ulster Bank. While these two companies have significant exposure to Ireland, the next stage of the crisis is threatening to hit others. Portugal is seen as the next most vulnerable state, but a Spanish crisis would turn the City spotlight firmly on Barclays, who have so far avoided the Irish and Greek crises relative to other major banks. The bank holds a total of around £26 billion in Spanish government debt and residential mortgages, by far the highest exposure of the UK banking institutions.

Political woes
As well as the European issues surrounding RBS, The Sunday Times reported the bank’s plans to pay an estimated £1 billion in bonuses to its investment bankers early in the New Year, inflaming the political row over City pay. The Business Secretary, Vince Cable, has demanded additional disclosure of the pay packets of top bankers, and said that he will push for reforms despite threats of a City exodus. He told the paper, “Bonuses this year will probably be down, but we are still faced with this problem about the fact that they are excessive and unjustified. The key is disclosure and we’ve got to have strong disclosure rules.” Directors at RBS, in which the taxpayer has an 84% stake, have begun discussions on payouts in recent weeks, but no final decision will be made until January at the earliest. David Cameron warned on Friday that banks should prepare for further taxes if they plan to pay out these sums.

Astra slump
One of the UK’s most widely held shares, AstraZeneca, slid sharply on Friday as it looked increasingly unlikely that a blood-thinning drug, thought to be key to its future, will be approved for the

market. The US Food and Drug Administration told the company that it had not approved the medicine, Brilinta, asking instead for more information about its clinical trial results. AstraZeneca has pinned much of its hopes on a revenue boost from Brilinta as patents expired on some of its best-selling drugs, as analysts had expected that

sales of the drug would contribute around 10% of earnings per share by 2015. The drug has been approved for use in Europe but being unable to sell in the world’s largest drug market would limit Brilinta’s potential, while even if it is approved next year, this will reduce the amount of time that AstraZeneca is able to maximise revenue before the patents expire.

Winners and Losers in 2010
It is the time of year when the weekend press begins to reflect on 2010, producing a comprehensive review of the various asset classes. As pointed out in The Mail on Sunday, investors became less risk averse with regards to equities as the year progressed, and despite fears of a global double-dip recession, the year has been a rosy one for equity investors. This general upwards trend masked some sharp falls, as the FTSE 100 started the year at 5,412 and now sits within reach of the 6,000 level, but dipped below 4,800 as recently as July. As reported in The Sunday Telegraph, the Emerging Markets performed best, with Asia unsurprisingly the next best place you could have placed your equity investment this year. Europe showed slightly positive returns, but given the shaky currency and the ongoing debt problems, any positive return would perhaps be a surprise to many. Looking ahead, if inflation continues to be a concern for investors, then for equity markets it is generally good news as companies can increase their prices to keep pace.

Ian McVeigh of Jupiter recently reported “We think that equity markets in general have substantial upside potential provided that there is a reasonable economic outcome. There are clearly risks around, principally the ongoing uncertainties in the eurozone and the biggest concern of all, Chinese inflation. Although we need to watch the situation in China closely, we are optimistic that the country can sustain its strong growth and, along with a recovery in the US, continue to drive the global economy. Provided this happens, we believe equities can make significant further progress.”

Perhaps the investment story of the year was the rise in commodity prices, but while gold and oil have risen the most and are the highest profile commodities generally, there were other winners such as copper, cotton, corn and cocoa. While this has stoked inflation and caused food prices to rocket, those who invested directly in commodities have made good returns. While there are serious fears over a commodity bubble in 2011, demand from China and

India

does not look like slowing and this is partly what is driving prices upwards.

For every winner, there is seemingly a loser. The Sunday Times reported that more than £5 billion has been wiped off the real value of British savings in 2010, the only year since the 1990s that average savings rates have not kept pace against inflation. Savers have been hit with rock-bottom interest rates and rising inflation, with this year being even worse than 2009, with banks and building societies chipping away at rates and inflation eroding the value of the money. According to Moneyfacts, there are just three accounts paying a real return on savers’ money, while for higher-rate taxpayers there is only one. A basic-rate taxpayer currently needs an account paying an annual equivalent rate of 4.13%, while a higher-rate taxpayer requires a rate of 5.5%. The one silver lining is that rates on cash ISAs have risen slightly, although the average instant access account is still paying just 0.8%. Looking ahead to 2011, the Governor of the Bank of England is on record as saying he does not expect inflation to fall in the short term, while interest rates look set to remain low for the foreseeable future, with some analysts not anticipating a rise until 2012. Inflation looks likely to continue to creep up as the impact of a 2.5% hike in VAT in January takes effect. This could encourage the Bank of England to increase the base rate by a small amount, but opinions among economists remain divided.

One of the most popular sectors in the investment world recently has been the bond market, with investors seeking income and wary of stock market volatility. Some £19.3 billion has been invested into this area in the past three years. The performance of the sector has not been as impressive as 2009, but returns have still been reasonable and good-quality corporate bonds are still yielding significantly more than cash.

There have been increasing fears of a bond bubble forming, due to the ongoing concern over inflation and the prospect of rising interest rates, so we asked Paul Read and Paul Causer of Invesco Perpetual for their thoughts. They reported optimistically, “In terms of strategy, we continue to favour higher-yielding investment-grade names and better-quality high-yield issuers. We believe that with many high-yield credits still offering attractive yields and corporate issuers in a recovery phase, there remain opportunities. Demand for high-yield paper remains strong, there has been a collapse in the default rate and it has been a record year for issuance. Elsewhere, despite November’s weakness, we continue to see value in banks and other financials. Market volatility saw us add to some positions with attractive yields, such as Parpublica, a Portuguese state holding company. We also participated in the new issue in Pipe, a manufacturing company, at a yield of 9.5%, as well as adding to our position in financials through the purchase of Lloyds.”

2010-12-13T16:25:00.001Z

In this week's bulletin:

The eurozone sovereign debt crisis may have moved to the back burner but the region's latest victim, Ireland, will be paying the price for some years to come following the country's most recent austerity package
The markets' attention turned to the unexpected stimulus package announced by President Obama following his deal with congressional Replubicans which is estimated to be worth some $900bn
Whilst there was a positive reaction from equity markets - government debt markets in the West slumped as investors fretted over higher interest rates in response to the new growth package which is likely to stimulate inflation but also mean increased US government debt
Elsewhere, the UK economy continues to grow faster than expected and is likely to end the year with a flourish following recent GDP estimates. China's growth remains robust but is raising fears of runaway inflation - Beijing endeavoured to slow lending by requiring the banks to increase their reserve capital ratios
Finally, investor worries over higher borrowing costs overflowed into the corporate bond markets - Paul Read and Paul Causer of Invesco Perpetual give their views on events.

Markets Move On
The eurozone’s recent travails have already begun to fade into the distance for global traders and speculators it seems who, once again, have found a new source of angst to be potentially exploited – the worry of higher interest rates, as we will discuss later. However, the legacy effects of this year’s sovereign debt ‘blow-up’ will continue to be lasting as peripheral eurozone governments take the red pen to their spending plans. The cost of losing investors’ confidence can be very high, as the region’s most recent victim, Ireland, has found out. Last week, the country’s finance minister, Brian Lenihan, announced a “substantial down payment on the journey back to economic health” as he slashed public spending and increased the tax burden on the middle classes. Ten days after the humiliating announcement of a €85bn bailout from the International Monetary Fund (IMF) and EU, Mr. Lenihan announced €6bn of budget savings for next year and warned that any postponement would mean even more pain. Of course, Ireland has not been the only country to be bailed out – Greece needed an emergency infusion of EU funding and the EU’s latest strategy has involved buying large quantities of Portuguese and Spanish government bonds in an effort to reduce borrowing costs for those countries. Will it be enough? Possibly, but the IMF’s Dominique Strauss-Kahn has called for a more comprehensive solution to shore up the region’s finances and calm investors’ fear. “The piecemeal approach, one country after another, is not a good one,” he said.

The Obama Boost
So, with the eurozone worries largely put on the back burner, it was left to President Obama to provide the focus of attention for the markets last week. On Tuesday, the market was given an unexpected fillip in the form of a deal struck between the President and Congressional Republicans, which effectively amounted to a second economic stimulus. The deal meant that the previous administration’s tax cuts are to be extended, along with the payment of unemployment benefits for 13 weeks, generous rules for business tax deduction and, most unexpectedly, the inclusion of a $120bn payroll-tax holiday. In all, the package has been estimated to be worth some $900bn and will help boost economic growth: with analysts at J.P. Morgan raising their 2011 growth forecasts up from 3.0% to 3.5%; and possibly higher in the view of Deutsche Bank. Whilst the US tax cut gave equities a tailwind, it will come at a significant cost, said some economists – The Financial Times pointed out that the US will be the only large industrialised country not to tighten fiscal policy in 2011 and will result in a budget deficit totalling some 10% of GDP and a government that pays for 40% of its operating costs by borrowing. Whilst the US Federal Reserve is likely to welcome the prospect of an additional short-term stimulus, rating agency Moody’s voiced its “long-term concerns” about the US credit outlook.

Unsurprisingly, the prospect of the world’s largest economy growing at a faster rate than previously thought was enough to send investors racing into commodities – gold and copper hit record highs mid-week whilst silver touched a fresh 30-year peak and US crude oil hit a two-year high of almost $91 per barrel. Optimism that the deal would boost consumer spending and offer hiring incentives to companies – unemployment remains stubbornly high at almost 10% – helped push US and European equities to their highest levels since September 2008. The mood was more muted in China and other Far Eastern exchanges as investors worried about higher interest rates being imposed by the Chinese authorities in their efforts to curb inflation – on Friday, Beijing raised the reserve ratio requirement for banks by a further 50 basis points: the sixth increase this year. But elsewhere, stock markets enjoyed gains on the back of Mr. Obama’s economic boost – notwithstanding the sudden change in mood that prevailed in world government bond markets late last week. Most of the major stock market indices – with the notable exception of Bombay where the index fell over 2% – gained traction as the week progressed, resulting in gains of around 1% or more.

Bond Blues
Whilst equities benefited from the proposed stimulus, government bond markets remained dubious as investors mulled over the implications. More borrowing – the package adds an extra $270bn to the deficit, said economists – means more bonds being issued; specifically US Treasuries. The result was that, in the very short term, investors found their appetite for government debt sated and decided to head for the exit. So on Wednesday, US Treasuries were hit by their largest sell-off in two years causing yields to rise (as capital values fell) and thus pushing up the cost of borrowing for the US government and ultimately consumers. But the sell-off was not confined to just the US bond market: investors’ worries overflowed into the UK, German and Japanese markets too. For example, by the end of the week the yield on UK Gilts had risen to 3.6% – up from 3.0% just five weeks ago. The sharp decline in values caused hot debate amongst traders and investors as to whether the Obama deal was the catalyst – yields on developed economy debt have been rising steadily over recent weeks in any event. The primary explanation is that growth expectations have increased because of better-than-expected economic data that has become apparent in recent weeks, removing the ‘double-dip’ recession scenario that has worried the markets. Either way, the cost of borrowing has begun edging up which, to some, is unsurprising. “Yields at this level are clearly unsustainable,” was the view of Swiss bank Lombard Odier. Whilst the environment of ultra-low interest rates in the West cannot last forever, it seems it is the speed of the rise in yields that has surprised on the upside, according to The Financial Times.

Ending with a Flourish
After a moribund start, it seems that the UK economy will end the year with a flourish following news that growth gathered pace last month, with figures showing a sharp rise in factory output, raising hopes that the recovery will maintain momentum for the final quarter of the year. According to estimates from the National Institute of Economic and Social Research, GDP rose by 0.6% for the three months ending November, up from the previous month, and the research coincided with data showing that manufacturing output had jumped twice as fast as expected in October. “For now, it looks like industry is in a good position to help offset some of the effects of the looming squeeze,” was the view of Capital Economics. Elsewhere, the UK jobs market grew at its fastest rate for the same three-month period ending in November, but remains delicately poised ahead of next year’s austerity measures. Whilst the survey showed stronger rises in permanent and temporary hirings, the Recruitment & Employment Confederation said that skill shortages are beginning to emerge.

On the other side of the world, growth is going well too – in fact, the economy is probably growing a little too fast. China’s inflation surged to a two-year high last month despite government efforts to increase food and fuel supplies – the annualised rate edged up from 4.4% to 5.1% last month, according to the National Bureau of Statistics of China. The inflation figures follow stronger-than-expected Chinese trade data for November which showed exports and imports booming – both were a third higher than the same month last year. This resulted in the People’s Bank of China upping banks’ reserve ratios in an effort to slow lending and thus temper growth. Worries about slowing Chinese economic growth – with all its ramifications for the West – have caused stock markets to vacillate throughout the second half of this year. Economists consider it unlikely that China will raise interest rates significantly as this would attract unwanted, short-term foreign capital, which would potentially fuel further growth. Some argue that there is actually a silver lining from higher Chinese inflation, believing it will ultimately mean that the country would lose some of its competitiveness, which in turn would help Western exporters.

Income Seekers
The recent rise in government bond yields mean that the inverse relationship with capital values has resulted in falling bond prices and the change in investor sentiment has overflowed into the corporate bond market too. In the very short term, investors may have seen values fall back somewhat, although this has to be seen in context with the extraordinary returns that have been witnessed in the last 20 months or so. The big question of course is what happens next. Paul Read and Paul Causer of Invesco Perpetual are recognised as market leaders in this field and here they discuss the outlook for the corporate bond market.

“Looking ahead, markets are likely to see further bouts of volatility in the short term. Both government and corporate bonds issued by members of the peripheral eurozone countries, as well as European banks holding significant positions in them, may come under further pressure. Contagion fears may at times also spread into the wider market. However, whilst the focus remains on governments with excessive debt levels, it should be remembered that there are reasons to be positive in the current low growth, low interest rate environment. Corporate balance sheets remain generally strong, sections of the market are reasonably attractive by historic standards and there is continued demand for the asset class from investors. Although yields are now more modest and interest rates will inevitably move higher from their current emergency levels at some point, we think it unlikely that they will move significantly higher over the next couple of years. There is still a huge amount of de-leveraging required, while reduced bank lending and a weak labour market will continue to restrain economic activity.

Despite their recent weakness, we still think that banks are one of the most attractive areas, particularly the larger northern European banks that we favour. Recent events do not change our view or strategy as we always thought this would be a volatile process. We think that the combination of structural reform, conservative interpretations of Basel III and rising capital levels will be a powerful support for subordinated bank debt for years to come and that aggregate yields on this type of debt still offer real value even in the context of their higher volatility. Outside of financials, we continue to see value in higher-yielding, investment-grade names and in better-quality, high-yield issuers. The aggregate yield on sterling BBB-rated corporate bonds is back above 6% at the end of November while in high yield, many credits still offer double-digit yields. So our view is that, despite the market’s recent gyrations, we have not altered our long-term view of credit markets in general and we still see areas of value and opportunity. Accordingly, we believe that corporate bond markets should continue to deliver a relatively attractive level of income going forward.”

2010-12-07T10:45:00.000Z

In this week's bulletin
Intervention by the ECB put paid to lingering investor concerns about the future of the eurozone - after falling sharply early in the week both the currency and equity markets rebounded sharply.

Positive economic data from China, the US and eurozone boosted confidence further, encouraging investors to favour equities over bonds.
The resilient performance of global markets during the latest sovereign debt turmoil has impressed many City experts who now believe a new bull market is underway with the FTSE100 set to test its record high of 7,000 in 2011.
With many ISA accounts failing to achieve real, inflation-adjusted returns investors are being reminded that the average dividend from the UK’s top companies is 3.7% net of basic rate tax and are expected to grow strongly next year.
Tipped as one of the City’s up and coming stars, Kevin Murphy together with long-term co-manager Nick Kirrage, look after UK equity funds for St. James’s Place. The two managers explain their approach and share some of their current views.

My Word is my Bond
The euro dived, government borrowing costs soared to new highs and stock markets tumbled at the beginning of last week as the Irish rescue failed to quell fears for the future of the eurozone. Despite the EU’s intervention, it’s much-vaunted bail-out package failed to impress with investors still fretting over whether contagion would spread to the Mediterranean: specifically Spain and Portugal. At its nadir, confidence fell to such a low point that even Italy’s government expressed worries over turmoil on international debt markets as new data showed unemployment rising and thousands of protesting students paralysed Rome. The result was that by mid-week Spanish, Portuguese and Irish companies – including banks – found themselves priced out of the bond markets as the crisis spread beyond sovereign governments. Credit strategists at Citigroup commented that, “It is really tightening up again. It is difficult to see where [peripheral banks] are going to get funding other than from the European Central Bank.”

This was exactly in chime with the ECB president’s own thoughts. M. Jean-Claude Trichet warned the markets that they should not underestimate Europe’s determination to resolve the escalating eurozone crisis as he hinted that the ECB might expand its government bond purchases – a form of quantitative easing – to drive down surging borrowing costs. And that was the turning point. Hopes that the ECB would step in, together with comments from the US that it would contribute more to any rescue fund via the IMF, were sufficient to boost the markets’ morale causing the euro to jump along with global stock indices. Evidence that the ECB had indeed boosted sharply its purchase of government bonds cemented the deal enabling markets to reverse earlier losses and add to the substantial gains seen mid-week. As understated as ever, M. Trichet replied, when quizzed at his monthly press conference about the level of support planned, that the ECB’s bond purchases were “continuing”.

Full Steam Ahead
There was another boost for stock market sentiment last week in the form of upbeat manufacturing data from China and the UK, along with evidence of improved consumer confidence in America capped with higher German retail sales. Defying a half-hearted recovery in the US, rising global commodity prices and cooling measures imposed by Beijing, China’s factories roared louder than ever last month. The country’s official purchasing managers’ indices (PMI) rose to 55.2, with any reading over 50 showing expansion. More worryingly – but ignored for now – were the inflation data which hit a two-year high. Inflation in China is being driven by unprecedented lending by China’s banks and rising wages. Unsurprisingly the commodity markets responded positively as traders marked up prices leaving copper near the year’s high – gold reacted similarly and the price of a barrel of oil jumped to $91.40.

Here in the UK, British manufacturers are on a hiring spree as they enjoy the best business conditions for 16 years. The UK PMI figure rose to 58 last month, up from 55.4 in October and its highest reading since 1994 as companies reported increased sales to France, Germany, the US and the Far East. Economists at ING said, “The data suggests that the UK will not slow significantly in the fourth quarter versus the third quarter. It also suggests that fears of a potential ‘double-dip’ will continue to fade.” The PMI data also showed that employment at British factories rose at its fastest pace since 1992, meaning that staffing levels have increased in each of the last eight months. In the US it was a similar story, with an increase in the Chicago PMI and better-than-expected consumer confidence figures buoying the mood.

Whilst sentiment improved as the week progressed it was not all good news. UK consumer confidence hit a 21-month low as the looming prospect of government public sector spending cuts sent a chill throughout the UK. Not helping was news from the Nationwide Building Society that house prices fell again last month by 0.3%, bringing the cumulative fall over the last three months to 1.3%, marginally better than the previous quarter, hinting that the market may be flattening out. Nationwide’s chief economist said there was “little evidence” to suggest the downturn was set to accelerate because there were relatively few forced sellers. A similar climate exists in the US where house prices dropped for the third consecutive month, reversing gains made in the spring and raising expectations of a double-dip. Friday’s US payroll numbers completed the set of poor data, with the unemployment rate nudging up to 9.8% following a much smaller-than-expected payroll increase of just 39,000. But as The Financial Times pointed out, the trouble with the data is that it represents the difference between two very large figures: the 130.50m Americans employed in October and last month’s 130.539m, leaving plenty of room for statistical error.

More Zoom to Come?
Notwithstanding last week’s initial wobble, global stock markets ended the week in good spirits with most of the major indices gaining around 1.5% and Wall Street topping the leaderboard with a rise of almost 3%. The stock markets’ resilience has surprised many and a number of City experts believe this augurs well for 2011 according to The Sunday Times, with the FTSE 100 index forecast to hit a new high of 7,000 by the end of next year. Over in The Sunday Telegraph it was a similar story but this time with a Far Eastern flavour with many fund managers looking forward to a new bull market driven by emerging economies. Jim O’Neill, chairman of Goldman Sachs Asset Management said, “We’ve entered a new bull market in global equities,” crediting emerging markets with the turnaround. Private investors seem to agree – the global emerging markets sector attracted more than £336m in October; the highest figure ever.

One of investors’ long-term concerns is inflation but it seems that billions of pounds are languishing in cash Individual Savings Accounts (ISAs) losing value in real – inflation-adjusted – terms according to The Daily Telegraph. The official rate of inflation (CPI) is currently 3.2% but, unsurprisingly given base rates at 0.5%, some 82% of all cash ISA accounts are failing to beat inflation. It’s worth remembering that historically UK dividends have risen at a faster rate than inflation – currently the average dividend yield for FTSE 100 companies is 3.7% (this is net of basic rate tax) giving a ‘real’ return. Morgan Stanley predicts dividend payments could grow as much as 20% in 2011 according to The Sunday Times. And it may be time to review your With Profits bonds according to Telegraph Money with many of these investments having delivered lacklustre returns over the last ten years.

Recovery in Their Sights
The Sunday Times thought its readers might be interested to know who the rising stars of finance are – young professionals with the ability to innovate and adapt and who are tipped to become the next generation of City leaders. One of these stars is Kevin Murphy, an investment manager with Schroder’s, who co-manages some £4bn with his long-term colleague Nick Kirrage. In an interview last week the two managers explained their approach to stock-picking and how they go about managing the St. James’s Place UK equity portfolios.

“From an investment perspective it’s very important to have a disciplined approach,” explained Nick Kirrage. “Kevin and I are value investors which means we are looking to buy shares in businesses that are trading in the market at a significant discount to their intrinsic or fair value – usually because the market is not prepared to be patient. Short-termism is a common feature of markets today and that actually throws up a number of opportunities when investors decide to fall out of love with a stock. A key aspect for us is that we pay particular attention to the strength of a company’s balance sheet and its ability to turn profits into cash, so the central concept is to invest with a margin of safety to reduce potential loss of capital. So when we come across a company that might be interesting – there are probably a few hundred we are analysing and filtering at any point – we always carry out a downside ‘stress test’. When we are both satisfied that we want to make an investment we build up a position gradually – we don’t attempt to ‘time’ the market because if we are right then the value will be released over time.”

Kevin also outlined their current strategy. “The portfolio we are running for you comprises around forty stocks. From our analysis we have identified some key sectors where we believe there is compelling long-term value – these include construction and building, insurance, autos and banks – and approximately 75% of the portfolio is exposed to these areas. So in the portfolio you will find the likes of Lloyds, Barclays and Inchcape. One stock we own – the jewellery firm Signet – is a good case study that encapsulates our recovery approach. The stock is dual-listed in both the UK and US and has a consistent track record of solid growth. However it was badly hit in the recession and its share price fell from $50 to $8 so we took the opportunity to assess the actual risks to the business and came to the conclusion that whilst it had debt, there was no real balance sheet problem. We bought the stock at very lowly prices and in the last 18 months, the share price has gone from $8 to $40. But usually, investing in recovery situations means you do need to be patient – they don’t all recover as quickly as Signet!

“Following the market lows of last March it was no surprise that a large number of companies came onto our radar – it was then a question of selecting those companies we liked most. The market is currently not expensive but it is no longer cheap either. Using our own analysis, we expect the market to revert to more average type returns over the next ten years following the last decade which has been particularly disappointing from a broad market view. For example the FTSE All-Share would have delivered a total return of just 33% in the last ten years – our portfolio has increased by over one and a half times.”

Adding a cautionary note Nick commented, “Of course we cannot be sure of repeating this but with a relatively low starting point we are confident that the recovery-style approach that we have will continue to add value for our investors over the medium to long term.”

One Final Word
Our sincere thanks go to all those clients who participated in the recent Daily Telegraph Wealth Awards. At the award ceremony held at the Mansion House last week, St. James’s Place won the award for the Best Wealth Management Company – making this our fourth consecutive year as an award winner.

2010-11-30T09:00:00.001Z

In this week's bulletin:

Last week the Irish crisis dominated financial markets but the final eurozone bail-out was never in doubt so its formal announcement had little impact.
With the certainty of knowing the Irish problem would be addressed, international investors turned their sights on Portugal causing the cost of government debt to soar.
Endeavouring to stay ahead the Portuguese government announced a new austerity package which co-incided with a national one-day strike.
Elsewhere Japan’s export-led recovery seemed in doubt following disappointing trade data and Chinese stock markets remained volatile in anticipation of further interest-rate rises.
With UK equities lowly priced and investors worried about income and inflation the press highlighted the merits of dividends. UK fund manager Neil Woodford explains why his portfolio is so concentrated around a smaller number of high-quality, high dividend-paying companies.

Eurozonked
Using the Greek crisis as a template, the week unfolded in a pretty predictable way for the eurozone’s latest victim, Ireland. Following initial protestations from the Irish premier that the country was sufficiently well financed until the middle of next year and that it would not need to tap the EU/IMF bail-out fund, the administration performed an exemplary volte face. By the beginning of last week it was a done deal, with only the finer detail to be sorted following agreement by European finance ministers to grant Ireland’s request for a multi-billion euro emergency rescue – thought to initially total around €80bn–€90bn. The rescue was driven by the need to assist the country’s debt-ravaged banks and to prevent contagion from destabilising the entire 16-nation eurozone. However, as The Financial Times pointed out, the deal put paid to Europe’s hopes that a ‘shock and awe’ €750bn backstop, arranged after a bail-out of Greece in May, would never need to be used.

By the end of the week, though, events took a twist when investors fretted that some bondholders might have to accept potential losses – mainly banks like RBS and Lloyds – particularly as the Irish government’s hopes of pushing through a further €15bn of austerity cuts were put in doubt following a by-election win by Sinn Fein. Over the weekend the EU announced an €85bn package – sufficient according to the French finance minister Christine Lagarde “because that will keep Ireland afloat for three years”. Irish Prime Minister Brian Cowen said that it was the “best available deal for Ireland”, providing “vital time and space to successfully and conclusively address the problems we’ve been dealing with since the financial crisis began.” In the government bond market, yields on ten-year bonds [used as a benchmark] in the Republic of Ireland, Portugal, Greece and Italy were largely unchanged as reaction to the bail-out was largely muted.

Once it became clear that Ireland’s woes would be addressed, international investors decided to look further afield for potential problems and the financial caravan moved on to Portugal. On Tuesday shares closed sharply down in both Portugal and Spain as fears grew that Europe’s sovereign debt panic would lead to the next bail-out centred on the Iberian Peninsula. Reflecting these concerns, the cost of borrowing for the eurozone’s peripheral economies rose to record highs as investors demanded a higher premium to offset the perceived risk of owning Irish, Portuguese and Spanish debt. Endeavouring to stay on the front foot, the Portuguese government announced a €5bn austerity budget for 2011 with the country’s prime minister saying his tough package would move Portugal “out of the danger zone”. The announcement coincided with a national strike which brought the country to a virtual standstill as people protested against the proposed 5% public sector pay cuts, reduced welfare payments and higher VAT. Speculation about whether the contagion could spread to Spain also heightened during the week, although most observers seem sceptical – Spain is the fourth largest country in the eurozone, accounting for about 10% of its economic output.

Golden Autumn
In the continuing aftermath of the banking crisis, European Union officials want liquidity ratios to be considered in a new round of Europe-wide bank stress tests as part of a plan to further stabilise the region’s banking sector. The previous exercise, conducted by the Committee of European Banking Supervisors, scrutinised and passed 84 of Europe’s 91 banks, including Bank of Ireland et al, but has been subject to criticism. Lord Turner, chairman of the UK’s FSA said, “We think the tests were useful exercises… the issue here is to work out whether these were liquidity or solvency problems.” There was speculation in the press that the eurozone’s emergency bail-out fund may not be enough, but Axel Weber, president of the Bundesbank, said the facility ought to be adequate, although if not, “it will have to be increased”. However, the German government took a firm line to quash any further speculation, saying it was a non-issue for Berlin. The country is the EU’s largest financial contributor and joint architect of the single-currency union.

Unlike many of its eurozone neighbours who are mired in slow economic recovery – recession in the case of Greece – Germany is enjoying robust growth, dubbed a ‘golden autumn’ by its economics minister Rainer Bruderle, who said the recovery was self-sustaining. His optimism is borne out by the latest German business confidence survey – the closely watched Ifo index of business sentiment. The index climbed to 109.3 this month – the highest level since data started after German re-unification. The rise was higher than expected and came just a day after data from factories and service companies suggested that growth was gathering pace – Germany’s third-quarter GDP growth was confirmed at 0.7%. German exports have responded strongly to changes in world demand, especially to the emerging market economies. There was further evidence to support a positive outlook for the major European economies, with data showing a rebound in bank lending to the private sector – up by an annualised 1.4% – the fastest since May 2009 according to the ECB.

Yen and Yuan
Away from continental Europe there was other news to occupy investors’ minds. In Japan, export growth fell sharply last month to 7.8%, resulting in another setback in the attempts to conquer deflation and secure a lasting – and frustratingly elusive – recovery. Whilst the official data confirmed the eleventh month of expansion, the rate was below expectations – the year-on-year growth rate recorded to September was almost double at 14.3% – reflecting the influence of a strong yen and low consumer confidence in Europe. Concerns are growing that corporate Japan will suffer from the extended strength of the yen. There was a bright spot though in the trade numbers; Japanese shipments to China were up 17.5% and the first surplus since the summer. However, economists were sceptical about the sustainability, alluding to the Chinese growth curve which is widely expected to flatten under efforts by Beijing to lower inflation.

They may have a point. Markets in Shanghai and Hong Kong have been very volatile of late as investors try to second-guess how savagely the Chinese authorities will wage war on inflation and the ‘hot money’ onslaught created by quantitative easing (QE) in the West. The Communist government has already increased rates twice in recent months in a bid to quell inflation and a property bubble. Last week, ten of the world’s largest investment banks updated their forecasts to incorporate another 0.25% rate rise by the Chinese central bank. “The Communist Party is looking even more concerned about inflation than growth,” commented one veteran to The Times. But it is a difficult balancing act for the Chinese, according to economists at RBS; if rates are pushed too far they will attract even more foreign cash inflows which will exacerbate current excess liquidity.

The impact of the US Federal Reserve’s latest round of QE was always going to be controversial – another $600bn of new money is to be created over coming months in an effort to stimulate

America

’s slower-than-expected economic recovery. Minutes released last week showed that the Fed acknowledged that their money-printing scheme could drive down the dollar. The minutes said that any currency effects would be “unwanted” but that QE2 could put “downward pressure on the dollar’s value in foreign exchange markets.” For example, the greenback has traded below ¥90 for some while now – helping boost

America

’s exporters’ competitiveness. The Fed’s desire to boost the economy is understandable given that unemployment remains stubbornly high at 9.6%, but it may well be that QE2 will be seen to be unnecessary in coming months. Data from the US Commerce Department showed that economic growth increased by 2.5% in the third quarter – up from 1.7% in the second quarter. But if all else fails there is always QE3, according to Standard Life’s global strategist Richard Batty. He suggests the Fed could think about printing $2,000 vouchers to give to Americans to spend if the

sinks into sustained deflation.

Paying Dividends
Whilst equity prices have been undeniably volatile over the last decade, one aspect of investing hasn’t changed – the power of re-invested dividends; a point made by commentators in the Sunday press. The Financial Times also pointed out that with inflation rising, a high quality portfolio of

equities should allow investors to achieve a longer-term income return comfortably above inflation – whatever that level turns out to be. One fund manager who is well aware of this is Neil Woodford of Invesco Perpetual who has a long-term track record of outperformance. In an interview last week, Mr Woodford gave an insight into his current strategy.

“At a macro level my views are well known. We are experiencing a ‘balance sheet’ recession which has rippled out into the economy, resulting in both consumers and governments rebuilding their balance sheets and this process will last for a number of years. In the short term there has been much excitement around industrial production growth but this is outstripping sales which implies to me re-stocking. I think the outlook remains gloomy.

“Against this backdrop equities are attractively priced relative to other assets. There is a subset of shares that are very cheap. They are quality companies that have navigated their way through recession and continued to grow their earnings and profits. But this has not been priced in; in fact, these companies continue to be priced for decline. This presents a huge opportunity to capture this value from a small group of very dependable businesses so my portfolio today is, based on history, very concentrated at around 57 stocks. The core comprises companies like AstraZeneca, Glaxo, Tesco and other quality blue-chips, many of whom yield in excess of 5%. Rolls-Royce is another and I used the recent price weakness following problems with some of their engines to buy more: it is a world-class business and continues to win orders. Tobacco and utility stocks remain key core components too.

“I understand the excitement over emerging markets and I’m positive longer term, but today the opportunities are not as good as presented. The interesting aspect is that many of the companies I own do have significant indirect exposure to the emerging markets. Take Imperial Tobacco – its business is heavily focused towards Brazil and India. AstraZeneca is the second-largest pharmaceutical company in China and one third of Tesco’s earnings now originate from abroad. Overall, the portfolio, when measured by earnings, has less than a 25% exposure to the UK economy: the rest is overseas. It is a proven fact that it is cheaper to buy emerging market growth via developed economy companies and of course it comes without the currency risk. So today I have the portfolio I want. The large positions reflect my conviction about the state of extreme undervaluation and I’m very positive about the opportunities ahead.”

2010-11-23T08:59:00.000Z

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

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

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.

2010-11-15T15:52:00.000Z

In this week's bulletin:

All eyes were on Ireland this week as rumours of a EU bailout increased in pace
The long-term prospects of India and China were discussed in depth
Hugh Young, manager of the SJP Far East funds, gives his views on the Asia region
Commodities and mining stocks continue to be in fashion
The Bank of England increased its inflation forecast to hit 3.5% by the end of the year

Irish Alarm Bells
All eyes were on Ireland towards the end of the week as Irish government bonds plunged, sending yields to record levels amid increasing fears that the country will be forced to restructure its debt. The euro also went into retreat over the risk of contagion to other eurozone nations, notably Portugal and Spain. As yields reached levels of 8.95% on Thursday, a figure seen on Greek debt just before Athens was bailed out in the spring, a wave of rumours spread through the markets that Dublin was in talks about receiving emergency funding of €80 billion from the European Union. Sources in Brussels confirmed that preliminary rescue talks were taking place.

Although Ireland has yet to make a formal request from the €750 billion eurozone bailout fund, it is understood that tentative discussions have taken place on the structure of any potential rescue. According to The Sunday Times, France and Germany have both said Ireland would have to raise its 12.5% corporation tax rate in exchange for any aid (France is 33% and Germany is 30%), and Dublin’s tax breaks have been a long-standing source of complaint from both countries. However, Brian Lenihan, the Irish finance minister, is fiercely opposed to the move for fear it will kill off any prospects of an Irish economic recovery, though is still denying that the country needs any external aid at all, claiming that “it makes no sense”. Sources close to the Irish government were claiming that Brussels was attempting to force the country into an EU rescue deal through a series of leaks, and that Ireland does not need to raise more debt until the second quarter of 2011.

With this news playing havoc with currency and bond markets, global equities also retreated from their recent highs. News that the People’s Bank of China had raised the reserve ratio requirement for all commercial banks was swiftly followed by data pointing to solid growth and accelerating inflation. On Friday, the Shanghai Composite Index experienced its largest daily drop in more than a year, while Wall Street also found itself under pressure amid worries of increasing Chinese interest rates. Closer to home, the FTSE 100 fell 1.3% for the week, heavily affected by the Irish sentiment and falling metals prices which impacted on mining stocks.

India and China
With economic uncertainty still very much in investors’ minds, The Times highlighted the opportunities to take advantage of India as an emerging economic superpower. The Indian stock market has given investors a highly profitable, but bumpy, ride in recent years. Between January 2004 and January 2008, the market rose fivefold before losing two-thirds of its value before March 2009. It now sits 167% higher than its nadir last year. A key element of why India is popular is its demographics, with a considerably younger population than China as well as most countries in the developed West. With a population of a billion, the average age is 25 and 60% is under 30. 70% of the economy is based on domestic consumption, so India is primed ready for the younger generation to continue buying scooters, cars, mobile phones and other electrical goods. More people are acquiring credit cards, eating out and spending money on travel and luxuries. The Times continued by pointing out that, as with any emerging economy, the road to long-term stock market growth may be rocky with high inflation and geo-political concerns, and that an investment into an area such as this should be made with the risks known in advance.

The most talked about economy in the world still remains the rapidly growing Chinese economy. Investors have been backing China for some time, taking a long-term view on the region, and as pointed out by The Independent on Sunday¸ it recently overtook Germany and Japan to become the second largest economy in the world behind the US and it is predicted to catch the Americans by 2020. To quantify this emergence, China contributed just 3.7% to the global economy in 2000 but the figure is forecast to rise to 11.1% by 2014. There is a pressing argument for long-term investment, with the undeniable shift of emphasis to the East and a growing middle class to power growth upwards. As with India, though, investment comes with risks, with China currently having severe problems with its currency as it continues to try to turn the yuan into an international currency to reduce its reliance on the US dollar.

With David Cameron visiting Beijing last week to woo potential trade partners, British businesses are waking up to the potential of the Chinese domestic market. The UK hopes to double its exports to China to £18 billion by 2015, identifying that the country sits on massive reserves built up over the last 20 years. Rolls-Royce has already picked up an order worth in excess of £750 million, while brands such as Burberry, Mulberry and Laura Ashley have rising Asian sales. The UK equity market is becoming increasingly exposed to Chinese growth with Tesco and Marks & Spencer looking to take advantage, while Diageo is waiting on approval from Chinese regulators for its bid for a stake in China’s largest distillery.

The positive view of Asia as a long-term opportunity was recently echoed by Hugh Young of Aberdeen Asset Management, who recently reported, “Looking ahead, Asian markets are likely to be buoyed by a further influx of foreign capital, as further quantitative easing by the US Fed forces funds into more promising assets. Asian governments also face a policy quandary: interest rate hikes to counter inflationary pressures may attract further capital inflows, thus exacerbating inflationary pressures. Governments may thus have to implement more direct restrictions on foreign capital. Equity valuations, however, are on the whole still reasonable, corporate results have been supportive and any market consolidation should be considered a buying opportunity. Asian stock markets are likely to stay volatile in the short term as global imbalances persist, but while the fate of regional equities remains tied to the fortunes of their Western counterparts, corporate fundamentals in Asia are more robust. Hence, the longer-term outlook for the region appears brighter vis-à-vis the developed world, given the asset class’s robust finances, sound businesses and fast-growing urban middle class. Meanwhile, valuations are still reasonable and any market correction should present investors with buying opportunities.”

Commodities in Focus
With the emergence of China and India over recent times driving commodity prices higher until the fall in 2008, The Financial Times highlighted how commodities and related stocks are very much in vogue again at the moment. In the year to date, the mining sector in the UK has outperformed the FTSE All-Share by almost 12%, with companies such as BHP Billiton at record highs, and the prices of gold and copper at unprecedented levels. The price of gold hit a record high of $1,424 per ounce this week, while copper peaked at $9,000 per tonne. The Federal Reserve launching a second wave of quantitative easing seemed to make investors more comfortable with the prices getting ever higher, with commodities being seen as a good hiding place from inflation and dollar debasement. Merrill Lynch said this week that they believe metals prices will continue to rise, as depressed bond yields would help push capital into emerging markets, where it will support economic growth. This is potentially a big positive for mining stocks.

On the flip-side, other analysts such as Citigroup believe that valuations are stretched and the benefits of higher commodity prices will be offset by rising costs caused by the weak dollar. Over the past couple of years, the currencies of producer countries such as Australia, Canada and South Africa have all risen sharply. For companies that report in US dollars but incur costs in local currencies, this has a negative impact on profits and cash flow. For example, the platinum producer Lonmin is very sensitive to currency movements, where the US dollar weakening by a further 10% against the South African rand would reduce its profits by around 30% next year. In contrast, the Kazakh miner Kazakhmys is less sensitive as the currency is pegged to the US dollar. As always, the future is never as clear as it might seem.

Inflation Forecast
A number of publications highlighted the fact that the Bank of England increased its inflation forecast last week; it currently sits at 3.1% and a figure of 3.5% is now expected by the end of the year, before falling throughout 2011. This would affect the performance of most portfolios, and a number of ‘solutions’ were put forward, but all agreed that, with a long-term focus, inflation poses less of a concern. The Financial Times emphasised the benefits of holding blue-chip shares, which traditionally offer high dividend yields while taking advantage of long-term growth. Equities also tend to offer more protection against inflation over the long-term because companies can generally adjust their prices to protect profits and dividends.

Following the herd
Thousands of investors have missed out on the recent gains in equity markets, according to The Daily Telegraph. Investors’ habit of following the herd has cost them hundreds of millions of pounds in lost returns after missing out on global gains – the FTSE 100 has risen more than 50% over the past twenty months. The paper highlighted that this was not an unprecedented occurrence with investors regularly following performance – buying near the top of the market and selling near the bottom. The most famous, or infamous, example of this was when investors piled into technology funds in 2000 and shortly after investments into these funds more than halved in value. During the first two months of 2009, investment into equities was just a small proportion compared to that being invested into corporate bonds, absolute return funds and the Cautious Managed sector, yet would have delivered significantly higher returns over the subsequent 18 months. Whilst predicting the future returns of any asset class is notoriously difficult, the need for diversification across asset classes is always prevalent regardless of market conditions, and having exposure to equities, fixed interest, property and cash limits the risk on any portfolio.

2010-11-09T09:02:00.000Z

In this week’s Bulletin

As expected the US Federal Reserve announced its intention to embark on a second round of QE to the tune of $600bn.
This was more than the markets expected and acted as a catalyst for a strong rally in global equity prices – many markets hit two-year highs as investors jumped aboard the Bernanke reflation express.
The flip-side to QE saw commodity prices also rally sharply – gold, other metals and oil all jumped to reflect the reduced buying power of the dollar.
A cheaper dollar might be helping US exporters but for the likes of China, Brazil and Germany it is making life difficult as their goods become less competitive.
Better than expected news on US employment prospects also helped buoy sentiment – 151,000 new jobs were created last month.

Daily Telegraph Wealth Management Awards
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Simply visit www.stockbrokingguide.com/howtovote.php.

Helicopter Ben
Despite the fact that the US Federal Reserve’s plan to embark on a second round of quantitative easing (known as ‘QE2’) was probably one of the central bank’s worst kept secrets, its chairman Ben Bernanke still managed to announce it to the markets with great panache. The secret of Mr Bernanke’s success was to under-promise and then over-deliver – financial markets had been primed to expect the Fed to say it would print just $500bn of new money in the coming months in order to bolster the flagging American economy. As it transpired, the Fed inflated it by 20%, meaning some 600bn of new dollars will be flowing through the system in the coming weeks and months, destined to be used to buy up medium-term-dated Treasury bonds which will help maintain the Fed’s policy of ultra-low interest rates. It’s not for nothing that Mr Bernanke, acknowledged as a leading expert on what caused the Great Depression, is colloquially known as ‘Helicopter Ben’ – in the last two years he will have inflated the Fed’s balance sheet from around $600bn to almost $3 trillion by dropping billions of new dollars into the economy and financial markets.

For some the policy is seen as highly speculative and fraught with potential – mainly inflationary – danger. Others see no alternative but to give the world’s largest economy another boost. As economist Irwin Stelzer pointed out in The Sunday Times, Mr Bernanke feels that persistent high unemployment makes this necessary and plenty of excess capacity, together with low inflation, make this economic shot-in-the-arm possible. Stelzer went on to say that, significantly, the Fed chairman says that the cash injection will support share prices “and higher stock prices will boost consumer wealth and spur spending”. To many this sounds like a re-run of the famous ‘Greenspan Put’ – the now-retired Alan Greenspan signalled to investors he would not allow the stock market to decline. The Fed’s initial announcement met with some disappointment in the bond (government debt) market because the message was that there would only be more purchases if economic conditions justified it. Specifically, the Fed said it will “adjust the program needed to best foster maximum employment and price stability”. Some economists are already looking to the next tranche, with Barclays Capital saying “the conditional linking of purchases to economic circumstances means the programme is open-ended and we believe there is a strong likelihood this figure will be exceeded”.

More Jobs Please
As previously stated, one of the primary reasons that QE2 is underway is to reduce US unemployment from its stubbornly high level of 9.6% – that’s almost 15m people who are out of work, with another 8m working part-time because they cannot find a full-time job. So Friday’s robust employment data was perfectly timed. According to official figures, non-farm payrolls showed a rise of 151,000 last month, far more than economists expected and the first increase since last May. “The report is better than expected and a most welcome development, corroborating our general thesis that the recovery is ongoing while the data suggests that worries about a double-dip recession are overblown,” commented economic group Miller Tabak. The only downside to the good news was that the overall unemployment rate remained unchanged, although observers expect that to change now the drag from changes in federal employment have finished – local governments have axed the final 1,000 of the 70,000 people temporarily employed for the US Census.

One other predictable outcome of QE was that the US dollar fell – although it rallied towards the end of the week – with the corollary that many commodity prices spiked higher as investors demanded more to compensate for the dilution of value as new dollars begin to flow. Gold hit a new all-time high of $1,395 per troy ounce as some investors feared higher inflation – made more likely as oil prices rose almost 5% on the week to almost $88 per barrel. The weak US currency is a boon for American exporters but at the same time is antagonising the country’s trading partners who have seen their competitiveness weakened. Indeed, the Organisation for Economic Co-operation and Development warned, with others, that the global economy faces an increased threat of protectionism because of tensions over exchange rates, according to The Times. On a more positive note, the OECD said economic growth would gain momentum next year and into 2012 with member state growth rising from 2.5% to 3%.

Overblown?
Worries over higher inflation are not confined to the US where it is currently muted and below the Fed’s tolerance of 2%. Here in the UK, rising prices have resulted in a higher rate of inflation than the Bank of England would like. It too has a target of 2% but the Consumer Prices Index – used by the BoE – remains elevated at 3.1% and RPI is 4.6%. Last week there were fresh concerns over a pick-up in inflation with news that the price of goods leaving Britain’s factories rose again in October. The Producer Price Index rose by 4% in the year to October, according to the Office for National Statistics, with higher petrol, food, chemical and pharmaceutical prices cited as responsible. Within the figures, the cost of food produced in the UK rose at its fastest rate for two years – up 9.8%. Some of the UK’s top retailers have warned that higher commodity prices will force up prices next year – Lord Wolfson, CEO of Next, was at the vanguard, saying higher cotton prices will add around 8% to its clothing range, which when added to the rise in VAT to 20% in January, will have a significant impact on consumers.

But is higher inflation really a problem? Well it seems that we probably need to get used to inflation remaining above the BoE’s 2% target for some while, according to Credit Suisse’s chief economist Neville Hill. “There is a good chance Mervyn King will be writing letters to the Chancellor throughout 2011. We’ve seen a big increase in food prices, some signs that retailers are front-loading the January VAT rise and there is a good chance wage inflation will pick up in the new year,” he commented. So, The Sunday Times reckons that the BoE will warn this week that inflation will remain higher than previously thought. Higher inflation, coupled with better-than-expected GDP figures last week has, said The Financial Times, reduced the probability that the Bank will restart its own QE programme for the time being.

Indeed, the pound rose strongly against a basket of leading currencies last week following an unexpected surge in manufacturing activity. The Purchasing Managers’ Index, which measures activity at British factories, showed that growth in the sector grew at its fastest since last May – the headline index rose to 54.9 from 53.5 in September – confounding economists’ expectations. And over in the jobs market, the demand for workers among British businesses rose to its highest level for a year, according to recruitment agency Reed. Demand was particularly strong in manufacturing and the marketing sectors, and accountant Deloitte said that robust profits, strong finances and tailwinds from reductions in corporation tax should help businesses cope with the impact of the £81bn government spending cuts.

Don’t Fight the Fed
That was the advice of a number of respected investment professionals last week, including Fidelity’s Tom Stevenson, writing in The Sunday Telegraph. Commenting that whilst the governments of China, Brazil and Germany may be squaring up to Ben Bernanke, equity investors in the UK and elsewhere are wisely acting on the adage of “Don’t fight the Fed”. Following the news of QE2, global stock markets, after initially hesitating, took off last Thursday with share prices rallying sharply, enabling many indices to close at levels last seen before the stomach-churning volatility of the autumn of 2008. In London, for example, the FTSE 100 index rose almost 5% on the week. Mr Stevenson thought that QE will probably work exactly as the Fed intends but also said that the danger of the central bank’s single-minded attention to solving America’s economic problems is that others will be caught in the crossfire. For example, those currencies pegged to the dollar are thus obliged to maintain expansionary monetary policies that are inappropriate for their own economies; hence the concerns being expressed by the nations attending the G20 summit in Seoul again. Mr Stevenson finished by saying that, notwithstanding, as long as the economic recovery continues, valuations remain reasonable and inflation does not spin out of control, it would be wrong to hop off Bernanke’s reflation express.

The Gangbusters
There are others who believe a second round of QE will work here too should the BoE restart it in the UK, including leading fund manager Richard Peirson of AXA Framlington.

“Although a second round of QE is less likely for now I do believe it would work this time. First time round the banks basically hung on to it but they have now addressed the balance sheet issue so therefore the next tranche would likely feed directly into the economy. I’ve found the last twelve months challenging – trying to get the right strategy has been difficult. Whilst I do have a substantial weighting of UK blue-chips, these are mainly international companies with the right ‘self-help’ attitude and that trade on low valuations.

So my equity strategy has been to avoid, for the most part, domestically biased stocks in favour of industrial companies that derive most of their earnings from outside the UK, mostly from the emerging markets. These companies have been real gangbusters – Weir Group is a perfect example. It makes valves and pumps for the infrastructure, mining, oil and nuclear sectors within emerging economies. Everything has gone right for the company – the share price has more than tripled since I first bought it and it is now a FTSE 100 constituent. I now have a little exposure to the property sector [not house builders] which has underperformed for 3–4 years – but in very niche businesses. Most of the performance has come from mid-caps and oil stocks where the portfolio is overweight in the likes of Premier Oil. High level, I do think we are on the right track for recovery but whilst I have exposure to financials such as HSBC, Standard Chartered and Lloyds the fund is not overweight and I am remaining vigilant.”

2010-11-01T22:04:00.000Z

In this week's bulletin:

Weak US economic GDP data last week raised the certainty of a new round of quantitative easing (QE) being announced by the US Federal Reserve at its meeting this week. Increased consumer spending was offset by declining construction activity.
A second round of QE may well succeed in boosting the US economy but the outcome is uncertain and not all members of the Fed are supporters. Equity investors though have already begun to price-in the benefits of such a policy.
In contrast the UK economy was given a boost with news that third-quarter GDP came in at twice the rate expected – 0.8%, boosted by the construction sector.
The market’s reaction was that the BoE would put on hold for now a further round of QE which hit gilt prices but left equities steady. MPC member Alan Posen cautioned the optimism by saying that growth would be hit by the government’s austerity programme and that the BoE should proceed with £50bn of new asset purchases.
Against a backdrop of stronger growth and lower pensions The Personal Money sections of the press interviewed fund managers focusing on recovery-based strategies, including Nick Kirrage of Schroders. The merits of both pensions and ISAs were discussed as a way of providing income in retirement.

Too Little, Too Late?
As international finance ministers headed home from their G20 meeting in Seoul last week, their upbeat message that they would collectively avoid competitive currency devaluations left the markets unimpressed. “On the whole, the G20 communiqué will not help to reduce the tensions between countries, notably on the issue of what constitutes appropriate monetary and currency policy,” was the view of Commerzbank. So it was no real surprise that once more the US dollar resumed its downward decline, heading towards a new 15-year low against the yen. The corollary of a cheaper greenback was that commodity prices – mostly priced in dollars – rose smartly, with copper reaching a 27-month high at $8,500 a tonne, and gold and oil following. Undermining the dollar’s strength was a continued expectation that the US Federal Reserve would embark on a further round of quantitative easing at its next meeting, due later this week.

The policy of printing even more money (colloquially known as QE2) as a tool to help the US economy has both its supporters and opponents; with the merits or otherwise of such a scheme having filled the press for weeks. However, as far as the markets are concerned, QE2 is a given. Economic data released last week showed that America’s economy is growing, but not quickly enough to chip away at its army of unemployed who number almost 10% of the workforce. Too little, too late was the view of The Times, meaning that although the data showed that consumer spending had quickened in recent months – private spending was up 2.6%, its fastest pace for almost four years – construction activity fell 29%. Exports are rising but at less than a third of the rate of imports and overall growth is still dependent upon federal government spending which rose sharply in the third quarter. The aggregate outcome was that gross domestic product in the world’s largest economy expanded at an annual rate of 2% in the third quarter, up from the previous figure of 1.7%.

Devil is in the Detail
So it’s not so much if but how much that economists and investors are speculating about. The attraction of more QE is simple. If the Fed were to embark on a $500bn purchase of assets (mainly government bonds) it “would provide about as much stimulus as a reduction in the federal funds [interest] rate of between half a point and three-quarters of a point,” commented William Dudley, president of the New York Fed. In other words, the rationale behind the policy is to lower Treasury yields, force banks to lend money and push investors out of government debt into riskier securities. Thus a further rally in equities and other risk assets translates into a “wealth effect” on consumers and companies, that in turn hopefully, said The Financial Times, boosts confidence and stimulates economic activity. But not everyone is convinced, including Thomas Hoenig, President of the Federal Reserve Bank of Kansas City, who warned that more QE would be a “dangerous gamble” and concluded that the move represented a “bargain with the Devil”.

However, the weight of opinion is that Ben Bernanke, Chairman of the US Federal Reserve, will announce a new dollop of money in the hope that, following the initial tranche of $1.2 trillion in 2008, this will do the trick. The difference this time is likely to be a more incremental policy of monthly injections rather than the ‘shock and awe’ tactics previously favoured. The detail is of course as yet unknown but apparently Fed officials are concerned by comments being made by the likes of Goldman Sachs who are saying that the size of the stimulus should correlate to the Fed’s inflation target of 2%; in other words, the Fed would need to buy some $2,000bn of assets. Anyway all, no doubt, will be revealed later this week.

No ‘Double-dip’ here
The ‘here’ being last week’s CBI conference in London which had an upbeat feel to it, with the Prime Minister delivering a positive message on economic growth and articulating supportive government policies. Whilst not all are happy with the plethora of regulations, most delegates, when asked, said they expected to add jobs in the coming year. Only one person, according to The Times business editor David Wighton, put their hand up when asked if they expected a double-dip recession. Industry’s confidence may also be percolating into the wider economy – according to the GfK NOP Consumer Confidence Index which showed that, whilst shoppers’ appetite for major purchases remains muted, overall confidence rose to -19; with the index once more remaining fairly stable. The CBI also announced that retail sales grew strongly in October, with an index reading of 36, not far off September’s six-year high. The same can’t be said though for confidence in the UK housing market, with news that house prices fell 0.7% in October, according to the Nationwide Building Society, coupled with a further fall in mortgage lending.

However, the best piece of news came mid-week with data showing that the UK economy grew twice as fast as expected in the third quarter, bolstering the government’s case that the economy is robust enough to withstand spending cuts. Growth came in at 0.8%, down from the previous quarter’s record 1.2% but double the 0.4% predicted. So far this year the UK has achieved aggregate growth of 2.4% – much in line with the annual trend rate but with the final quarter yet to come. The strong activity encouraged investors to switch bets that the Bank of England would not introduce a fresh round of QE here in the UK. In another boost, Standard & Poor’s, the rating agency, raised the outlook on Britain’s triple-A rating to “stable” from “negative”, offering a vote of confidence, said The Financial Times, in the government’s austerity programme. Of course, the reduced likelihood of more QE hurt the gilt market where yields rose above 3.0% on the ten-year bond, whilst equities held steady.

But you can’t please all of the people all of the time. Alan Posen, a member of the BoE’s Monetary Policy Committee, said last week that the coalition’s deficit-cutting plans will deliver a “material” hit to British economic growth over the next two years. He also took the opportunity to tell people not to get “too excited” about the latest GDP numbers, cautioning that the economy remains weak and reiterating arguments in favour of more QE. Dr. Posen, an expert on Japan’s two-decade period of low inflation and low growth, was the only MPC member to vote for a second round of QE last month. Saying he didn’t put a lot of faith in the data, Dr. Posen said, “The businesses I meet with in the property and construction sector don’t tell me we are having an historical boom right now”. Maybe not and it’s true that house builders’ share prices have fallen back, but the broad market held steady last week as investors digested the latest economic data and earnings figures from the corporate sector – 85% of which have come in above expectations. The London market closed down a little on the week, with the FTSE 100 slipping 1% to close at 5,675, mirroring similar performances in other global markets.

Green Shoots of Recovery
The better growth numbers for the UK encouraged the weekend money media to search out ways to capture future growth opportunities, with The Daily Telegraph talking to a number of fund managers who specialise in recovery strategies. One such manager is Nick Kirrage of Schroders who, alongside his colleague Kevin Murphy, targets companies which they believe are poised for recovery. “The fund is taking a longer-term view. If four or five years from now the economy is a lot better, then we are in a good position to do well,” said Mr Kirrage. “But if the double-dip does happen, we shouldn’t get wiped out either. We concentrate on buying shares in companies that have fallen out of favour and are trading at low valuations. At present this would include retailers, house builders and consumer-led companies, including banks such as Lloyds and RBS. We are trying to find companies whose share price has been dragged down by negative sentiment but which remain fundamentally sound businesses.”

Of course, equity investors can be forgiven for thinking that the world belongs to them – most people would know that the ‘Footsie’ is London’s index of the UK’s top 100 blue-chip stocks. But The Financial Times argued that it’s bonds – IOUs issued by companies – that really matter. Apparently, the global bond market is worth about $51 trillion compared with $32 trillion in global equity markets. In recent times, corporate bonds have been hugely popular with investors who are looking for higher levels of income. From time to time, it is also possible to make a capital gain – and also lose capital – the last three years are a good illustration as to the potential risks. Today, with the returns from deposits at very low levels and a balanced bond portfolio yielding c7.0%, it is no surprise this type of investment is attractive and some commentators believe certain parts of the bond market are overvalued. But as The Financial Times pointed out, not all bonds behave in the same way so it is important to have a fund manager who uses a multi-strategy fund which allows the manager – such as Paul Read and Paul Causer at Invesco Perpetual – to move up and down the risk spectrum.

Income in Retirement
The recent pension rule changes announced by the government will have a significant impact on most people in the UK over coming years. Most people aren’t saving enough – HMRC have calculated that some 758,000 people have cut back their pension contributions by almost £2bn during the credit crunch. But pensions aren’t the only way to save for income in retirement – Individual Savings Accounts (ISAs) are an efficient way to produce what is effectively ‘tax-free’ income – a point discussed by The Sunday Times. Both investments have their merits – once you have taken your tax-free cash, your pension fund can only provide income whilst an ISA allows access to capital at all times, as well as providing income. As ever, the most sensible strategy is to diversify – not just from an asset class standpoint as discussed above – but also in your choice of tax wrappers. In an age of increasing taxation, taking advantage of the tax-efficient vehicles available should be an imperative for all investors.

Daily Telegraph Wealth Management Awards
You may like to know that you can vote for this year’s Daily Telegraph Wealth Management Awards which recognise quality of service from wealth managers and stockbrokers.

Simply visit www.stockbrokingguide.com/howtovote.php.

2010-10-26T10:13:00.000+01:00

In this week's bulletin:

The government’s Comprehensive Spending Review had little impact on the markets last week – gilts, sterling and equities remained stable and marginally up on the week.
China surprised the markets by raising interest rates 0.25% as a means to moderate growth which saw its economy grow almost 10% last quarter.
Further exchanges in the currency war were met with calls for restraint and positive policies for co-operation at the G20 meeting held in South Korea last week. Ministers finally agreed not to engage in “competitive devaluation”.
Neil Woodford of Invesco Perpetual discussed with the Financial Times his latest strategy around owning dependable stocks.
Duncan Owen of Invista Real Estate sees opportunity in the top-end of the secondary commercial property market but sees returns flattening over the next 3-5 years with rental income the largest component.

Into the Unknown
That seemed to be the view of the majority of economists and financial commentators following the Chancellor’s delivery of the government’s Comprehensive Spending Review. In a nutshell, said The Financial Times, George Osborne has taken Britain’s largest economic gamble in a generation by betting that the country can withstand £81bn of public spending cuts at a time of global uncertainty, yet emerge stronger, fairer and richer. Whilst the cuts are widespread they will be introduced over a period of years in an attempt to avoid increasing the chances of the UK going back into recession. Around half a million public sector jobs are likely to go but the mood seems optimistic that private industry can take up the slack – the CBI and others were positive that its members could create new jobs at the rate of 200,000 a year. “Business has been clear: the deficit must be tackled, no matter what,” said David Frost, Director-General of the British Chambers of Commerce.

So what did the markets think about it all? With many of the cutbacks well advertised in advance, it was really no surprise that the news was received phlegmatically by the financial markets – gilts, currencies and equities were all flat as the Chancellor spoke. “At one stage while he was speaking it was as if the market was closed,” said David Jones of IG Index. The sectors where there had been some nervousness ahead of the review included outsourcing and infrastructure companies; but with the cuts not as bad as feared, there was a sigh of relief, with rail and bus operators rallying smartly. In fact, it was really a non-event from the markets’ perspective, with investors more focused on news from the emerging markets where China took everyone by surprise by increasing interest rates by 0.25%. In fact, by the end of the week, London, New York and leading European equity indices were all within a whisker of this year’s highs – last seen back in April.

Virtual Money
Not that there aren’t signs of economic uncertainty. Last week it became clear that the traditional autumn pick-up in the UK housing market had failed to materialise, with news that the number of mortgage approvals fell for the fourth consecutive month in September to their lowest point since April 2009. Just 44,000 loans were approved by the likes of Santander, Lloyds and HSBC with net lending falling to just £1.1bn according to the Bank of England’s (BoE) credit conditions survey. Market experts blamed the malaise on uncertainty around public sector job cuts and the potential for further house price falls. But paradoxically, much to the surprise of many economists, the asking price of property actually rose by 3.1% last month as hopeful sellers flooded the market, according to online property company Rightmove. Mind you, this comes fast on the heels of recent data from the Halifax which said that prices fell 3.6%. Either way, the market is clearly difficult, which has hit builders hard with the latest survey from the Home Builders Federation making gloomy reading, according to The Financial Times. Added to this, retail sales suffered an unexpected decline last month with high street sales down 0.2% last month, according to the Office for National Statistics.

So what does this mean for the economy and what action are the policymakers likely to take? Minutes from this month’s interest rate setting meeting showed that for the first time in over two years, the BoE was split three ways on rates, indicating deep divisions within the Monetary Policy Committee (MPC). Member Alan Posen called for more quantitative easing (or QE2 for short) – another £50bn on top of the existing £200bn. Andrew Sentance voted for a 0.25% rate rise, with the remaining seven opting to leave rates unchanged and QE on hold. Economists said that on balance the minutes suggest the MPC is leaning towards restarting QE – in other words a further stimulus to the economy. With the latest money supply figures showing underlying weakness – the 0.9% rise in September was the lowest on record – Mervyn King, Governor of the Bank, is worried about anaemic growth. He said that some gauges of inflation were “extremely subdued” and that monetary policy remained a “potent” weapon. A further round of QE would boost gilts but could weaken sterling as a result of the increased money supply.

Over in the US, the Chairman of the US Federal Reserve, Ben Bernanke, has been more open about the likelihood of further QE as a way of boosting the flagging American economy. According to the Fed’s latest survey, its ‘Beige Book’ report, the US economy grew at a “modest” pace in September and early October, pointing to expansion in manufacturing and signs of life in consumer spending, although unemployment remains stubbornly high at 9.6%. The report was more upbeat than the previous one, although consumers remain focused on buying necessities, with most housing markets still weak. Whilst no decision about another round of QE has been taken by Mr Bernanke he has said there is a case for further action, although most observers don’t see any new policy being announced ahead of next week’s mid-term elections. The view is that Fed officials are weighing up an approach that allows more discretionary meeting-by-meeting decisions rather than the “shock and awe” stimulus it launched in the depth of the crisis back in 2008.

A Dollar, a Dime
Not one but potentially trillions more if a second round of QE does go ahead in the US and this lies behind the recent friction between some of the world’s most dynamic economies and their American trading partner. Ben Bernanke may not have formally announced more QE but currency traders already see it as a certainty and in response the dollar has fallen sharply in value – the greenback hit a fifteen-year low against the yen last week. This is good news for American exporters but bad news for the likes of South Korea et al who have seen some of their competitive edge eroded. China has caused most annoyance by engineering the yuan to fall in lockstep with the dollar, thus retaining its relative position, although an unexpected hike in interest rates last week gave its currency a temporary boost. The rate rise was seen as the most decisive step yet to scale back the huge stimulus that the Chinese injected into their economy during the crisis. Data out last week showed the economy still grew at a robust 9.6% in the third quarter but lower than the 10.3% in the previous one, thus allaying some fears of overheating.

But the impact of higher Chinese interest rates soon became history as the markets once more mulled over the positive outlook for the country’s economy whilst still fretting over a possible currency war. Last week the G20 finance ministers and central bankers met in Seoul to find a way of toning down the rhetoric which threatens to escalate tensions further. India’s prime minister said he was worried about the global situation and appealed for “a meeting of minds” to give more impetus to co-ordinated financial reform and rebalancing of the world economy. His concerns were echoed by Mervyn King who warned that tensions over exchange rates could degenerate into trade protectionism. “That could, as it did in the 1930s, lead to a disastrous collapse in activity around the world,” he said. Over the weekend the G20 finally reached agreement that member nations have promised to refrain from “competitive devaluation” of their currencies and would “move towards more market-determined exchange rate systems”.

Dependable
Leading UK equity manager Neil Woodford took to the press last week to explain why he thinks some of the UK’s largest and most dependable stocks offer a huge opportunity. “There is no doubt in my mind that the economic outlook remains challenging. Deleveraging will remain a dominant theme for many years and growth will be lacklustre. It is interesting therefore that shares in some of the UK’s most dependable businesses currently trade at unusually low valuations – AstraZeneca, Vodafone and BAE Systems all trade on single digit price/earnings multiples. Dividends from these businesses look safe, are likely to grow and provide a yield that is very difficult to replicate from any other asset class. These businesses face challenges but they can influence their own destiny in a way that companies more vulnerable to the economic cycle cannot. In time, I believe companies with dependable characteristics will be valued more sensibly. Patience is required but in the meantime, the combination of dividend yield and dividend growth should result in very satisfactory returns for investors”.

Going Up
The residential property market may be in the doldrums but in the commercial sector there is apparently a race to build new towers in the City of London, with news that Land Securities is set to build a 37-storey skyscraper, nicknamed the Walkie Talkie, in the heart of the Square Mile. So now seems a good time to weigh up the outlook for commercial property – fund manager Duncan Owen of Invista Real Estate shares his thoughts.

“The recovery in average UK commercial property values over the last year or so has exceeded expectations but is perhaps misleading. The secondary property market has seen a much weaker recovery than the prime end and more fashionable sub-sectors of the market have overcorrected and are now arguably overvalued. Consequently, I believe that there are less fashionable parts of the market that offer better potential for both income and capital growth over the medium to long term and we are focusing attention in these areas. For example, shopping centres, City of London and regional offices are now valued at between 9–19% below their 2002 levels. There may be better potential returns in selective parts of the secondary market with some properties now offering opportunities for low entry prices as well as active management upside in the short term.

“In addition, in a lower growth environment, the income return offered by commercial property will become an increasingly important contributor to total returns. We are currently forecasting average total returns for the UK commercial market of about 8% per annum over the next three to five years, dominated by the income component of that return. The monthly initial yield on the UK commercial property market as a whole is very attractive at 6.45% – especially when compared to the other main asset classes. Whilst I remain cautious on the outlook for the wider economy and its potential impact on the commercial property market, the portfolio continues to be well placed, with good relative performance and significant liquidity to acquire assets to add to long-term performance.”

2010-10-18T23:33:00.000+01:00

In this week’s bulletin:

Ben Bernanke delivered his prognosis for the US economy
The US dollar drifts again, with consequences for the global recovery
Gold continues to surge upward, as demand stays strong
The UK government announce significant changes to pension arrangements
The UK Equity Income sector comes under the spotlight

All eyes on the US
The Chairman of the Federal Reserve, Ben Bernanke, had the attention of the world on Friday as he delivered a bleak prognosis for the US economy, firming up the likelihood of a further round of quantitative easing to battle economic slowdown and rising unemployment and head off the risk of a downward spiral in prices. As reported in The Times, speaking at a monetary policy conference in Boston, Mr Bernanke said that economic growth was less vigorous than the Fed preferred and that the risk of deflation was higher than was desirable. “There would appear, all else being equal, to be a case for further action,” he said. However, he also spelt out the risks of additional stimulus, as by buying long-term debt from the Treasury the Fed would force down long-term interest rates, which would make mortgages cheaper and encourage consumers to borrow and spend. Further down the line, it is feared that this would give companies licence to increase prices, leading to higher inflation. On the positive side for the Fed, it would be hoped that the increased revenue would encourage recruitment in the US, easing the current 9.6% unemployment rate.

This, in turn, has increased speculation of the UK following suit by pumping billions of pounds in to the economy, with The Sunday Times suggesting that this could be as much as £100 billion as early as next month. With the UK economy expected to slow over the winter, many fear a double-dip recession and economists suggest that the Bank of England will act to avoid such an event. The prospect of another round of gilt purchases has driven government debt yields sharply lower over the last month, starting when the Fed gave an initial signal of intent in September. The ten-year gilt yield has fallen to 2.94% from where it stood on the 20th of September at 3.14%.

Macroeconomic events may have overshadowed the start of the third-quarter earnings season for much of the week, but the results were generally greeted favourably as equity markets globally are now at their highest since September 2008. Despite a late dip on Friday, the FTSE 100 gave a rise of 0.8% on the week, now at a level 9% higher than the start of September; while Wall Street stocks closed ahead for the week after significant results from the technology sector.

Dollar under pressure
The prospect of further asset purchases in the US caused heightened tension in foreign exchange markets, as the week saw heavy dollar selling. In the moments after Ben Bernanke’s speech, the dollar drifted another 0.7% against a basket of major currencies, reaching parity against the Australian dollar for the first time since it was freely floated in 1983. The US currency sank to its lowest levels of 2010 including a 15-year low against the yen, and a nine-month low against the euro.

This dollar weakness saw a drive in global equity markets and commodity prices, most of which are priced in dollars. However, while the falling dollar may help struggling American exporters, The Sunday Times was quick to point out that there could be unprecedented consequences around the world should the push in commodity prices continue further, and posed the question: what does more damage, a weakening dollar or a stagnating America? With China the world’s biggest importer of raw materials such as iron ore and copper, a falling dollar makes these more expensive to import. This will push up the cost of everything that China itself exports, passing on the price increases to customers around the world.

Currency rows are rumbling all over the world. The Financial Times reported that the US is to publish a paper stating that China is a “currency manipulator”, and Brazil’s finance minister, Guido Mantega claimed that his country is a victim of an international “currency war” that is artificially inflating the Brazilian real. If America is perceived to be deliberately driving down the value of the dollar, this could add a new dimension to any row, but Ben Bernanke’s prime concern is American workers, as employment is one of the key objectives written into the Fed chairman’s contract. In addition to these disagreements, Japan accused China this week of attempting to make the yen artificially strong by buying Japanese government bonds. Japan’s reliance on exports makes a stronger currency a disadvantage, and government intervention has so far failed to stem the rise as the yen has strengthened more than any other currency (37.5%) against the US dollar since the start of 2008.

Rise and Shine
The surge in gold prices hit another high this week at $1,387 per troy ounce as concerns mounted over the global economic outlook. According to The Financial Times, this is causing mining companies across Australia, South Africa and Latin America to receive attention from buy-to-hold investors who subscribe to the view that metal prices will be driven higher for years to come. This view is generally due to soaring demand from the emerging middle-classes in China, India and Brazil. However, opinions vary on whether the superior way to gain exposure to this asset class is through mining stocks or through direct exposure to the yellow metal. The current rush to buy direct has been driven largely by investors seeking a hedge against inflation, or a currency play as foreign exchange markets have become increasingly volatile.

In spite of the gold price having quadrupled since starting the year 2000 at $280 per ounce, demand is expected to stay strong if central banks introduce further monetary stimulus programmes, weakening the value of paper currencies and increasing the risk of inflation in Western economies. The rally in gold has also helped push silver to a 30-year high of $24.90 per ounce, while base metals have also fared well with copper prices looking increasingly rosy due to shrinkage in supply.

Pension cuts
The weekend press were united in their advice to readers this weekend, advising pension savers to review their pension arrangements after the government announcement that the maximum that can be paid into a pension and earn tax relief will be capped at £50,000 per year (from £255,000) from April 2011. Of course, for the vast majority saving for retirement this still presents a very attractive objective and opportunity. In addition to this, the lifetime allowance will be trimmed from £1.8 million to £1.5 million from 2012 onwards. The intention of this announcement is to reduce the cost of tax relief on pensions, which HM Revenue & Customs estimates amounted to £19.7 billion last year. According to The Mail on Sunday, this will affect more than 100,000 savers, but experts suggest this figure will increase over time unless the allowances rise in line with earnings. However, The Independent on Sunday also pointed out that this will also affect people such as middle earners who are in a final salary pension scheme, or business owners who planned to use their company assets to fund retirement. Anything over the £50,000 cap, including employer’s contributions, will be subject to tax, which could trap those in final salary schemes for whom the taxable benefit of a pay rise could exceed the gross salary increase. The message was clear though; these proposals could well affect pension savers as the plans firm up, so this is an area that should be reviewed regularly.

Patience could pay dividends
Income investing was under the spotlight in The Daily Telegraph, which pointed out that investors in this area have suffered during the economic downturn. Recent times have seen many UK companies with little choice but to cut dividend payouts and retain the cash on their balance sheets, while the Bank of England has slashed interest rates to 0.5% to keep the economy afloat. Bond markets have been spooked by quantitative easing, while property values have fallen as well. In short, there have been few options for income seekers; but, according to the paper, that could be about to change with equity income funds being the beneficiary of dividends making a comeback over the coming months. Research from the US shows that cash held on corporate balance sheets in developed countries is at the highest level for 60 years – three times higher than it was in 1982, before the equity market surge. The paper pointed out that so far in 2010, 210 FTSE companies have increased their dividend, while 55 have remained the same and only 30 have cut the amount paid to shareholders. This compares with figures of 156, 51 and 86 respectively for the same period last year.

The importance of dividends should not be underestimated. According to the 2010 Barclays Equity Gilt Study, £100 invested in equities at the end of 1945 would be worth just £241 today in real terms without the reinvestment of dividend income: but with reinvestment, that figure rises to £4,011. In the UK Equity Income sector, fund managers tend to believe that the most secure dividends are currently to be found in sectors that did not rally with the general market last year. The likes of the pharmaceutical, utility and telecom sectors are amongst the cheapest markets, but could they offer good value? Neil Woodford of Invesco Perpetual told The Daily Telegraph, “I look to invest in companies that can provide sustainable long-term dividend growth. If I can invest in a business when its growth potential is not reflected in the valuation of its shares, then this not only reduces the risk of losing money, but it also increases the upside opportunity.”

2010-10-12T09:46:00.000+01:00

In this week’s Bulletin:

The flow of economic and financial data continued to create an opaque outlook for economic recovery which has frustrated investors for months now. Positive numbers from the all important services sectors and industry conflicted with poor figures on employment
As a consequence the markets are increasingly confident that there will be a further round of quantitative easing (QE) – printing money – by the US Federal Reserve and the Bank of England
As a result the dollar fell as did yields on government bonds whilst gold rallied to a record high. Equities benefitted from the perceived ‘sugar rush’ of QE with most indices rallying throughout the week as investors bought shares across the board
One side-effect of QE is currency devaluation – plus hopefully increased exports - and the IMF warned the international community of the dangers of the friction this could cause between large trading countries
Fund manager John Innes of RWC explains why, despite the current problems, he is very upbeat about the outlook for UK equities

Dodgy Data
In a world of instant communication it is no surprise that the release of economic and financial data can move markets up and down in a matter of minutes. Any investor who watches the markets will have understandably become quite frustrated in recent months as the flow of economic news goes from positive, to negative and often back to positive again. Last week was no exception in some respects – data was mixed throughout and was capped off with what some observers saw as a set of particularly dubious figures from the Halifax. According to the bank, UK house prices suffered their largest one-month fall since records began over 25 years ago – down 3.6%. Unsurprisingly there was scepticism in the market and even the mortgage lender itself cautioned against reading too much into one set of figures, pointing instead to the latest quarterly drop of 0.9% – in line with the Nationwide Building Society’s own index. The Times came to the conclusion that with some 30% of property transactions being done in cash the house prices indices are becoming increasingly unreliable.

On a more global view, the IMF released some data of its own. This time the message was that any slowdown in the economic recovery would push the UK’s debt as a proportion of national income to almost 100% – up from its current level of 77%. To put this in perspective, Ireland’s debt ratio is currently 92% and Greece’s 130%. The IMF’s stress test assumed global growth coming in 1% lower than the expected 4.2% next year. Growth may well have slowed a little but the world is still growing, albeit at different levels. For example, it seems that swingeing government cuts in Ireland mean the country’s economy is unlikely to grow at all, whilst Greece’s economy is expected to shrink by 2.6%, yet it unveiled a budget last week setting out even deeper spending curbs. Conversely, Germany saw industrial orders surge in August, up by 3.4% as businesses raced ahead – especially the automotive industry. Here in the UK the dominant services sector enjoyed better-than-expected growth in September with the activity index rising to 52.8 (any reading about 50 indicates positive growth). “The survey at least provides some reassurance that the economy is not plunging head first into a renewed contraction,” said Vicky Redwood of Capital Economics. Industrial growth rose in August too, along with construction; yet, perplexingly, confidence levels in the sector are now at their lowest for 18 months.

More Yo-Yos
It’s a similar story in the world’s largest economy too. The US housing market is displaying further signs of stabilisation following the release of data from the National Association of Realtors’ index showing pending homes sales rising 4.3% in August. As The Financial Times noted, it appears that the property sector is regaining some ground, albeit from a low level. Activity in US services also rose last month with the US Institute for Supply Management saying its index was up to 53.2 from 51.5. But the one number that finally swung it for investors was the US non-farm payrolls figure. Earlier in the week a poor set of US labour market figures caused the dollar and US Treasury bond yields to plumb fresh lows and gold to climb to a record high. According to ADP Employer Services, private payrolls fell by 39,000 in September and set the scene for Friday’s employment report which showed that, contrary to expectations, the economy shed 95,000 jobs. To put this in context, The Financial Times reckoned that, more than a year into recovery, the economy ought to be creating 300,000 to 400,000 jobs a month if unemployment is to fall from its current level of 9.6%. The paper also pointed out that the loss of 76,000 local government jobs speaks of further pain as the stimulus wears off. And it’s not just the unemployed who are likely to stifle increased consumption – America has another six million people working part-time because they cannot find a full-time job.

So the question being asked by most economists – and the White House which faces mid-term elections in November – is why America’s recovery is proving so fragile and tenuous. Well, according to a former chairman of the US Federal Reserve, Alan Greenspan, it is fear that is undermining recovery. Writing for The Financial Times he pointed out that fixed capital investment (by businesses) has fallen far short of the level that history suggests should have occurred given the surge in corporate profits. Combined with a collapse of long-term illiquid investments (property) by households, this has, in his view, frustrated economic recovery. Mr. Greenspan went on to say that these shortfalls in spending were the result of widespread private-sector anxiety over America’s future. This has led to businesses and households responding to the uncertainty by disengaging from those activities. The net result is that households are paying down debt and businesses are hoarding cash – by mid-2010 total liquid assets had risen to $1,800 billion, the highest share of total assets in half a century. Unsurprisingly, Mr. Greenspan concluded that the greatest unknown was how long it would be before lasting economic growth unfolded.

QE2 Launched
Not by shipping line Cunard, but by the US Federal Reserve and most likely the Bank of England too. As discussed above, the ongoing weakness of economic recovery and uncertainty will, in the eyes of the markets, almost certainly mean that America’s central bank will embark on a second round of quantitative easing (QE2 for short) – the so-called printing of virtual money in an effort to pump-prime the economy once more. Having already spent some half a trillion dollars buying bonds (thus keeping interest rates low), Ben Bernanke is being urged to do more – the Fed chairman left the door open to this policy in his most recent testimony to Congress. Economists at ING said they favoured an incremental version with an initial amount of around $250 billion, with the promise of more if needed. Here in the UK the CBI is calling on the BoE to do likewise by adding another £50bn to its existing QE programme of £200bn. Indeed, Chancellor George Osborne gave himself room for such a move by saying, “If it [the BoE] makes judgements, I would want to basically follow those judgements.” Speaking after a breakfast meeting of G20 member nations, Mr. Osborne also joined the chorus of ministers calling for “market-orientated” exchange rates, amid worries about a possible currency war as countries attempt to devalue their way to export growth.

The link from QE to currency manipulation is a natural follow-through according to economist Liam Halligan of Prosperity Capital Management. Writing in The Sunday Telegraph, he said that QE is now being seen as a policy designed to weaken a country’s domestic currency (by increasing the supply) in order to make exports more competitive and lessen the real value of sovereign debt (government bonds) held by creditors overseas. Since expectations by the markets of a second round of QE surfaced in recent weeks the US dollar has fallen significantly – sterling has risen to almost $1.60 for example – and should therefore help exports. However therein lies the rub. The race for cheaper currencies has just begun – Japan intervened last month in the currency markets for the first time in six years by spending some $15bn selling yen. China is determined not to lose its competitive edge though as any threat to its economic growth could have serious social implications for its government. So since China’s trading partners can’t get it to increase the value of its currency – it has been dropping in lock-step with the dollar – they have decided to reduce the value of their own currencies in a round of devaluations which could be harmful to the world economy. These international frictions have led the IMF to try and strike a deal but it has failed so far, despite US calls to deal with the issue more forcefully.

Sugar Rush
Against this backdrop financial markets have reacted fairly predictably – the dollar is down, gold is up and yields on quality government bonds are at rock bottom.

Over in the equity markets investors have already made up their minds that central governments will add a further stimulus. “This is now happening through quantitative easing in Japan and will almost certainly happen in the US and down the road also in the UK,” was the view of Danske Bank, clearly shared by many others. Last week global equities rallied smartly in anticipation of more cheap money with the Dow Jones Industrial index closing above the 11,000 mark for the first time since May. It was a similar story elsewhere with nearly all the major shares indices advancing steadily as investors bought up shares across the board. Some well-known investors are extolling the virtue of a ‘Bernanke put’ for the stock market – in other words any signs of further weakening will lead to more easing by the Fed thus protecting equities from the risk of losses – effectively an equity put. But as The Financial Times pointed out, whilst the signs are promising there is no guarantee that QE2 will work.

Solid Optimism
One fund manager whose glass is most definitely half-full is UK equity manager, John Innes of RWC and here he explains why.

“This is a most interesting time in the financial markets. Many participants are still very nervous following the credit crunch and the authorities’ extraordinary response, leaving some fearing deflation and others worried about roaring inflation and some that we will experience both at the same time! Previously I have been pretty gloomy about the UK economy. The situation is still not good but with one very important and positive change for UK companies. After 13 years the UK has an administration that is no longer taxing the private sector to expand a less productive public sector. This must be to the advantage of those investing in UK companies and hopefully will result in a stronger recovery in time.

The most obvious global trend currently is the shift in economic power from the developed to emerging economies. The current exuberance for developed economy [government] bonds does not seem to me the safest route at all for real wealth preservation in this environment, whereas selected equities do give you a genuine route to participate in the increase in global prosperity. So it should be no surprise that the portfolio is positioned for economic recovery and a positive market trend. The equity market is supported by both valuation and liquidity. The philosophy of the fund is supportive as many stocks in the cyclical and financial sectors are still regarded with suspicion and in an investment world where the current fears are dissipated then these stocks should perform well. The cyclical element of the fund is also heavily biased towards emerging economy growth but where share price valuations are low, for example, Xstrata, Cookson, Charter and GKN; but the fund remains cautious on exposure to the UK consumer. So overall I am positive: the UK market is cheap, liquidity is increasing, M&A activity is picking up and share buy-backs are becoming more common. The next few months are looked forward to with optimism.”

2010-09-28T21:45:00.000+01:00

In this week's bulletin:

Global markets hit five-month highs despite double-dip and eurozone fears. Gold reaches another record high.
Government announces planned tax clampdown on high earners in a bid to recoup more than £7 billion. At the same time, research reveals the UK has the largest pensions gap in Europe, confirming that we are not making the most of the tax advantages available.
Vince Cable slams the short-termist approach in UK boardrooms and evidence shows investors are falling into the same trap. John Wood of JO Hambro gives his views.
Stuart Mitchell of SW Mitchell gives his views on the outlook for Europe, where many companies are in very good health.
The focus on investing for income continues as corporate bonds and equities come under the spotlight.

Stealth rally
A range of conflicting signals contributed to another volatile week in global markets, with bonds, equities and gold all in demand. Global share prices climbed to five-month highs on Friday; gains which are all the more remarkable for coming against a backdrop of lingering fears about a double-dip recession and the health of the eurozone’s most indebted economies. Even as gold, a haven for anxious investors, hit record highs above $1,300 per troy ounce, the US S&P 500 index has risen by more than 9% in September and is on track for its third best monthly performance in a decade.

The week’s key event came in the US as the Federal Reserve signalled it was willing to sanction a further round of asset purchases, or quantitative easing, if economic growth failed to recover in coming months. After initially coming under pressure, US equities rallied strongly at the end of the week as doubts over the economy were soothed by encouraging data which showed that spending on durable goods rebounded in August and that the figure in July was better than previously reported.

The S&P 500 rose 1.8% over the week and the same US economic data lifted banks and energy stocks in the UK, leaving the FTSE 100 index up 1.6%, to register its fifth successive weekly advance. The minutes of the Bank of England’s last policy meeting, released after the Fed’s comments, were widely interpreted as an indication that further quantitative easing (or QE2, as it is becoming known) could also be seen in the UK.

Taxing times
In an attempt to recoup more than £7 billion in additional taxes over the next four years, Danny Alexander, Chief Secretary to the Treasury, last week announced a crackdown on tax avoidance, concentrating efforts on the finances of 150,000 people who are 50% taxpayers. Ministers warned that legal tax avoidance schemes as well as illegal tax evasion would be targeted, but critics argue that the politicians are blurring the lines – the former is merely planning your finances so you don’t pay more tax than you have to. The Sunday Times outlined possible targets for the taxman and those considered safe, for now.

Tighter rules are expected for non-residents and non-domiciles; property ‘flipping’ and stamp duty avoidance schemes are thought to be in the sights of the government, and HMRC may crack down on self-employed professionals who have set themselves up as limited companies to avoid National Insurance and income tax. Offshore bonds and tax-efficient investments such as VCTs and EISs were considered by the paper to be on the safe list.

The Sunday Telegraph also had advice on the subject, stressing the need to make use of all available allowances (especially between couples), check tax codes, plan ahead for ways to reduce inheritance tax and remember the basics such as maximising pension and ISA savings.

Against this backdrop, it was notable that The Times reported that the money held in equity ISAs has overtaken the funds held in their cash ISA equivalents for the first time since April 2000. Figures from HMRC confirmed that ISA investors had a total of £177.6 billion in equity ISAs at the beginning of the tax year, compared to £172.3 billion in cash. The numbers seemed to confirm that equities are back in favour with investors whose risk appetite is increasing in the search to improve on the derisory returns from money held on deposit. Latest Bank of England figures reveal the average cash ISA rate is currently 0.6% a year.

Worryingly though, The Financial Times reported news that there is a lot more UK individuals should and could be doing in terms of pension planning. Research by Aviva, with accountancy firm Deloitte, found that the UK has the largest ‘pensions gap’ per person in the whole of Europe. Each UK adult needs to save an average of an extra £10,300 a year to close the gap between the income needed to live comfortably and the actual income individuals can expect. The report covered those retiring between 2011 and 2051, which includes the thousands of baby boomers who start retiring over the next few years.

Stick or twist
The banks were again in the news and again in the sights of Vince Cable, the coalition Business Secretary, in his speech to the party conference in Liverpool. Amidst references to “the spivs and gamblers” and “casino bankers”, valid concerns were raised about the dangers of short-termism and the desire for quick results in UK boardrooms. The Sunday Telegraph picked up on this theme, pointing out that the blind pursuit of short-term performance is similarly pervasive in the world of investment. Figures show that the average holding period for a share on the London Stock Exchange has collapsed from around 7.5 years in 1966 to about 8 months today – a story repeated in the US market. The same issue afflicts investors in mutual funds – the average holding period in the 1950s was 16 years, perhaps four times as long as it is today. The article warned that such impatience runs the risk of bailing out of a winning investment which, with the benefit of hindsight, was simply going through a rough patch. Research shows that even the best fund manager should expect to experience a significant number of lean years. The final words to readers were to understand the randomness of investment returns in the short term and the importance of sticking to a long-term plan through the inevitable ups and downs.

This message was recently echoed by John Wood of JO Hambro. “The market in general has become very short-termist, giving rise to what I call ‘microwave management’ – if it doesn’t go ping after three minutes, take it out and try something else. This has created a great deal of sentiment momentum, but taking a long-term view means you have to see through these false signals and unsustainable trends. The current environment lends itself to ‘old school’ fund management with a focus on qualitative research and understanding of the company rather than being a slave to the numbers. Current valuations are very attractive and we are continuing to find streamlined companies with reduced levels of debt, in markets with growth potential. There is also scope for good dividend growth to boost total returns. A lot of the themes we are identifying are long term – anticipating a low growth environment over 3 or 4 years means we are not unduly concerned about double-dip fears. A couple of quarters of negative growth needn’t matter significantly given our long-term view.”

Eurovision
As questions remain over whether and what steps will be necessary to keep the UK and US economies on track, The Sunday Telegraph debated the merits of the European investment story, despite ongoing concerns in the eurozone. For much of the past decade Europe has outperformed other regions – since 2003 the Investment Management Association (IMA) Europe excluding UK sector average has risen by 80%, compared with a return of 60% from the UK All Companies sector and 22% from North America. Stuart Mitchell, of SW Mitchell Capital, who manages the European portfolios for St. James’s Place, recently gave his views on prospects for the region.

“We spend all of our time out on the road meeting companies and speaking to suppliers and people who sell the products of the companies we invest in. Business confidence has improved sharply since all the panic over Lehman and we’ve seen a sharp recovery in industrial production numbers, particularly in the northern part of Europe. The economic growth numbers in France, Germany and Holland are breathtaking – year on year they’re running at between 6% and 8%.

Your average European company is as strong now as it ever has been. You would expect companies to have a lot more debt than they do at this stage of the cycle, but they were much more reticent about taking on too much debt at the peak of the last cycle and in the last two or three years they’ve worked really hard to pay down debts and to improve profitability. Economic growth is recovering nicely and northern Europe doesn’t need austerity like Britain and America do. Northern Europe is very strong fiscally. Northern Europe didn’t lose discipline like the UK and America did with public and corporate debt. Europe is a completely different world to the profligacy of the Anglo-Saxon countries so we think the chance of a double dip is significantly less than what you might see in the UK and America. Looking forward, we believe growth in Europe is going to be quite a bit stronger than the consensus expects.

We’re reasonable relaxed, or much more relaxed than most others, about what’s been happening in Greece, which needs to be put in context. Greece is a tiny economy. It’s 1% or 2% of European GDP and the Greek debt in total is only €300 billion – comparable to a large corporate. The debt really is extremely limited within the wider European context. We think it’s very unlikely that the anxiety panic will spread into the other weaker eurozone countries, particularly the more important ones – Spain and Italy.”

Investing for income
The merits of diversification were again underlined as the press continued the focus on income investing. The Daily Telegraph reflected on the outlook for corporate bonds, in particular investment-grade, and fears of a ‘bond bubble’ as yields are dragged lower by declining government bond yields. Paul Read, the co-head of fixed interest at Invesco Perpetual, which also manages funds for St. James’s Place, argued that bonds were still a good source of long-term income, but were not as cheap as last year – “ a market in which you could get equity-like returns from fixed income.” He went on to say, “There are not that many good sources of relatively safe income available, so I think that corporate bond funds remain a core asset class and should be a very important part of portfolios.”

The Financial Times highlighted the attractions of equity income funds and the scope for attractive dividend yields from both UK and overseas companies. According to Capita Registrars, UK cyclical companies have significantly improved their dividend payouts in the first half of the year compared to 2009. Valuations of more defensive, yet profitable large-cap companies also offer very attractive yields and remain the focus for many income-seeking managers – AstraZeneca yields 5%, Vodafone 6.7%, GlaxoSmithKline is on 5.5% and British American Tobacco currently yields 5.1%.

2010-09-13T17:06:00.000+01:00

In this week's bulletin:

Globally equity markets shook off uncertainty and generally advanced with the UK FTSE 100 achieving levels not seen for over four months
As expected Bank of England Monetary Policy Committee maintained interest rates and quantitative easing at current levels
Spectacular crash of Connaught, the building and support services firm, provided a stark reminder of the harshness of the current environment
The debate between those favouring further easing and those seeking austerity continued as President Obama proposed further subsidies
The Sunday Times reported investors in structured products were not receiving the returns expected

Markets shake off uncertainty
Last week saw a general rise in global markets, with the UK FTSE 100 achieving levels not seen for over four months. However, the overall gains masked continuing uncertainties, as financials and energy stocks ‘see-sawed’ throughout the week. Whilst the Bank of England Monetary Policy Committee’s decision to maintain interest rates and quantitative easing at current levels was widely expected, the rapid and spectacular crash of Connaught, the building and support services firm, provided a stark reminder of the harshness of the current environment.

Connaught went from a stock market value of £626m to bust in just three and a half months. A lack of clarity around the company’s reporting and true financial situation compounded by their reliance on local council spending, which is expected to be severely limited by governmental austerity measures, led to a run by creditors, finally resulting in Connaught running out of cash. None of the St. James’s Place funds had holdings in the company.

In the financials arena, the announcement of Bob Diamond as the new chief executive of Barclays Group prompted mixed reaction, somewhat surprisingly given his track record. This is a man who has been responsible for the development of Barclays Capital into a global financial colossus in just 13 years. His track record alone should have dispelled any fears. However, as an investment banker, he is regarded with suspicion by some shareholders and investors, who suspect his entrepreneurialism will lead to increased risk taking and greater potential for catastrophe. In the current environment of increased corporate governance and governmental regulation, it is unlikely that Barclays will be led to meltdown by an optimistic doer who has experience of building a global brand.

Cutters vs. Spenders
With the back drop of governmental austerity measures being indirectly linked to the Connaught decline the argument between the ‘cutters’ and ‘spenders’ continues, as reported by The Financial Times, both in the UK and in the US.

The argument against austerity measures has been recently joined by Ed Balls, Labour Party leader nominee. He argues that, with a credible economic alternative to the expected measures, the aggressive cuts could be avoided and the rug not pulled from under the fledgling recovery. Balls went as far as to suggest that the Government’s approach to spending is “economically misguided and dangerous”. However, what this fails to recognise is that the Coalition inherited a policy of fiscal tightening which they have simply accelerated in order to complete it, so that it does not spill into a new parliament. The short term aim was to reassure markets and regain fiscal credibility for the UK. The current low gilt yields would seem to reflect, at least in part, the confidence instilled by the announced measures, although the spenders will say that they indicate no crisis in the public finances.

In the US, it would seem that President Obama and his regime fall squarely into the camp of ‘spenders’. His new proposals, which include $50bn of extra spending on infrastructure, expanded tax credits and relaxed rules on corporate investment write-offs, would all seem to offer boosts to corporate U.S.A. However, it is highly likely they will be rejected or diluted. The current US stimulus package sits at $1 trillion and seems to have been largely ineffective, so what will an extra £50bn achieve? Whilst tax incentives may seem attractive, it is highly likely they will be replaced by other taxes. Many see the proposals as purely electioneering to try and stave off the march of Republican candidates in the mid-term elections in 50 days’ time.

The Federal Reserve Board’s business survey’s noted “widespread signs of deceleration (in growth) compared with preceding periods” are currently offset by increased consumer spending activity and a reduced trade gap. However, consumer and trading confidence may take a knock if government policy is further clouded by political infighting.

What cannot be denied is that the banks continue to hoard funds. Unless the financial institutions begin to lend more widely at reasonable terms, any further easing will simply improve the balance sheets of many banks.

End of Year Stock market predictions encourage
Encouragingly, The Sunday Times reported that City analysts are predicting a 10% share price rally by the end of the year. Although UBS downgraded their FTSE 100 forecast for the year end from 6250, they still targeted 6,000. This aligned with Citigroup, whilst Morgan Stanley upgraded forecasts from a rather pessimistic 5,000 to 5,800.

Expectation will be buoyed by improving US trade deficit data and a reducing number of unemployment benefit claimants in both the UK and US. At the same time, the Organisation for Economic Co-operation and Development (OECD) said Britain would be the fastest-growing economy in the G7 group of industrialised nations in the third quarter of this year.

Recent profit reports from a large number of big businesses have also boosted confidence. However, it cannot be ignored that a large proportion of these profits have come from cost cutting and streamlining in flat markets.

So which areas might lead the charge? Two possible opportunities highlighted, which are pursued by a number of managers of St. James’s Place funds, were banks and companies from developed economies with exposure to emerging markets.

Lloyds Banking Group led the FTSE rally last week after several analysts updated their outlook for the stock, noting a number of UK domestic banks still offer long term value.

With the wealth of conflicting comment, policy and data we asked Mark Lyttleton, co-manager of the St. James’s Place UK Absolute Return funds, which can take advantage of both falling and rising share prices, to comment. “Equity markets globally were weak last month as investors continued to wrestle with the fragility of the economic recovery, particularly in the United States. In our mind, the data is inconclusive. On the one hand, it is perfectly consistent with historic precedents that the rate of expansion should slow in the second year of recovery. On the other, the removal of stimulus and the need to reduce excess leverage understandably raises questions as to what the new normalised level of aggregate demand really is.

A good illustration of the uncertainty surrounding the economic outlook is US employment data. In August, private employment grew by only 71,000 and the previous month’s report was revised sharply lower, but the workweek continued to expand and hourly earnings also rose. On balance, we believe the evidence points to a mid-cycle slowdown rather than a prelude to a double-dip recession and are comforted by the vigilance of financial authorities globally. One particular illustration is the Federal Reserve’s announcement that principal payments from its agency and Mortgage Backed Securities holdings would be reinvested into longer-term Treasuries in a move designed to bolster growth and prevent the US economy from lapsing into recession.

Within the fund, we modestly reduced the net exposure (the value of our long positions less the value of our short positions) of the Fund over the month but our gross exposure (the combination of our long and short positions) remains high, reflecting the conviction we have in a number of different stock positions. We remain positively exposed towards the beneficiaries of increasing corporate discretionary expenditure and further healing of funding markets, but are more cautious on areas of the economy that remain over leveraged”.

Considering alternative investments
With the uncertainty felt by many and the average easy-access account paying “a measly 0.77%” (The Sunday Telegraph – source: Moneyfacts), The Sunday Times considered alternative investments.

They reported that thousands of savers who invested in products claiming to offer stock market returns without risks are finding that they are maturing and paying little more, or even less, than they would have got from cash on deposit.

Protected or structured products, which accounted for £13.9bn in investment in 2009, have been maturing this summer and many are only repaying the original capital invested. 5 year plans maturing this year have seen no stockmarket growth versus a rise in the retail prices index of 16.6% in the same period (July 2005 to July 2010). Concerns were also raised over the ability to exit early if conditions were unfavourable and the penalties for doing so. Shorter term products also came in for criticism.

The Sunday Times also carried an extensive article on the rush by many fund managers to launch bond funds, focussing on those offering a higher income or yield. Yields on traditional bond funds have been falling as institutional and private investors have moved into this area, as evidenced by the Investment Management Association’s data indicating the fixed income sector was the best selling in July.

It was interesting to note that whilst the article outlined high yield bonds, and funds investing into them, which offer higher potential returns but with bigger risks, no mention was made of Senior Secured Debt (SSD). These bonds seek to offer an alternative route to recovery if the company cannot maintain their interest payments to investors or repay the loan. The investor can call upon tangible assets such as property, machinery or even intellectual property rights in lieu of the debt. In this way the investor may recoup a greater proportion of their investment in the event of a default.

2010-09-06T23:15:00.000+01:00

In this week's bulletin:

Global equities record their first weekly gain since the start of August
BHP Billiton continues its pursuit of PotashCorp
There are many views on where we are economically, but The Sunday Times encourages a look at the bigger picture
Thursday sees the Bank of England make the latest decision on base rates
John Innes gives his views on the outlook for UK equities

Equities march on
Global equities recorded their first weekly gains since the start of August as US economic data countered fears of a double-dip recession. The Independent reported that the US employment data for August revealed that private sector jobs increased by 67,000, far exceeding the forecast of 41,000.

The Times reported Barack Obama’s reaction to be, “That’s positive news and it reflects the steps we have taken to break the back of this recession.” The jobs report, on top of better-than-expected data from China on Wednesday, sparked the biggest one-day rally in equity markets in two months. Across the globe, stock markets saw a significant rebound from the falls of the last three months. In the UK, the FTSE 100 closed the week 4.3% higher than the level at which it began, while in the eurozone, European stocks gained 3.6%. A host of merger and acquisition speculation globally added to economic optimism, with US markets closing with gains of 3.2%, with financial and industrial stocks especially boosted.

BHP v PotashCorp
One of the largest hostile takeovers around the world today is BHP Billiton’s bid for Canada’s PotashCorp. Potash, derived from mineral deposits, is used almost exclusively as a fertilizer and the demand for food is set to keep demand high for years as the global population continues to increase. BHP felt that the company was significantly undervalued. But as The Mail on Sunday pointed out, by turning the spotlight on the company it is trying to take over, BHP has ensured that it is no longer undervalued to the same extent that it was previously. The result of this may be that BHP finds it very difficult to succeed in its bid for control. The paper speculated that PotashCorp could have been permanently revalued for a number of reasons. China consumes about three million tonnes of potash per year, a figure that will only rise, while the Russian wheat export ban will only serve as a reminder of the value of potash.

BHP shares rose last week to close at 1936p, which has caused speculation that the market does not expect the company to succeed and therefore spend any cash. The mining company has offered $130 per share, but after they had alerted investors to the value of PotashCorp and its role in the global economic picture, the stock closed the week at $149 per share, an all-time high. China is the world’s largest consumer of commodities and The Times reported on the potential for the country launching a bid of its own to derail the BHP plans. However, opinion is still divided over whether a rival bid would come from state-owned Sinochem, or from a consortium behind a Chinese sovereign wealth fund. The Financial Times was of the opinion that the Chinese government was actively backing a counterbid in an attempt to secure global resources. Mining analysts were of the opinion that the size of BHP’s $39bn opening offer was always going to be the largest stumbling block, because very few private companies can match that sort of financial strength. However, Chinese government-owned companies have access to a far deeper pool of funds, either through soft loans by state banks or via access to sovereign wealth funds.

The bigger picture
Depending on who you listen to, or which papers you read, the US economy is either booming or collapsing, and Britain has either the best prospects for economic growth in Europe or is about to sink into recession. It is almost no wonder that global stock markets have seen increased volatility over the past three months. However, The Sunday Times encouraged its readers to look at the bigger picture. The International Monetary Fund expects global growth of 4.6% this year and 4.3% in 2011. These figures are heavily weighted towards emerging economies such as China and India at around 6.5%, but growth is still there in most parts, with the US and Britain at around 2.5%. Even Europe, the area perceived as having the most short-term problems, has had its predicted growth rate raised to 1.6% for this year. The paper pointed out that recovery has never gone in straight lines. There will be months when data will seem weak, and there will be months when it is strong, while pockets of extreme weakness will always exist, much like the American housing market currently.

The article also asked why businesses are so keen to downplay economic recovery. The first reason they cited was that chief executives in statements rarely shout from the rooftops about the state of the economy, for fear that they undermine their own efforts. Secondly, and more importantly, businesses think of recovery in different terms than economists. For companies, it is not about when the economy lifts off the bottom, but when order books and trading activity gets back to normal. Only when this happens will chief executives start to acknowledge a real economic recovery, which could realistically take a further two years or more.

The paper opined that a real recovery indicator was that thoughts are already turning to rising interest rates. One member of the Bank of England’s Monetary Policy Committee, Andrew Sentance, has already voted for a rise in each of the last three months. While it is expected that interest rates will remain at 0.5% this week, and indeed for months to come, the fact that discussions have begun on an exit strategy is a significant “straw in the wind”. Whilst such a decision would mean the 18th consecutive month without change, the Governor, Mervyn King, has repeatedly stated he would feel more comfortable with base rates at normal levels. The Sunday Telegraph opined that while the general consensus is that 0.5% will be the base rate for the foreseeable future, when they do start to rise they will do so quickly. Sir John Gieve, the former Bank of England deputy governor, said last week he expected rates to rise at a quicker pace, stating, “I am expecting a recovery, and when that is strongly established, rates will rise quicker than the market expects. I wouldn’t be surprised to see rates at 2.5% a year from now.”

Outlook for equities
The Financial Times discussed how equities are currently viewed by investors looking for long-term solutions for their money. Price to earnings ratios are two and a half times cheaper than they were 10 years ago, dividend yields are higher than 10-year Gilt yields, which rarely happens, but investors are still in some cases wary of equity investment. As the paper pointed out, global equities have only returned 4% total in sterling terms, while government bonds have delivered 103% over the same ten-year period. During this time, investors have had to cope with two savage bear markets. Also, in a world where Japanese-style deflation is seen as a significant threat, bonds are often seen as a more attractive investment. However, the article stressed that investors shouldn’t give up on equity investment. Half of FTSE 350 companies currently yield more than 10-year government bonds, and in a low-inflation environment, that will always look attractive. Also, large corporations are buying assets in the equity market and borrowing cheaply on the bond market, which will push prices higher the more it happens.

This week, research from Reuters showed that August marked the first time in five months that investors have increased their holdings in equities. As reported in The Times, most fund managers now seem to think a double-dip recession can be avoided, though the primary reason for equity investment could well be that real returns in cash are virtually nothing, as savers are all too painfully aware, while Gilt yields are being pushed lower due to the necessity of further issuance by the government.

John Innes of RWC Partners recently commented on his outlook for UK equities in particular. “The latest market rally was on much thinner volumes than during the falls in the early summer. For the technical analyst, the market is therefore still troubled after the breakdown. For the fundamental analyst, however, the bear stories are being knocked over one-by-one. The global economy has not melted down into a 1930's depression, nor has inflation taken off despite all the quantitative easing. The ‘climate of fear’ was re-created with a credit market-inspired attack on the Euro and Sovereign Debts, but this has been countered by the huge €750 billion support package agreed in May. The new UK coalition government has also avoided any sterling crisis by a new-found emphasis on deficit reduction. Corporate results have generally been much better than expected, including the banking sector, and the threatened regulatory strait-jacket has been considerably loosened. Corporate M&A activity has also materially picked up, suggesting an increase in corporate confidence and bank willingness to support soundly financed deals. Other than the normal worries over global terrorism, Iran etc. there remain two major economic concerns. The most obvious is the current "soft patch" in the US economy and in particular the lack of rapid improvement in the jobs market.

The other concern is whether the planned slowdown in China develops into something more severe. The fund is still positioned with a more optimistic view of the equity market and the global economy so the portfolio remains invested to benefit from a cyclical improvement in economic activity from a very low level and from a continued reduction in stress in the financial markets. We remain fully invested in recognition of the overall cheapness in the equity markets, both on an absolute basis and especially relative to government bonds and cash.”

2010-08-23T22:45:00.001+01:00

In this week’s bulletin:

Global equity markets received a welcome boost from resurgent Merger & Acquisition activity last week with BHP Billiton’s $39bn for PotashCorp of Canada. Although rejected, investors expect rival bids to emerge
The relentless rise in demand for both soft commodities as well as oil and metals reflects increased demand amongst the growing middle class in emerging markets but is pushing up inflation in the West. It is also leading to potential shortages as East Asian countries seek to build reserves
Another outcome has been to fuel investor demand for products to capture these opportunities – Emerging Market funds (and our own Alternative Assets Fund) can be part of this strategy
But poor economic data from the US and Japan weighed on sentiment resulting in equities drifting as investors opted for the safe haven of government bonds where yields continued to fall
Contrarian fund manager Andrew Green of GAM, shares his thoughts on the economic outlook and explains why he continues to favour Japan

Food for Thought
Global stock markets were given a much needed boost last week as news emerged of a hostile bid for Canada-based PotashCorp, the world’s largest listed fertilizer producer, by BHP Billiton, the world’s largest and most cash-rich mining company. However, BHP’s $39 billion offer was dismissed by PotashCorp as “grossly inadequate”, thus setting the stage for a takeover battle which is likely to include China’s Sinochem. In the interim, shareholders of Potash saw the price of their shares jump some 27% on the news, above the BHP offer, suggesting investors see a higher offer. BHP is making a big bet that agricultural fertilizer ingredients – including potash, nitrogen and phosphate – will rise in price as the developing world requires more meat and plants, according to The Financial Times. World potash consumption is growing again after falling during 2008–09 but at c$300 per tonne, the price is well below the $1,000 per tonne seen in early 2008.

As the world’s developing economies grow, so too do standards of living as the growing middle classes eat more meat, which puts pressure on crops as the volume required to feed a cow is far greater than the amount needed for crop production related to human consumption. Greater demand, along with poor grain harvests in Russia, has pushed up prices: wheat is up 50% from a year ago and corn up 30% and this feeds through into food inflation. Last week, inflation in the eurozone accelerated to its quickest pace for 20 months, triggered by higher food and energy costs – consumer prices rose at an annual rate of 1.7%. However that compares favourably to Britain where the latest figures show that the UK has one of the highest inflation rates in Europe – whilst the Consumer Price Index fell to 3.1% last week, it is still significantly above the BoE’s 2% target.

And the issue of increased future demand for food staples means governments are adopting new strategies. According to The Times, more than a dozen countries across East Asia are preparing to create a massive emergency rice reserve to protect the region’s two billion people from environmental disaster and runaway inflation. Russia has already imposed a temporary ban on wheat exports. Against this backdrop investors are seeking out ways to capture this opportunity so it was no surprise that UK supermarket groups like J Sainsbury are benefitting from the food inflation story. More globally, the demand for soft and hard commodities is very much down to the growth of the emerging markets and, according to The Sunday Telegraph’s experts, owning emerging market funds is a good way to participate in this opportunity.

M&A Mania?
BHP’s bid for PotashCorp also threw the spotlight on other merger & acquisition activity – both real and rumoured. The Sunday Times attributed the recent increase in activity to John Maynard Keynes’ so-called ‘animal spirits’, which he used to describe how emotion and confidence play a major part in shaping the economy. The paper opined that following the Great Recession, corporate leaders are once again putting their heads above the parapets and reviewing their strategies: they are also cash-rich, with many companies coming out of the downturn stronger than they went in following aggressive cost-cutting and balance sheet rebuilding.

In recent weeks there have been a number of bids announced. HSBC is close to a £7bn takeover of Nedbank of South Africa, Intel is buying MacAfee, Rank has just paid $5bn for Pactiv and here in the UK, Royal & Sun Alliance has offered £5bn for part of its rival, Aviva. And there’s more too. Shareholders in Cairn Oil are set to receive a cash payment after Cairn India sold a controlling stake to Vendanta Resources, whilst Korea’s state oil company has gone hostile with a bid for North Sea oil explorer Dana. Add to the shopping list a possible bid for BG (the former British Gas) by Shell, the possibility of Campbell Soup swallowing part of United Biscuits and it’s all washed down with a bid for Fosters by brewing giant SAB Miller. So whilst the economic backdrop may have faltered temporarily the slack has been taken up by renewed excitement in the boardrooms of some of the world’s most respected corporations, which is good news for the equity markets.

Setting Sun
Investors took flight from equities back into government bonds last week as worries about the health of the US and Japanese economies resurfaced. Japan recently ceded its position as the world’s second largest economy to China based on GDP, but its contribution to global growth remains significant so news that its economy had grown by a mere 0.4% last quarter – down from 4.4% – sent investors scurrying. With output shrinking so dramatically credence has been given to the possibility of a double-dip recession and so once again the yen – perhaps perversely – continued its seemingly inexorable rise, hurting its exporters. Against this backdrop the Japanese government has intensified pressure on the Bank of Japan to try to halt the rise of the yen which threatens to derail economic recovery. “The cause [of the yen’s rise] is the difference in approach between the US Federal Reserve and the Bank of Japan,” said Japan’s minister Koichiro Genba. The US Fed announced more easing measures last week whilst the BoJ has made no changes to its monetary policy.

But the recent move by the Fed appeared to have back-fired in the short term with financial markets unnerved following a string of poor economic data – the latest being an unexpected rise in US jobless claims on Friday. A senior Federal Reserve official said last week that the negative reaction to the central bank’s move towards an easier monetary policy was “unwarranted” because the US economy was not in worse shape than investors thought before the decision. Either way, investors were unimpressed and maintained their preference for US, Japanese and German government bonds, the yields of which all touched major lows – record lows in the case of 10-year German Bunds – as prices rose to reflect increased demand. This left the equity markets to drift once more and seemingly following a pattern of rising early in the week only to fall back again. Most markets succumbed with indices falling around 1% despite the tonic of a spurt of M&A activity.

But it wasn’t all bad news. Global trade has recovered to 2008 levels, according to one of the world’s largest port operators DP World and Danish shipping operator Maersk, with both companies reporting improved earnings. As testimony to this UK manufacturers are planning their greatest hiring push for more than a decade, according to Bank of England research. The feedback from the BoE’s regional agents showed that there were widespread reports of businesses looking to export into new markets amid soggy demand in the eurozone. Elsewhere in the UK economy, retail sales continued to be buoyed by the warmer weather but, conversely, clouds are continuing to build in the property market with vendors cutting prices in order to sell their properties. According to Rightmove, the property website, there was a rush of new sellers in July but with a dearth of new buyers, prices were being cut.

A Contrarian View
Fund manager Andrew Green of GAM is well-known for his deeply contrarian approach to investment – preferring to avoid investment fashions and instead seek out low-valued companies that are deeply disliked by the markets but which are fundamentally good businesses looking for a recovery catalyst. The last ten years have not been particularly kind to equity investors but Andrew has a proven track record of out-performance over the longer term. He recently shared his views on the markets and how these affect his portfolio strategy.

“Current economic data is still mixed and suggests that recovery in developed economies remains weak and potentially at risk. How authorities in these areas respond to this, given their fiscal constraints and current monetary policy settings, remains a significant question for investors. With the risk of a policy mistake as high as it has ever been, sentiment is likely to remain nervous and markets febrile so the main challenge has been to keep out of trouble as equity markets whiplash to and fro.

With this in mind we raised the portfolio’s allocation to cash at the end of the second quarter – back up to around 18% – although the overall strategic positioning of the fund remained otherwise unchanged. The cash allocation weighed on the portfolio’s performance as the market rose in July, though its impact was partly offset by gains in our banks and insurance holdings. In particular, portfolio performance benefited from an announced bid for long-term holding SSL during the month – it was a good solution to realizing a 300% profit – and I have also taken gains of 160% from Spirent. In the US the pharmaceutical stocks have done well along with Sara Lee and El Paso. In the UK, banking stocks have done well and in the long term they will continue to recover as they remain a crucial component to financial stability and economic recovery.

Although Japan has significantly under-performed global markets my conviction that it is entering a period of out-performance remains robust – it has become totally loathed by investors which for me, as a contrarian, is positive and I am comfortable maintaining my 23% exposure to this area. Japanese bond yields are back to their lows of 2003 and with companies having so much cash on balance sheet it really only needs for the government to tilt the tax system in favour of payment of dividends for a renaissance in investor interest to begin. The strength of the yen is problematical and likely to be reversed so within the portfolio the exposure has been reduced via hedging. Our holdings have performed relatively well – they have beaten the Japanese market in each of the last five years – and I continue to concentrate on the IT, telecom and banking sectors.

Overall I am gradually moving away from small and medium cap stocks into larger companies where I see greater safety in the near term. People are obsessed with Emerging Markets and whilst undeniably we are seeing the West cede power to the East, it is a long-term story and in the short term those markets are very expensive in my view. So whilst I am very positive in terms of new ideas, the earnings outlook remains opaque and I anticipate using the elevated cash levels in the portfolio to take advantage of opportunities presented over the medium term by ongoing volatility in the equity markets.”

2010-08-17T09:56:00.000+01:00

In this week's bulletin:

Economic data showed a two speed recovery in the eurozone with the German economy racing ahead of its rivals at the fastest rate for two decades – demand for its cars boosted exports.
US Federal Reserve Chairman, Ben Bernanke, was forced to announce a change in policy following recent poor US economic data: the Fed will give a monetary boost by re-investing its maturing mortgage-backed securities into government bonds, thus keeping interest rates low.
In the UK the BoE reduced its growth forecast for the next two years but still sees the economy growing around 2.7% pa – much in line with longer-term trends.
Stock markets suffered a two way pull but finally succumbed as investors decided to head for less-riskier investment such as the dollar, government bonds and yen.
Standard Life’s investment chief Keith Skeoch believes now is the time to buy UK equities seeing the FTSE100 index hitting 6,000 by year end.
Despite their excellent run there is still value and merit for investors in owning corporate bonds within their portfolios according to fund manager Paul Read of Invesco Perpetual.

Vorsprung durch Technik

It was a week of mixed fortunes for the global economy and financial markets last week. Topping the bill though was Germany, following the release of economic data which showed that the country’s economy had grown by 2.2% during the second quarter – the fastest pace for two decades – boosted by exports. As The Financial Times pointed out, German manufacturing success has enabled the country to return to pre-crisis levels for exports of goods, with renewed demand for German cars and machine tools, particularly in Asia, leading to a surge in output. For the euro-bloc as a whole, growth was a respectable 1% during the quarter, equivalent to 4% annualised and nearly three times the rate recorded since the euro was created in 1999.

Yet beneath the headline rate, the familiar theme of a two-speed Europe is apparent: Germany represents the healthy ‘core’ whilst much of the troubled southern periphery continues to stumble along. Greece, for example, sank deeper into recession – the economy contracted 1.5% in the second quarter with a fall in investment and a significant reduction in public consumption contributing to the decline in GDP. Unemployment has also shot up to 12.5%, reflecting worsening conditions for the real economy, which, although awful, is still not as bad as in Spain where the rate is 20%. “It’s the same old story: Germany in a league of its own, carrying a few of its neighbours along and beneath that, the laggards that are teetering on the brink of recession,” said Carsten Brzeski of ING.

The mixed economic data did little to assuage concerns in the money markets, which saw German benchmark market interest rates fall to record lows as investors opted for quality – fleeing from bonds issued by the peripheral states. The net result was that the spreads between German bunds and Greek, Portuguese, Irish, Italian and Spanish debt all rose sharply which, analysts say, illustrates the on-going problems. Ireland came into focus with fresh concerns about its banking sector and market rumours of the ECB intervening to buy Irish bonds – The Financial Times noted that there has been a near doubling in interest rates paid by Ireland compared with three weeks ago.

Fed Gives Economy another Fix

Worries about a possible ‘double dip’ for the US economy – although considered highly unlikely – led the US Federal Reserve to give its frail patient another monetary shot in the arm. Fed Chairman Ben Bernanke said last week that economic growth was likely to be “more modest in the near term than had been anticipated”, as evidence showed that the US recovery had slowed, household spending was constrained and bank lending was contracting. As a result, the Fed decided to make a shift in its economic stimulus programme, saying it would re-invest money from its portfolio of maturing mortgage bonds (bought as part of its policy to prop up the housing market) into longer-term government debt. The effect of this change will mean that, instead of a small amount of monetary tightening, the reinvestment of its MBS bonds will keep interest rates low and cause a small but meaningful shift towards monetary easing.

It was only last month that Mr. Bernanke told Congress that he was not planning specific new measures to support the economy, but the recent raft of poor economic data appears to have forced the Fed’s hand. As The Times said, almost two years of near-zero interest rates, a $1.2 trillion expansion of the Fed’s balance sheet and a near $800 billion government stimulus package have yet to generate a sustainable recovery in economic growth. Not that it’s all bad news though: American economist Irwin Stelzer opined that most economists do not believe the US will drop into double-dip territory. Corporate earnings are at the record highs reached before the downturn and they have $2 trillion of cash that they will soon have to spend. Business spending on equipment and software is increasing at an inflation-adjusted rate of more than 20% – the most rapid since the late 1990s. And if necessary, the Fed can resume money creation, known as ‘quantitative easing’. Stelzer finished by saying that a “longer-than-one-week look” shows that jobs are being created in the private sector, share prices are up, profits are ample and businesses have started to reinvest.

King Cuts Forecast

Last week the Bank of England cut its forecast for UK output over the next two years, warning that constrained bank lending and questions about recovery in the economies of Britain’s main trading partners posed risks to growth. At the same time, the BoE raised its forecast for inflation over the same period, saying prices are likely to rise faster than its 2% target. However, bank governor Mervyn King also said that it was unlikely to toughen monetary policy – a euphemism for raising interest rates – in response because it believes temporary factors are behind the current inflation blip. The BoE now expects the UK economy to grow at an average of 2.7% – much in line with longer-term trends – rather than the 3.4% it originally thought, and more in line with recent data showing the UK economy has grown around 1.7% so far this year.

Much like in the US, recent economic data for the UK has been mixed to good, but with some signs that the rate of growth is slowing. Last month, growth in retail sales slowed to 2.6%, down from 3.4%, as consumers became more cautious ahead of likely job cuts. “The overriding factor is consumer confidence – it’s fallen recently, though people are still more confident than this time last year,” said the British Retail Consortium’s director general. The Financial Times took a slide rule over some of the latest data and came to the conclusion that there are still some silver linings to be found – even if the news is a little gloomier than a few months ago. The number of people at work surged in the three months to the end of June, although this is likely to slow as the public sector begins to cut jobs. In the car market there is still growth in the high-end of the market, although fleet sales have fallen recently. The paper concluded that recovery is likely to be long and slow.

Investors Vacillate

Global investors started the week in good mood, but were quickly forced onto the back foot after being hit with a triple whammy: Ben Bernanke’s less optimistic prognosis on the US economy, the largest US trade deficit in 21 months and disappointing import figures from China. The trade deficit jumped $7bn to $49.9bn in June as a result of falling exports, whilst in China, data from Beijing showed that industrial production growth slowed marginally to 13.4% (from 13.7%) last month. In response to the news investors took shelter in the perceived safety of government bonds, the US dollar and the yen. Japan’s stubbornly strong currency rose to a 15-month high against the US$ – pummelling shares of the country’s largest exporters and approaching a level where some analysts believe the government will be forced to intervene.

The relentless rise of the yen has sparked new fears for the country’s economy, but many think that the Bank of Japan is unlikely to take any meaningful action – partly because of disastrous forays in the past and also so as to remain on good terms with the US, according to The Times. Washington has made no secret of its irritation with China’s manipulation of its currency and the perceived unfair advantage it gives the country’s manufacturers and the threat to US jobs. So, as the global economic tides eddied, investors decided to adopt a ‘risk-off’ mode in the short term, preferring to wait and watch developments. By the end of the week most equity markets had given ground, with Wall Street leading the way; although in London falls were more modest with the FTSE 100 slipping around 1% by close of business on Friday.

Buy, Bye

For the most part, shares have remained pretty flat over recent months, reflecting investor uncertainty about whether it’s a good time to buy equities or, for some, time to sell. So, many stock markets have been subject to a two-way pull: buoyed by good corporate news to only then be disappointed by worse-than-expected economic news. So where does this leave private investors? Well, for the chief executive of Standard Life, Keith Skeoch, now is definitely the time to buy, believing that the FTSE 100 will defy volatility in the global financial markets by “reaching the 6,000 point barrier” by the end of the year. The index closed at 5275 on Friday. “If you look at [government] bond prices across the world, then we think the markets have already priced-in slow growth – verging on a double-dip recession – but not deflation,” commented Mr. Skeoch.

The Sunday Times agreed, saying British shares are at their cheapest for 50 years relative to government bonds. Barclays Capital, the investment bank, analysed over 100 years of data and found that currently dividend yields are trading at a premium to gilt yields – a very rare event and, using monthly data (as opposed to annual data), the first time since 1958. Shares have historically yielded less than gilts on the basis that they offer greater capital growth prospects. And it’s not just British shares that are cheap. Dennis Jose of Barclays Capital said, “European equities are trading at multi-decade valuation lows relative to cash, government bonds, investment grade and high yield [corporate] bonds and US equities. Taking the price-earnings ratio, for example, European equities are currently trading at a 36% discount relative to the 27-year average.”

But equities are just one option for investors and diversification is fundamental to any investment strategy, so what other choices are there for investors? Corporate bonds – IOUs issued by companies – have been very popular with investors seeking higher levels of income and in recent times they have also delivered capital growth. But having enjoyed a good run, what now, asked The Times. Paul Read, a respected bond manager at Invesco Perpetual, believes corporate bonds still have a role to play in many investors’ portfolios. “Corporate bonds are there to provide a good long-term source of income in a period when significant parts of the income people had depended on has gone. We have lost the BP dividend, we have lost many bank dividends, gilt yields are low and the interest rate on your bank account is low. There are not many good sources of relatively safe income available, so I think that corporate bonds should be a very important part of people’s portfolios.”

2010-08-09T21:43:00.000+01:00

In this week’s Bulletin:

The five largest banking institutions in the UK report half-year profits
Equity markets closed the week ahead, despite disappointing US economic data
The strong pound hits London properties
Analysts predict a gloomy inflation report from The Bank of England
Bernie Horn, of Polaris Capital Management, gives his views on the long-term opportunities in equity markets

Banking profits on the rise
Taking the high-profile headlines were the biggest UK banks, as the robustness of the British banking industry was highlighted in a week where the five largest UK institutions reported half-year pre-tax profits of £15 billion. As reported in The Financial Times, the revival in fortunes was in stark contrast to 12 months ago, when the sector was reeling from billions of pounds of impaired loans and uncertainty over the extent of the government bail-outs. While the government is highly unlikely to start selling down its stakes until next year, even though the share prices are above the levels that the government paid for its stake, the recovery of Lloyds and RBS is a positive signal that taxpayers will eventually claw back a return from their £62 billion investments in the two banks. UBS calculate that between 2012 and 2014, Lloyds could pay out £15 billion in dividends while still retaining £30 billion more capital than it needs to meet regulatory requirements.

RBS, which is around 80% state-owned, revealed a first half net profit for the first time in three years, with profits of £9 billion compared to a loss 12 months ago of £1 billion, as bad debts fell and margins rose in its retail and commercial operations. But have things actually improved and is this good news for the general public? Certainly not as far as The Mail On Sunday is concerned, as the paper pointed out that in the past year, not much has changed. Using somewhat emotional language, the paper opined that savings rates are “excruciatingly low” and the banks are making bigger margins at the expense of their borrowers, treating their customers as “exploitable fodder”. In rather less emotive terms, The Sunday Times also stated that it is borrowers that are paying for bank profits, with margins for three and five year fixed-rate mortgages rising significantly over the 12 month period. The margins measured show the difference between the rate the banks charge the borrower, and the cost to the bank of securing the mortgage funding on the wholesale market. In addition, Vince Cable, the Business Secretary, warned that there were two major issues with regard to banks at present, “At the moment, the great danger is that recovery is choked off by a lack of funds. The other issue is that the big banks seem structurally dangerous.”

UK banks are being forced to meet tougher rules on capital and liquidity as well as a new levy on their balance sheets whilst also, of course, being encouraged to lend more. Standard Chartered and Barclays last week both declared that they would consider leaving the UK market if they felt it was becoming uncompetitive. The chief executive of RBS, Stephen Hester, stated that it was “most unlikely” that RBS would quit the UK, but that the government must understand that financial services was one of the areas in which the UK can best compete.

Optimism v Pessimism
The FTSE 100 finished the week in positive territory, but once again failed to close above 5,400 due to a fall on Friday following the release of US economic data that painted a gloomy outlook for the US recovery. The number of American workers who lost their jobs in July was higher than expected, with the US Labor Department calculations that 131,000 jobs were lost against expectations of 65,000. This disappointing data prompted concerns that the Federal Reserve may have to take further steps to stimulate economic growth. The Times also reported on a survey that the recovery in the world’s leading economies may well have peaked. In a sign that British growth may be easing, the National Institute of Economic and Social Research said that GDP growth had slowed to 0.9% for the three months to the end of July.

Overall, equity markets showed some sort of resilience over the week buoyed by positive earnings news from European banks. Wall Street stocks and European equities closed the week a little under 1% ahead, while Japanese stocks rose for a third consecutive week. Globally, the biggest winners were Hong Kong and China, rising 3.1% and 1.4% respectively. Within currency markets, the stubbornly weak recovery in the US left the dollar as the world’s least popular currency for the week, compounding the 10% decline against a range of currencies since the start of June on a trade-weighted basis. The US currency fell to a 15 year low against the Japanese yen, and helped push short-dated Treasury yields to their lowest on record at 0.5%. The strength of the yen prompted more speculation that the Bank of Japan might ease policy even further, while the 10-year Japanese government bond yield fell below 1% for the first time since 2003.

One asset class did have a strong week ─ gold prices rose as the economic concerns sent investors turning to the precious metal once again as demand soared. The negative sentiment helped bullion rebound above US$1,210 per ounce for the first time in a month.

Mixed fortunes for property
Commercial property prices in the UK are continuing to rise, according to The Financial Times, driven by increasing demand. Prices for retail, office, and commercial buildings have been rising since September last year, and figures from the Investment Management Association show that private investors saw Property funds as attractive again after shunning the sector for 12 months. The general consensus among analysts however, is that capital growth could be slower than in recent times, and that income is likely to make up the bulk of investor returns for the second half of 2010.

Foreign investors keen to buy at the bottom of the market began buying prime London residential properties last autumn, but recently that sharp recovery has stalled somewhat following 15 consecutive months of price gains. Prices for prime London property fell 0.5% in July, the first monthly decline since March 2009, with analysts blaming this on falling demand from foreign investors after the increasing value of sterling (including a 10% move against the dollar in just two months). It is thought that buyers from the Eurozone, Hong Kong and the Middle East were able to achieve effective reductions of 30─50% on London house purchases, thanks to the relative strength of their domestic currencies.

Inflation on the horizon
There was speculation in The Sunday Times that the Bank of England’s quarterly inflation report, due out this week, will include the grim combination of low growth and rising prices for the next 18 months. The forecasts are set to show that inflation, which has been above the official target of 2% since 2006, will remain above this level for the foreseeable future after George Osborne announced the increase in VAT to 20% from January 2011 onwards. However, it is the Bank of England’s growth forecast that is likely to unsettle the most. Last month, it predicted 3.4% growth next year and 3.6% in 2012, but this week it is expected they will remove a whole percentage point from these forecasts.

A report in The Mail on Sunday suggested that high street prices are set to rise throughout the year as retailers are hit by higher manufacturing costs, and the impending rise in VAT is passed on to customers. Clothing retailers Next and Marks & Spencer both warned this week that shoppers would soon see increasing prices, after the entire retail industry has seen a range of increased costs such as the price of fabric, particularly cotton which has risen by 60% in 12 months. Other factors weighing against consumers are transportation costs, with fuel prices being 10% higher, and enhanced labour costs.

Historically, one of the better ways to combat any threat of inflation over the long term is through investment in equities. One advocate of this approach is Bernie Horn of Polaris Capital Management, manager of the SJP Worldwide Managed funds, who is confident there are significant opportunities in equity markets despite the recent doubts over economic recovery. Bernie recently reported: “Our conversations with companies worldwide indicate further mixed economic progress. Some industries and countries are stabilising, while others are experiencing only sparse improvement. Inventory cycles appear ambiguous. Economic growth remains modest to stagnant in developing countries, while emerging market demand appears strong and sustainable. Since we are concerned about uneven economic growth, we are attempting to reduce portfolio exposure to countries or sectors facing a protracted recovery. Over the past few years we have made a conscious effort to minimize portfolio risk, increasing defensive positions in energy, utilities and healthcare to better balance the portfolio and reduce cyclical exposure. In healthcare, we recently bought a U.S. company, Questcor Pharmaceuticals, that manufactures ACTH, an orphan drug effective for infantile spasms and numerous other diseases, and a French biotech company, Transgene SA, designing therapeutic vaccines for pre-cancerous cervical lesions, non-small cell lung cancer and Hepatitis C.

Information technology also offers an interesting value proposition, as we identified numerous companies with strong free cash flow, promising growth and cash rich balances sheets with little debt. New investments included Wincor Nixdorf, a German manufacturer of banking machines and point of sale hardware and software, and Brooks Automation, a U.S. based company that serves the semiconductor industry.

Economic ambiguity expected throughout this year creates more normalised market volatility – unlike the abnormal upward trajectory evidenced in the 1990s─2000s. Faced with normal volatility, we remain steadfast to the pure value investment strategy that governs the portfolio. We harvest gains in more cyclical companies, hold cash as a buffer, and reinvest in new purchases when the markets undervalue fundamentally strong stocks. Maintaining this buy/sell discipline over these past twelve months has proved advantageous, and we intend to continue executing this strategy in an effort to achieve benchmark-beating returns with lower than market risk. We will continue to buy opportunistically, taking advantages of volatility to purchase positions in down markets and reduce positions in market advances.”

2010-08-02T14:27:00.000+01:00

In this week's bulletin:

Positive corporate results were offset by continuing uncertainty in developed economies
US economic data showed similar underlying weaknesses to those of the UK released the previous week
The Governor of the Bank of England attacked the banks for their harsh treatment of small businesses
The first new UK high street bank for 100 years opened its doors to customers
The Government announced plans to scrap compulsory retirement at age 65

Big Business starts to leave the economy behind
News and data last week continued to fuel the divergence between the outlook for big business and the developed economies as well as offer opportunities for both the austerity mongers and stimulus seekers to strengthen their arguments. A number of leading global companies reported strong second-quarter figures to boost first-half results, although global equity markets remained fairly neutral as uncertain economic data dampened enthusiasm.

In the UK, British Gas led the charge by reporting first-half profits up 98% over the same period last year. Although not quite in the same league, in terms of growth, BAE Systems, Rolls-Royce, BSkyB, Centrica and BAT all raised dividends on the back of good results. Astra Zeneca reported it would convert increased profits into an increased share buy-back. Even as the profits kept rolling in, and the previous week’s positive GDP data was digested, the UK’s FTSE 100 lost ground against the previous week’s close, down by 1% (source: Lipper). In the US, the Federal Reserve Board’s survey of business conditions noted corporate earnings to be up more than 20% in the second quarter. Both FedEx and UPS, whose revenues depend on transporting goods, reported healthy increases in shipping profits. Technology companies such as Apple, Intel and Microsoft lead the way on profits and many companies upped dividends. Again markets offset positive corporate news with weak economic data and ended the week neutral. The S&P 500 closed down 0.09% for the week and the Dow Jones Industrial Average was up 0.4% for the week.

On the back of increased profitability, Bloomberg reported that global mergers and acquisitions activity has seen a surge with a 10% increase over the first seven months of 2009, at over US$1 trillion, which may begin to boost stock market returns in the latter part of the year. The pattern of robust profits and dividends is being replicated across the globe and may offer excellent opportunities for investors seeking investment in quality companies at reasonable prices even after stock markets have strengthened over the last 15 months.

However, the detailed picture may not be so rosy when considering the benefits to the developed local economies in particular. Much of the increased profitability being seen can be attributed to the strength of corporate streamlining which has been taking place over the last couple of years. For most, sales growth has been negligible or non-existent; however, profits have been growing comfortably. Increased efficiency from outsourced production to low labour cost economies, squeezing profit levels of suppliers, job losses and preferring temporary staff or part-time employees to permanent staff along with relatively modest capital investment, has been reaping rewards.

What price profits for the economic recovery?
Whilst figures released on Friday showed the US economy grew again in the second quarter by 2.4%, this was down from the previous quarter’s 3.7%. Interestingly, when measured in the same way as the Office for National Statistics (ONS) interprets UK data, the growth was only 0.6%, compared to 1.1% for the UK. Similar to in the UK the previous week, the recent US recession was even deeper than previously estimated according to the US Commerce Department’s annual revisions, reflecting bigger slumps in consumer spending and housing than originally calculated. The world’s largest economy shrank 4.1% from the fourth quarter of 2007 to the second quarter of 2009, compared with the 3.7% drop previously on the books, the report showed. Deeper analysis of the US economic data revealed a number of similarities to the UK with employment figures being supported by part-time jobs rather than full time, house prices and the housing market showing little sign of life and consumer confidence continuing to waver.

In fact, the confidence of the UK consumer was dealt a further blow by a string of negative outlooks on the UK housing market from the Land Registry, National Institute of Economic and Social Research (NIESR), Nationwide and Halifax. Overvalued properties and slumping loan approvals are not expected to be helped by depressed outlooks for household income and indebted Britons attempting to reduce borrowings.

On a positive note, Goldman Sachs’ economists, who have close links with the new Chancellor’s advisors, according to The Times, are upbeat about the global economy and the ability of the UK economy to grow in the face of tax rises and austerity measures. Their global forecasts were supported by Baltic Dry Index data showing recent rises continued in freight rates for shipping dry commodities. Economists who use this as a lead indicator for the global economy noted its recent sharp falls had reversed and it was 16% up from its lows, although still below its Spring peak. However, increased movement of goods does not necessarily translate into economic recovery, especially for economies deemed to be consumer and services led.

It has to be noted that most global economic growth predictions are still heavily reliant on the emerging economies to bolster somewhat weaker figures being contributed by developed economies. The Times’ reporting of the NIESR’s revised findings, that at current rates of growth China will overtake America as the world’s largest economy in only nine years, only served to underline the situation. China’s GDP is expected to grow by 11% this year and based on currency adjusted GDP they have already overtaken Japan for second place. In both the UK and the US, opinions are divided on whether governments should focus on curbing spending through austerity measures or potentially boosting the economy and creating jobs through further injections of funds. This highlights the continuing fragility of developed nations’ economic recoveries where further quantitative easing is still a very real possibility in contrast to developing economies where fiscal and monetary controls are in full swing to control rampant growth. India’s central bank raised interest rates for the second time this month last week whilst this week the Bank of England Monetary Policy Committee is expected to leave the UK base rate unchanged at 0.5%.

The Governor does his bit for small business
As the outlook for big business appears to be strengthening, Mervyn King, the Governor of the Bank of England, launched a scathing attack on leading banks over his perception of their harsh treatment of small and medium-sized businesses in the UK, and indirectly the impact on the UK economy. Citing the ‘credit drought’ and the banks’ claims that there was a ‘lack of demand’ as not an adequate response, he attacked their disregard for long-standing business relationships in their relentless pursuit of profits to bolster their capital buffers.

Credit conditions have improved this year; however, they have slowed recently. This has been most apparent for small and medium businesses that, if they do gain funding, are being hampered by tough borrowing criteria. For the UK investor, however, this is broadening the opportunities from corporate bond markets. The resolve of many companies to approach the corporate credit markets for borrowing has seen investment opportunities in fundamentally sound, quality companies, through their corporate bonds, increase. With the increasing recognition the senior secured debt sector of the market is attracting, even fledgling and recovering companies are seeing the chance to borrow at reasonable rates by offering good collateral as security.

The British public does its bit for small banks
Even the British public showed their appetite for new competition to the established high street banks when the first new high street lender to open its doors in 100 years, Metro Bank, had potential customers queuing in the streets. The last time customers queued around a bank was in September 2007 when Northern Rock fuelled panic with its financial statements and a run on its banks occurred across the country.

Forced retirement scrapped
If you still have a job, be it full time or part-time, you will no longer be forced to retire at 65. The Government announced this week that since we all enjoy working and that it keeps us active and living longer, that they would abolish compulsory retirement at 65. Don’t be fooled however, as the longer you work, the longer you can contribute towards the upkeep of those who don’t. The dwindling workforce is now required to support the 16% of the population who are over 65, up from 5% in 1901.

As The Times commented on Thursday, this is not an opportunity to defer saving for the day you finally decide gardening is better than office work: ‘The bigger danger is that people see this as an opportunity to put off or save less for retirement, when in fact it is probably the worst thing they can do’.

2010-07-26T23:18:00.000+01:00

In this week's bulletin:

Markets recovered from early losses to close the week at the highest level since April.
Just 7 of the 91 banks tested failed the much anticipate ‘stress-test’ conducted by the Committee of European Banking Supervisors (CEBS).
The UK economy grew by 1.1% in the second quarter of this year, more than double the expected gain.
Interest rates look set to remain low for “three to four years” according to Ernst & Young
National Savings & Investments (NS&I) closed its popular inflation-beating certificates to new customers and cut interest rates on a number of other key accounts
Back shares and not property, according to Price Waterhouse Coopers, who suggest equities will grow by 5% versus residential property which will grow by just 2% over the next 10 years

This weekly Briefing Note aims to pick out some of the key financial and economic issues touched on in the press over recent days and from time to time includes the views of some independent fund managers.

Equities rally
Global stock-markets shook off early weakness to end the week higher, with the UK’s FTSE 100 closing up 3.0% - its highest weekly close since the end of April (source: Lipper). Bearish tones dominated news-flow early in the week when credit rating agency, Moody’s, cut Ireland’s rating by one level. UK home sellers were faced with the prospect of falling prices for the first time since December as asking prices declined by 0.6% in July according to Rightmove, as the suspension of Home Information Packs led to an increase in the number of homes coming to market. Across the Atlantic, there was similar pessimism in housing when the National Association of Home Builders confidence index fell to its lowest level since April 2009 and housing starts (builds) declined to their lowest level since October.

Amongst the gloomy economic data, corporate earnings have been providing a much needed fillip in recent months. However, it appeared there was little relief in the UK either when the likes of Goldman Sachs, Johnson & Johnson and Cable & Wireless all issued disappointing numbers or downward revisions to forecast earnings. Markets were rocked further by US Chairman of the Federal Reserve, Ben Bernanke’s, dour assessment of the recovery prompted a slide on Wall Street. Speaking to the Senate Banking Committee, Bernanke acknowledged the labour market’s continued weakness is the “most important problem we have right now” and that the economy faced “unusually uncertain” prospects.

In the second half of the week, markets rebounded with banks and miners leading the way on renewed optimism over the banks stress test and strong metal prices. Corporate earnings also took a turn for the better with Ford Motor, Verizon Communications, SAB Miller, Great Portland Estates and Capita just some of the companies to beat expectations. A wave of merger and acquisition activity emerged in the week, typically a sign that confidence is returning to stock markets, with SSL International accepting a £2.5 billion offer from the consumer products maker Reckitt Benckiser. Canadian institutional investors launched a £2.9 billion approach for Tomkins, and International Power confirmed talks with French utilities company, GDF Suez.

Macro-economic data also showed signs of improvement with German business confidence reaching a three year high in July and the pound receiving a much need boost as UK retail sales rose more than forecast, up 0.7%, according to the Office for National Statistics (ONS). The end of the week saw surprisingly positive GDP figures for the UK, released by the ONS, leaving investors looking towards the outcome of the banks stress test, the results of which were announced after markets closed on Friday.

Stress, what stress?
The stress test undertaken by the Committee of European Banking Supervisors (CEBS) on 91 of Europe’s banks and its results have been met with indifference by a large number of economists, strategists and commentators. Many had called for a more meaningful test with tougher criteria which included exposure to sovereign debt default by a country such as Greece. However, the scenarios of a significant economic downturn including recession, falling property prices and spiking interest rates or another Lehman-style collapse were seen as an opportunity to confirm that banks had strengthened their defences against the foreseen, not the unforeseen. As it was, 84 of the 91 banks passed, but a tougher test may have seen at least 11 more banks, who only just scraped a pass, failing on more stringent criteria. Markets will have a chance to respond today, however with no surprises and the majority of markets having already priced in the expected outcome, it should be nothing more than ‘business as usual’.

Growing or slowing?
Dominating the end of week’s financial news was the ONS’s release of GDP data showing second quarter growth of 1.1% (double expectations) up from 0.3% in the previous quarter. Terms such as ‘remarkable’, ‘unbelievable’ and ‘totally unexpected’ were commonplace in the media but this does not necessarily mean the economy is about to see unbounded growth. It should be considered the low base from which this growth has come. The Sunday Times pointed out that the savage downturn at the end of 2008 and early 2009, caused by the collapse in world trade, was always going to fuel a short term spike when the situation reversed. What was probably more unexpected was the source of the growth. Whilst manufacturing and services (in particular, business services and finances) contributed to the strong growth, construction provided the greatest contribution as output leapt by 6.6%. This is surprising in light of recent reports that the number of residential properties coming to market has increased dramatically, and the commercial property sector is awash with properties being sold by banks to generate cash. It is difficult to tell if the current level of growth will be maintained, but what is obvious is that the current level of bank lending to businesses, which is contracting at around 6.0% p.a. will need to reverse dramatically or the corporate credit markets must take up the slack, unless businesses have deleveraged to such an extent that their growth is ‘self-funded’.

The stronger-than-expected earnings data saw sterling strengthen against both the euro and the dollar, and the price of gilts fall. The latter move was an indication that some investors now see the prospect of inflation as more of an immediate threat. However, the Bank of England needs to keep interest rates low for several years according to the latest Ernst & Young Item Club report. According to The Sunday Times, the Item Club forecast, which uses the Treasury’s model of the economy, shows that interest rates need to stay low for the next three to four years to counter balance the government’s tax rises and spending cuts.

No guarantees
Savers received more bad news this week when government-backed National Savings & Investments closed its popular inflation-beating certificates to new customers and cut interest rates on a number of other key accounts. These ‘risk-free’ investments were offering tax-free returns of 6% and having invested over £11 billion into these certificates over the last 5 years, investors are uncertain about what their alternatives might be. With interest rates low, deposits and savings bonds may not keep pace, especially when income tax is factored in. So what other opportunities exist? Fund managers have not been slow to remind investors of the other opportunities over the last few days with alternatives ranging from offset mortgages to equities being touted. Neil Woodford, manager of St. James’s Place High Income and SJP/Invesco Managed funds, has been reinforcing his view that future growth is likely to be low and that yields from stocks and shares will become more popular. This aligns with his long held view that defensive, high-yielding shares in quality companies will continue to provide investors with a way to stay ahead of inflation.

Back shares not property
The Sunday Times reported on a publication by leading accountant, Price Waterhouse Coopers (PWC) that said it expects property to grow by 2% a year over the next 10 years, after inflation, but equities to return an average of 5% a year. PWC’s Head of macro-economics, John Hawsworth said: “Our analysis highlights the high degree of uncertainty over future house price prospects, emphasising that housing is a risky asset that is not guaranteed to generate positive real returns in the future, even though this has been the pattern in the past.”

This forecast growth of 5% per annum for equities sounds good, although relative to returns of 7.1% seen over the past 30-years (source: Barclays Equity Gilt Study) it may seem relatively slow. This view was reflected by manager of the St. James’s Place Property fund, Duncan Owen, who said about the commercial property market, “The UK market is continuing to recover but there is some concern about sustainability in parts of the market. Our projection is for future capital value movement to be flat on average, but it is not a homogenous asset class; prime property prices continue to be driven by low supply and strong demand. Despite capital returns being negligible, income returns from rents are still strong at somewhere between 6.5% and 7.5% and there is potential for growth through active management, our analogy is to buy the worst property on the best street and look to improve it.”

Mark Lyttleton, managing director of BlackRock and manager of St. James’s Place UK Absolute Return fund, told The Sunday Times there were still plenty of opportunities for investors, “Slower growth is better than no growth. Given that companies have cut their costs and are operating very efficiently, it doesn’t take a huge growth in the top line to make a material improvement in profitability. So you can still make money, maybe not as quickly as investors might have liked, but I don’t think that when interest rates are nearly nothing, people need to make such high returns.”