This weeks bulletin covers:
Indian Summer
After weeks of strong price rises across a number of the major asset classes, investors took a rain check last week and decided to move to the sidelines. Commodity prices fell back, with crude oil slipping almost $6 per barrel, eventually settling at around $65pb and were closely followed by copper, gold and silver prices. Global equities drifted downwards with most major indices giving up between 1%-2% and, partly in consequence, investors moved into government bonds causing prices to rise a little, resulting in small yield falls. But with little real activity – trading volumes remain light – it seemed that after a six-month super rally the markets just decided to relax and enjoy the improving global economic environment whilst remaining vigilant.
During the week, whilst announcing that US interest rates would remain low for an extended period, Federal Reserve chairman Ben Bernanke also said that the central bank would start to scale back short-term cash auctions next year, implying that US policymakers feel the financial sector crisis was largely over. Globally, policymakers have as yet been light on detail about exactly how they will implement exit strategies following the huge financial stimulus for the global economy a year ago, but a joint announcement by the Fed, ECB and Bank of England said that some of the emergency operations to provide dollar liquidity would be scaled back from October. “It’s going to be a very tough recovery in the US and UK and, in the near term, there is growing concern about what will happen once quantitative easing ends” was the view of Cazenove.
Leading the call for growth were global policymakers who, at the end of the G20 Summit meeting in Pittsburgh, supported a US communiqué calling for new mechanisms to generate sustainable and balanced world growth. Washington wants, according to The Financial Times, an agreement on a framework for balanced growth including co-ordinated economic policies to achieve faster world growth without creating asset bubbles. US Treasury Secretary Tim Geithner took the opportunity to say that “We’re beginning to see growth in the US and around the world. This is encouraging but we have a way to go”. Breaking ranks with the Chancellor, Gordon Brown used the summit to suggest that “some economic growth” could be announced at the pre-Budget Report – expected just after the publication of third-quarter economic figures in late October.
Better Times Ahead
In a more concrete way, data complied by the Bureau for Economic Policy Analysis, showed the volume of world trade rising 3.5% in July - following a 1.6% rise in June – the steepest since December 2003. The numbers suggest that the fall in trade over the past year was mainly caused by lack of demand than a breakdown in the trading system. “The fact that global supply chains are getting back to normal is good news for export-dependent countries like Japan and Germany” was the view of Capital Economics. Not everyone seems to be in agreement though, with the IMF saying the world’s leading economies will have to wait until 2015 or later for growth to return to normal rates. As the global economy recovers, it is the emerging countries such as China that are leading the way, underlining the shift of wealth and power from West to East. In recognition of this fact, HSBC, one of the world’s largest banks, announced last week that it would be run from Hong Kong, a sign that the world’s economic centre of gravity has indeed shifted decidedly to the Orient.
Here in the UK, the CBI upgraded its forecasts for Britain’s economic prospects, predicting the UK would emerge from recession by the end of this month, giving some credence to the Prime Minister’s G20 statement. The business group expects growth of 0.3% this quarter, rising to 0.4% in the final three months, reflecting a sharp rise in confidence. However, there do appear to be some risks to the fragile recovery, according to the Society of Motor Manufacturers, who have called on the government to extend its ‘cash for bangers’ £300m scheme which is close to ending. The scheme has given UK car production a huge boost – halving the previous year-on-year drop of 56.5% - but it seems that production fell back again last month raising concerns that recovery could falter. Car makers have cut jobs and shifts as sales have slumped and last week it emerged that the proposed sale of GM’s Vauxhall arm to a foreign consortium could now lead to 1,200 job cuts at Vauxhall plants in Britain.
Taking a Pounding
Reading the press one might be forgiven for believing that sterling has had a major setback on the foreign exchanges and whilst it did fall last week, the headlines contained a touch of hyperbole. As The Financial Times said, in a week lacking relatively little hard data about the state of the UK economy, the markets turned their attention to the metaphorical movements of Mervyn King’s eyebrows. In an interview last week the governor of the Bank of England said the drop in the pound over the course of the financial crisis of around 20% was “helpful” in rebalancing the UK economy. At its low point, sterling hit $1.37 last year but has recently recovered to around $1.67 until encountering some resistance and selling in the last week or so. The Times said there were other concerns; not least the possibility of the BoE cutting the interest rates it pays British banks for money held on deposit with it. There has also been some unease over the extension of the Quantitative Easing (QE) programme to some £175bn, together with concerns over Britain’s huge budget deficit.
With some economists saying the weak pound is permanent, a report from Goldman Sachs endeavoured to put events into context. The bank said that the UK could transform itself from chronic over-spender to a global surplus country as the weak pound revives its export industry. The bank has advised its clients to build up sterling positions, saying the economy was in better shape than it looked and that public debt at 80% of GDP was lower than France or Germany. The point made by Mervyn King reflected his view that the economy could rebalance by increasing exports and that “the fall in the exchange rate that we have seen will be helpful to that process”. The effect was to give currency traders another excuse to sell which pushed sterling below $1.60 and €1.09 and to leave the Governor standing accused of talking down the pound.
Going Continental
With France and Germany emerging from recession last quarter, investors are understandably searching for investment opportunities that have emerged from the wreckage of the credit crunch – not least is Stuart Mitchell who manages European funds for St. James’s Place. “We continue to believe that the outlook for European equities remains very positive. Our highly active company visiting programme suggests that business could be recovering far quicker than even the most optimistic have suggested. Coupled with aggressive cost control and strict financial discipline, first half corporate results have in many cases been much better than expected and the economic backdrop of low interest rates is supportive. Whilst we are mindful of the potential impact of the reversal of quantitative easing and cuts in government spending we don’t think this will become an issue until next year.
“Despite the strong rally European shares remain very good value and at a discount to the US market, despite the corporate sector being just as profitable. At the low point earlier this year, equity valuations for European companies were in many cases back to levels not seen the 1970s - offering enormous investment opportunity. In response, we consciously took a more aggressive strategy for the portfolios – almost three-quarters of the fund is now exposed to cyclical and financial shares, which have seen some of the largest rises in the recent rally. Amongst our cyclical holdings the largest portion is devoted to construction and building-related companies such as Lafarge and Norsk Hydro and in the consumer sector we own companies like Accor and Daimler. Within the financials we own a number of insurance companies, including Swiss Re and Allianz. The balance of the portfolio is spread across quality growth and value companies such as LVMH which has strong brands and increased its revenues by 40%. Looking forward I remain confident that there is more upside over the medium term – perhaps as much as 20%-30%”.
50-Something
From next month the investment limit for Individual Savings Accounts (ISAs) is being boosted to £10,200 for investors who are aged 50 or over this tax year – this is a £3,000 increase on the existing ISA allowance. The Financial Times pointed out to its readers that had you invested the maximum amounts each and every year since 1999 the value of a stock market ISA portfolio could be worth over £92,000. Investments held within an ISA are free of Capital Gains Tax and income is free of higher rate income tax so it makes sense to shelter the maximum each year. The paper also discussed the types of funds one could consider – those looking for lower risk might invest in Corporate Bonds, with Invesco Perpetual managers Paul Read and Paul Causer favoured. For medium risk investors, global equity or UK equity income funds were highlighted.
One other investment product homed-in on were with-profit funds – designed to smooth returns for investors. Many of these have struggled and underperformed for years was an observation made by The Financial Times. According to Money Management figures to be published next month, every life insurance company has reduced its payout this year, despite the strong rally in share prices this year. But there is a silver lining for with-profit investors, the improvement in the economic outlook is encouraging life companies to remove exit penalties – often called Market Value Adjustments - for investors who wish to exit and re-invest elsewhere.
Stuart Mitchell is the principal of S W Mitchell Capital.
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