In this week’s bulletin:
- The threat of a hung parliament in the UK spooked investors last week and led to a sharp sell-off in sterling
- Conversely, UK equities soared as the pound’s fall made equities relatively cheaper and enhanced the value of companies’ overseas earnings
- Economic data was positive and well received by investors even though US jobless figures still rose slightly
- Globally markets enjoyed a good week as tensions over Greece eased and there was no bad news from central banks in respect of possible stimulus exit policies
- Nick Montgomery, a fund manager with Invista Real Estate, gives his views on the outlook for the UK commercial property market
Investors’ attention switched last week from Greek’s woes – and the many other ongoing global concerns of course – to the UK. News that the latest opinion poll for The Sunday Times showed the Conservatives’ lead over Labour wilting to just 2% was enough to heighten fears of a hung parliament in this year’s election. The worry is that a minority government will not have the ability to take swift and decisive action over Britain’s public finances. As a consequence, foreign investors voted with their feet and decided it was time to bail out of sterling – the pound collapsed by more than four cents against the dollar at one point on Monday before steadying around $1.50. It was sterling’s worst day since February last year and analysts warned there could be more to come, with Nick Beacroft of Saxo Bank saying “We are witnessing what can justifiably be called the beginnings of sterling’s collapse”. And indeed that seemed to be the view of many leading forex experts, according to The Sunday Times, with predictions of the pound falling to anywhere between $1.45 and $1.20 over coming months. Worries have overflowed into the gilt market where the Bank of England said that foreign investors sold a net £1.49bn of gilts in January.
But not everyone agrees that sterling is set for more falls. Economist David Smith writing in The Sunday Times said it was easy to exaggerate the extent of the crisis – the pound has after all, been lower against the dollar and euro than it is now, although the outlook may remain cloudy for a while yet. Smith said that in fundamental terms, sterling is undervalued against both the dollar – where the long run rate is $1.68 – and euro. Bank of New York Mellon thinks fair value for the euro is 70p which translates to roughly €1.40 to the pound (it closed at €1.11 on Friday). As the week progressed though, the pound perked up a little, with an unexpected bounce back in Britain’s crucial services sector helping to push sterling back above $1.50 to close at $1.51 on Friday. But many analysts continued to take the view that the outlook for the pound does not look good with Caxton FX, a foreign exchange broker, saying “With the EU stalling on the situation in Greece, the market has taken a break from selling the euro and focus has turned to the pound. Few could argue that the fiscal situation in the UK is too dissimilar from that of the peripheral eurozone nations and sterling is suffering heavily as a consequence”.
Heading in the other direction though were UK equities, with the London market rushing ahead to hit an 18-month high on Friday – the index closed up almost 5% on the week. Whilst positive economic data from the US in the form of fewer jobs being lost last month was part of the reason, UK equities benefitted from the falls in sterling, according to The Financial Times – the currency’s fall makes stocks cheap relative to other markets and also helps lift the value of companies’ overseas earnings. London is one of the most international stock exchanges in the world with some 70% of corporate earnings coming from overseas markets, so helping the likes of HSBC, BP and Vodafone. “It [sterling’s weakness] makes the UK a place to come shopping, from European tourists on Oxford Street all the way to buying into stocks” said Adrian Cattley, senior equities analyst at Citigroup. At current levels The Financial Times pointed out that the FTSE100 companies were trading on prices equivalent to 12 times their forecast 2010 earnings – still below the long-run average of 14 times.
The personal finance press mulled over the implications for private investors and came up with a few suggestions as to how to make the most of the opportunity. The Financial Times said that equity strategists at asset management firms are rebalancing their UK stock portfolios and issuing new stock recommendations. Goldman Sachs’ strategists are therefore encouraging investors to take long [buy] positions in UK companies with exposure to foreign markets. Other advice – some more esoteric – included selling overseas property, buying foreign currency now for one’s holidays, buying the Swiss franc and overseas government debt and taking a punt on the foreign exchange markets. Of course, one of the safest ways, as discussed, is to capture overseas earnings by investing in a diversified UK equity fund and remember too that investments in overseas equities will of course potentially benefit from any further sterling weakness.
Away from the currency markets there was plenty of news to keep investors on their toes. In the US the latest jobless data revived hopes that the economic recovery in the world’s largest economy is gathering steam even though the pace of job losses accelerated slightly. The latest data for February showed a small increase in job losses – up 26,000 – but less than expected and the unemployment rate stayed steady at 9.7%. The Financial Times opined that the jobs report suggested that the economy is now on the verge of creating jobs. In the Far East, China’s premier Wen Jiabao pledged that the country will maintain its expansionary monetary and fiscal policies, warning that economic recovery was still “insufficient” and of “latent risks” in the banking system and promised to reduce speculation in booming property markets. In Germany the latest economic data showed exports jumping sharply as the country’s manufacturers enjoyed a revival in their fortunes, with an increase in orders both in developing economies and its more traditional markets.
Here in the UK, the manufacturer’s organisation the EEF said factories exporting British innovation to overseas markets will outperform the rest of the economy and lead the country out of recession. “Manufacturing is out of recession and more buoyant than we expected” said the EEF. The services sector is also more upbeat too – the purchasing managers’ index (PMI), which is closely watched as a measure of activity in businesses ranging from hotels to accountants, hit a three-year high of 58.4 last month (any reading over 50 indicates growth). Not that there aren’t a few concerns – input costs (what manufacturers pay for raw materials) are rising fast; bank lending data looks mixed, with mortgages dropping by 17% last month and probably explains why house prices, according to the Halifax, fell 1.5% last month. And the British Chambers of Commerce predicted last week that the economy is likely to grow at only 2.1% next year, down from an earlier forecast, with the group saying the threat of a ‘double-dip’ recession had not been totally eliminated. All this probably explains why the Bank of England kept interest rates on hold at 0.5% last week – one year on from when the BoE slashed rates to stave off financial disaster.
So by the end of the week global markets were in good spirits as tensions over Greece eased and fresh signs that the global recovery was holding up combined with a lack of negative views on central bank exit strategies all provided a solid backdrop. A key indication of mood came from the Vix equity volatility index (colloquially know as Wall Street’s ‘fear index’) which fell 11% on the week, leaving it at its lowest point since May 2008. Talking to The Financial Times, strategist Nicholas Colas said “Simply put, everything is moving in the same direction lately – to the upside”. The positive mood was reflected across the board with London, New York and European indices all moving ahead sharply. In the Far East, Tokyo and Bombay all enjoyed higher prices – the only laggard was, perhaps surprisingly, China where the Shanghai Composite index ended the week slightly down.
It’s not just been the equity markets that have enjoyed a revival since the nadir of the crisis – commercial property has also turned the corner, albeit more sedately. Having fallen some 44% from its high point in July 2007 – without historical precedent – the UK commercial property is now on a firmer footing, albeit on a selective basis. Nick Montgomery of Invista Real Estate, the UK’s largest real estate manager in the UK, gives his views on where he sees the market going. “The worst does seem to be behind us, at least in the better or prime end of the UK market, although the same cannot be said for the secondary part of the market where rents continue to fall and vacancy rates are increasing. We are concentrating our attention on the prime part which has enjoyed a strong revival, primarily on the back of foreign and institutional buying – prices for some of London’s most fashionable offices are up 20% since last summer which does make us a little wary.
We are still seeing rents falling in many parts of the market but we do believe the market is stabilising. And one needs to look at rents in context because in real terms, that is after the effects of inflation, City rents are only 30% of those seen in the 1988 boom period and there is now upward pressure. Also, unlike the last downturn seen in the 1990s, there is no oversupply problem – in fact new supply is falling to the extent that there will be no new net supply in London next year. For this reason City offices will be a focus for your fund and we anticipate some 10% of the fund’s assets being directed towards this sector, although the portfolio will continue to be diverse by geography and sector. Whilst it is good to see the market stabilising we remain cautious because the banks have yet to become sellers, preferring to be patient even if loan covenants have been breached. We do think that supply will increase as the year progresses and we are waiting to deploy some of our cash strategically.
So where we are now is that the market has stabilised. The prime quality of the fund’s assets is being recognised in the market and this is feeding through in the form of higher capital values. But it’s important to remember that the prime function of this asset class is to produce income – capital growth has, annualised, always been a minority part of the overall return. The UK market as a whole yields around 7.4% gross while the fund yields a little less and the quality of your tenants means we have experienced little, if any, tenant distress. So for now we are cautiously optimistic and believe there should be a place for commercial property as part of a well diversified portfolio”.