In this week’s bulletin:
- The prime minister said last week that whilst Britain’s economy is recovering the path ahead will be difficult – data on consumer spending and the housing market reinforced that outlook.
- The global economy continues to pick up with Chinese exports racing ahead, along with its real estate market. In the US consumer spending surprised on the upside.
- Global equity markets ended the week little changed as investors digested the sharp gains of the previous few weeks.
- Corporate bonds enjoyed a spectacular year in 2009 – Paul Causer of Invesco Perpetual shares his views on what might lie ahead for corporate credit.
- With the Budget just days away time is running out for investors to maximise this year’s tax allowances and also their Individual Savings Account allowance.
ISA allowances: With regard to the last point, ideally Wednesday, 31st March is the last day for making online ISA contributions.
With Good Friday on the 2nd April, while an ISA payment collection utilising a debit card could be made on Thursday 1st, (the last working day before 5th April) if any problem occurred in processing the payment through the Bank there may not be sufficient time to re process the payment.
The Road to Recovery
Last week Gordon Brown told the markets what they already knew – that Britain is on the mend but growth is tenuous. “Although the economy is now growing, recovery is still in its early stages and remains very fragile. There will be many months ahead of conflicting statistics, false hopes and mixed signals” he said. And mixed signals there definitely were. Retail sales rose last month, reversing a dismal start to the year because of poor weather, but still fell short of expectations. Stephen Robertson, the British Retail Consortium’s director general commented “Despite appearances, these results are not strong. When weather-related conditions are stripped away, it’s clear that customers are still cautious”. Over in the all-important UK housing market the news was lacklustre too. Turnover fell sharply in January, raising doubts about the sustainability of the demand that led to a sharp recovery last year. The Council of Mortgage Lenders said that loans advanced for house purchase fell to just 32,000 – half the December figure. The drop is somewhat surprising given that the average rate on new mortgages has fallen to just 3.98% – only the second time rates have fallen below 4% since records began in 1983. More encouragingly though was data provided by Acadametrics – based on completed sales as opposed to offers to buy, used by the Halifax – which showed that, whilst prices fell in January, they rose sharply in February by 1.9%.
But if the prime minister is right it will be some while yet before a clearer, more consistent picture emerges although in the meantime, investors took a sanguine view, leaving sterling little changed on the week despite a flurry of nerves earlier in the week when it dipped to $1.49. One of the key policies that helped restore confidence last year was the Bank of England’s quantitative easing (QE) policy which saw it pump some £200bn of new money into the economy via its purchases of government bonds, known as gilts. Writing in The Daily Telegraph, economist Roger Bootle mulled over whether it had worked and if the BoE might hit the start button again. He pointed out that asset prices have risen pretty much across the board but gilt yields are no lower than before, whilst inflation has jumped to 3.5% – vindicating some people’s concerns. However, Bootle went on to say that the latter has been caused by short-term factors such as higher energy prices and the restoration of full rate VAT – these will fall out of the calculation soon meaning the deflationary threat remains real. His conclusion was that whilst it was right to suspend QE for now, a continuing weak economy will see the BoE back buying gilts and other assets in a major way fairly soon.
A Global View
Investors taking a more panoramic view of the global economy saw plenty of reasons to be encouraged last week. In the Far East, Chinese exports rose 45.7% in February compared to a year earlier, beating forecasts and providing fresh evidence of a robust recovery in the economy which is poised to overtake Japan this year as the world’s second largest. Zhu Guangyao, assistant minister of finance, warned though that despite the strong trade performance, the global economic situation remained unpredictable. He said that it was too early to decide whether to withdraw stimulus policies, including the renminbi’s peg against the US dollar. The latter policy has led to criticism by the US that China’s currency is being kept artificially low to boost exports but make imports more expensive. One outcome of Beijing’s own version of QE has been a boom in property prices – Chinese real estate prices jumped 10.7% in February, despite Beijing introducing policies aimed at cooling prices, and hopefully avoiding a potential bubble. Meanwhile, over in the US, retail sales recorded a surprise rise in February as consumers lifted recovery hopes by braving winter storms to show renewed interest in spending. “Consumers are beginning to come out of their shells” said Global Insight and the news was welcomed by other analysts who use the data as a key indicator of spending which accounts for about 70% of US economic output.
One aspect that helped assuage investors’ concerns was news that a multi-billion euro rescue package for Greece is set to be put to eurozone finance ministers very soon, with Germany and France cited as likely to be the main backers. Greece’s stricken economic condition has upset the bond markets in recent weeks, raising concerns the country would not be able to borrow the money it needs to fund its deficit. Investors’ concerns are not restricted to Greece – Portugal and Spain are potential targets too. But The Financial Times pointed out that, despite six quarters of negative growth and unemployment rates around 20%, public debt is still low in Spain, with the country able to meet its obligations over the next few years. So, by the end of the week, growing confidence in the global recovery helped support investor risk appetite. Goldman Sachs commented that “The general mood has become more optimistic on the back of a macro environment that remains supportive”. This mood was reflected in share price movements where, for the most part, indices consolidated the recent large gains enjoyed by investors, by moving sideways during the week. In London the FTSE100 closed above 5,600 once more – its highest level for some 18 months or so. The week’s best performer though was Tokyo, where the Nikkei 225 index advanced 3% as foreign investors continued to take a more positive view on corporate earnings and future outlook for the economy.
It’s not only been equities that have done well in the last year. Corporate bonds – effectively IOUs issued by companies – have been through one of the most extraordinary periods ever seen in fixed-interest, following the aftermath of the financial crisis seen in 2008. Paul Causer, co-head of Fixed-Interest at Invesco Perpetual explains why, although these exceptional returns cannot realistically be repeated this year, there is still selective value in UK corporate bonds. “The outlook for 2010 is very different to that which Paul Read and I predicted for 2009: a year in which we were able to make significant returns for our investors. I do believe that, selectively, there is still value – it is just less prevalent and requires more circumspect credit selection. There remain sections of the market that continue to offer attractive opportunities. For example, yields on insurance names and financials still have attractive spreads and yields of over 6.5% in aggregate, while on subordinated financials, spreads remain well above historical levels with yields typically around 7%-10%. Bank debt has performed exceptionally well from the lows in March. Nevertheless, despite a widespread recapitalisation of the sector and a better understanding of the risk of holding these bonds, in many cases spreads are still materially wider of where they were before the Lehman Brothers bankruptcy, so there is still opportunity for further tightening. We have also seen a reduction in the uncertainty surrounding coupon payments.
“In the high yield markets, default risk has declined significantly. Last March, rating agency Moody’s forecast that European high-yield defaults would peak at 22% at the end of 2009. However with markets recovering, many companies have been able to refinance. As a result, Moody’s is now expecting the default rate to peak at 10%, below 2002’s 16% peak. With many high-yield credits still offering double-digit yields there remain good opportunities even after the strong rally of recent months. Underlying conditions remain supportive of bond markets, mainly low interest rates and subdued inflation. With a large output gap as well as high unemployment I feel that the UK is a long way from having an inflation problem. So whilst the days of equity-like returns from credit markets have passed, there is still value as I said, so I do expect more modest returns in 2010”.
Last week Gordon Brown confirmed that the Budget will be held on March 24, effectively starting the countdown to the general election. The Financial Times reported that if the Chancellor shows any lack of commitment on tackling the deficit, the markets could take fright. So instead, the view is that Mr. Darling will try to engineer a marginal fiscal loosening to allow spending on projects that illustrate the government’s themes, such as job creation. In any event, financial markets remained little changed with both sterling and gilts treading water. Whilst there are expected to be few if any tax changes, the announcement of the Budget is a useful reminder that we are very close to the end of the tax year and time is running out to maximise the use of allowance across a range of regimes such as Capital Gains Tax, Income Tax and Inheritance Tax.
On the investment side, the media reminded its readers that time is also running out to utilise this year’s Individual Savings Account (ISA) allowance. As a reminder, for those over 50 this tax year the allowance has been raised to £10,200 – for everyone else it is £7,200. The Sunday Telegraph reported that many investors have renewed their appetite for risk, with more than half of people prepared to invest in stocks and shares. The paper also pointed out that the Easter weekend means that savers could lose their last opportunity if they don’t act by the 1 April.