In this week’s blog:
- Greece’s economic woes returned to upset the markets last week but, after a short period of panic, order was temporarily restored by the EU easing lending rules.
- Stock markets generally enjoyed another positive week – encouraged by both the BoE and US Federal Reserve decisions to hold interest rates.
- Economic data and survey results for the UK economy were very positive last week, showing the economy growing in the first quarter of this year and likely to grow faster than its eurozone rivals.
- With the general election just a few weeks away commentators are mulling over whether the markets will do better under a Labour or Conservative government – based on recent evidence it seems it makes little if any difference in the short-term.
- For those investors seeking income, the outlook is improving with companies once again looking to increase dividend payments following cuts in 2009.
Greek Tragedy – Part II
Greece’s woes returned to the fore last week following a period of relative quiet for the heavily indebted eurozone member. Following the country’s austerity package announced a few weeks ago, as the price to be paid for EU economic support, the bond market – where the government raises cash – had returned to some semblance of normality. The apparent calm was illusory though because last week there was a sudden sell-off in Greek sovereign bonds which further pushed up the cost of borrowing for the embattled state to record levels. Rumours circulated that Greece’s finance minister was trying to renegotiate the terms of the finance deal cobbled together by the EU and IMF – vehemently denied – which involved promises to provide rescue funds if the country failed to raise sufficient funds itself. Investors are worried that any involvement of the IMF will involve punitive measures, but were also unsettled by Germany’s continued insistence that Greece pays a ‘commercial rate’ for any EU loans. Such terms would be unbearable for Greece and Berlin’s apparent intransigence merely exacerbated events, with the bond market in panic on Thursday – pushing up the cost of government borrowing to what would be crippling levels.
One side effect resulted in the euro falling against the dollar as investors headed for safer currencies. So, anxious to restore order as soon as possible, the European Central Bank eased the pressure on Greece’s troubled domestic lenders by loosening the rules on using government bonds as collateral for its loans. With ratings agencies such as Fitch downgrading Greek bonds to almost junk status, the markets are convinced that the country will have to ask for help. “It is now up to the Greek Government to go publicly to the EU and IMF and ask for cash and support” said Chris Pryce at Fitch Ratings. Almost on cue news emerged that, according to EU eurozone officials, proposals had been put together for emergency funds to be made available at a pre-agreed interest rate that would help Athens, according to The Financial Times. Whilst the proposals have yet to be approved by political leaders, it was enough to change the mood – the local bond and equity markets swung from deep depression to wild enthusiasm as investors rushed to buy Greek stocks. The positive mood also enabled the euro to stage a recovery against the US$, completing the circle on a topsy-turvy Greek week.
Away from the travails of the Greek markets, the rest of the world’s major equity markets continued their steady advance, with many leading indices hitting their highest levels since the demise of Lehman Brothers in September 2008. On Wall Street, traders were encouraged by news that the US Federal Reserve had voted to keep the federal funds rate at between 0% and 0.25% for an ‘extended period’ as the US economy continues its slow recovery. Data continues to be mixed for the world’s largest economy – whilst inventories held by US wholesalers rose more than expected in February, according to the Commerce Department, the Fed said that consumer credit fell unexpectedly – down $11.5bn. Investors were also keen to pre-position themselves ahead of the first quarter earnings season reports which start this week and expectations are clearly running high.
In the eurozone, rising exports helped to boost Germany’s trade surplus above expectations whilst industrial output in France remained unchanged in February. So, by the end of the week, most equity markets had secured further gains during shortened holiday-week trading – in London the FTSE100 closed at 5,770. In the commodity markets, copper prices failed to hold above $8,000 a tonne – the highest level since August 2008 – as traders fretted about whether China would need to continue stockpiling. The metal is used extensively in the likes of infrastructure building projects, many of which were brought forward during last year’s stimulus package and are now nearing completion. Crude oil also hit a new post-2008 high, ending the week at c$87 per barrel – a fact not lost on British drivers, who are having to pay a near record £1.20 per litre. The price of petrol in the UK has been aggravated not just by rising oil prices but also sterling weakness which also pushes up the cost.
Spring Into Action
Not only has the weather improved but also the outlook for the UK economy. With the economic recovery temporarily on ice in January following the severe weather, activity has since picked up significantly across the country, feeding into better economic numbers. Data out last week implies the threat of a double-dip recession has receded, with figures suggesting the economy grew in the first quarter of the year, according to a survey by the British Chambers of Commerce (BCC). Although positive, the BCC sees growth of only 1% this year compared to the Treasury’s forecast of 1.25% – official figures will not be available for another two weeks. The BCC reported that the all-important service sector continues to report improvement in business, whilst manufacturers’ confidence remains stable. More encouraging was the fact that the building industry seems set to emerge from its torpor, with the construction sector posting its first positive growth in two years.
And later in the week, figures from the National Institute of Economic and Social Research (NIESR) calculated that GDP grew at 0.4% in the first quarter, buoyed by better weather and factories springing into life in February. This rate of growth would match that achieved in the last quarter of 2009 and if sustained would mean annualised growth of 1.6%. Economists believe the sharp improvement is down to a strong increase in production across a number of sectors including food and drink, electrical equipment as well as bricks and cement. Whilst the NIESR data has boosted expectations it also cautioned that the underlying state of the economy was fragile – which probably explains why the Bank of England once more voted to keep interest rates on hold at 0.5%. The Times commented that economists are of the view that base rate could be held at 0.5% until late this year or even into 2011. But in the property market it seems that the stamp duty tax break announced in the Budget has, so far, failed to tempt first-time buyers, according to many estate agents, said The Times. The reality though is that most lenders still require first-time purchasers to come up with a 20% deposit which is proving a significant hurdle.
The UK’s recovery is not only still on track but is forecast to grow faster than its leading eurozone rivals according to the Organisation for Economic Co-operation and Development (OECD). While the OECD is predicting an early bounce in the UK economy in 2011, the situation in the eurozone remains troubled. The EU’s statistical office reported nil growth from the 16 nations that use the single euro currency for the period from October to December last year. The news is mixed for the region, with France enjoying stronger growth than Germany in the first quarter of this year. On the other side of the Atlantic the OECD expects the US to grow by 2.4% in each of the next two quarters, while Canada is booming with GDP growing by 6.2% so far this year.
Blue or Red?
With the general election imminent and the possibility of a hung Parliament being the outcome, the question being asked, unsurprisingly, is how this might affect share prices. Common belief is that the markets prefer Conservative governments and indeed, longer-term research shows that the average market gain since 1932, according to figures used by The Sunday Times, has been 32% under a Labour government compared to 52% under a Conservative regime. Over the shorter term it is less clear though, according to Gareth Evans of Deutsche Bank. “Whether it is a change in government from Labour to Conservative or Labour holding on to power, there is no clear divide in how the equity market has responded. In fact, it is virtually 50-50” he said. One thing most commentators are agreed on is that markets hate uncertainty so it will be no surprise if equities were nervous ahead of the election, according to Schroders’ head of equities Richard Buxton.
However, markets can be unpredictable and the UK stock market seems to be taking a pretty phlegmatic view of events based on its recent performance – the market has successfully ended up for six consecutive weeks. Whilst short-term this is clearly inconclusive, it does indicate that investors are finding reasons to be positive. One aspect is that profit warnings by UK companies dropped to a three-year low in the first three months of this year as the economic recovery gains traction. According to data complied by accountancy firm Ernst & Young, the latest figure was not only sharply lower than a year earlier but also below typical levels when the economy was growing rapidly in the past.
The improving global economic outlook is also providing tangible benefits for those investors seeking income – with interest rates being held at ultra-low levels investors are looking for other alternatives and a traditional home has been equity income funds. The Financial Times pointed out that in a sharp reversal of the situation in 2009, dividend payments from shares in some companies are set to rise by more than 5% this year, according to analysts. The revival of dividend payments follows some barren months for some companies who were severely hit by the recession, both here and in the US – payouts fell on average by 15% in the UK last year and 20% in the US. But so far in 2010 just 48 of the 7,000 US companies tracked by research group Standard & Poor’s have reduced their dividend and, whilst data is not yet available for the UK, a similar trend is expected. The weakness of sterling is also expected to help boost dividends from London listed companies that report earnings in US dollars such as household products giant Unilever.