In this week’s bulletin:
- It was a mixed week for the markets: it started well, buoyed by positive second-quarter earnings news from the likes of Alcoa.
- But as the week progressed investors became unsettled by poor US economic data and news that the US Federal Reserve had downgraded its growth forecast.
- Economic data from China and India, whilst robust, showed some signs of slowdown which again left the markets fretting.
- The UK property market seems to be slowing further with an increasing number of sellers beginning to outnumber a shrinking number of buyers.
- The weekend money press advised investors to think about diversifying into funds that can reduce market volatility such as Absolute Return, Cautious and Strategic Bond funds.
- UK Equity Manager Neil Woodford gives an insight into his current thinking and portfolio strategy.
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 of our independent fund managers.
Earnings Boost Fades
Global stock markets got off to a good start last week – continuing the momentum of the previous week, with investor sentiment boosted by an upbeat set of second quarter figures from Alcoa, the largest US aluminium producer. Expectations that the soon-to-be released European Bank stress tests would allay fears about some banks possibly hiding liabilities off balance sheet also supported sentiment. Overall, European government bond markets have stabilised in the last fortnight, allowing the likes of Greece, Portugal and Spain to tap the markets with new issues. China, the world’s largest foreign exchange holder, bought several hundred million euros of Spanish bonds last week as Asian investors returned to the eurozone peripheral market after a two-month hiatus, according to The Financial Times. The appetite for government paper, despite historically low yields, was evident in both Japan and the US too, with the investors in the latter absorbing $35bn of three-year notes at the lowest yield ever of 1.055%.
Unfortunately, as the week progressed, confidence ebbed despite good earnings figures from financial giant JP Morgan. Upsetting the apple-cart were figures showing a loss of recovery momentum in the US manufacturing sector. The Philadelphia Fed index of activity fell from 8 to 5.1 last month and the New York Fed’s Empire State index fell from 19.6 to 5.1; whilst the data suggested manufacturing was still growing, it’s not fast enough to create jobs. Paul Ashworth at Capital Economic commented “The data releases suggest that the industrial recovery is losing momentum, making deflation an even bigger threat”. The figures coincided with news that the US Federal Reserve had cut its forecast for economic growth in 2010 and had also considered further asset purchases [quantitative easing] to support growth. The Fed’s minutes said that such measures might be necessary should the economic outlook “worsen appreciably”. Earlier in the week Fed Chairman, Ben Bernanke, stepped up the pressure by calling on the banks to increase lending to America’s small businesses, a critical element in spurring economic recovery.
Market Impetus Reverses
So by the end of the week investor confidence had faltered, unsettled by concerns that US economic recovery was not going according to plan. In the currency markets the US dollar dropped to a ten-week low against the euro, breaching $1.30, as a result of the worries over recovery and the possibility that the Fed might ease monetary conditions further – reducing the likelihood of any interest rate rises anytime soon. Any residual short-term lingering hopes were finally dashed on Friday with news that the Thomson Reuters/University of Michigan consumer confidence index had tumbled to 66.5, the lowest for a year. So, already weighed down by poor economic data, investors finally had to digest disappointing earnings news from Citigroup and Bank of America. This was sufficient to send the US equity market southwards – wiping out the week’s gains to leave the Dow Jones Industrial index some 100 points lower overall. Despite falling 1% on Friday, the FTSE ended up 0.5% on the week.
The other area of concern for the markets is China, where there are signs that growth – long seen as the saviour of the global recovery – is slowing. Whilst year-on-year GDP growth eased only modestly in the second quarter, a weak report on June industrial production was seen by some as a harbinger of a more serious slowdown. Caution grew with news that Chinese property prices fell for the first time in 18 months as signs that the government’s campaign to reduce real estate speculation and cool the economy was working. However, investors welcomed the news, probably buoyed by the fact that exports are still red hot – up 44% in June – indicating that talk of the demise of China’s boom is exaggerated. But illustrating just how capricious the markets currently are, the mood had swung back into negative territory by Friday on indications that Agricultural Bank of China was struggling to make ground after its $22bn flotation. By the end of the week the Shanghai Composite index of leading shares had fallen 2%, meaning the market has shed some 30% of its value over the last year, reflecting a sharp drop in private investor buying.
Another star of the emerging market sector is India where growth has been stellar too, although according to latest data, the country’s industrial output slowed to 11.5% year-on-year from a blistering 16.5% in May. Indian industrial production has grown at a double-digit pace for the last eight months and officials emphasised that growth remains buoyant. “Nobody should expect that the industrial manufacturing sector will continue to grow at abnormally high numbers for a long time to come. The secular trend . . . continues to be robust” commented Ashok Chawla, the finance secretary.
China is not the only place where property prices are cooling. According to the Royal Institute of Chartered Surveyors, about a fifth of estate agents expect UK house prices to fall in the next three months. The gauge of buyers’ interest also fell into negative territory for the first time this year, dropping from 8 to minus 4 last month. The survey seems to support a developing trend of slowly falling prices in the last three months, published by the Halifax. Lending too is just holding its own; the Council of Mortgage Lenders said approvals were up just 2% in May at 41,800, well down from the 63,000 approved in December. But official data from the Office for National Statistics has once again come under scrutiny following news that Britain’s recession was worse than initially reported – it contracted 6.4% – and that the economy was more reliant on government spending in the first quarter than first estimated. Long time sceptic of ONS data, Ben Broadbent of Goldman Sachs said the figures still looked “weird”.
One of the UK’s most respected fund managers is Neil Woodford of Invesco Perpetual. Known for his forthright and often contrarian views – he refused to buy into the dotcom boom, eschewed banking stocks and sold his holding in BP last October because of worries over dividend cover – last week he gave an insight into his current thinking. “A year or so ago I think I was in a minority of one by not buying into a ‘V-shaped’ economic recovery – today there are a few more who now share my views. The recent bout of volatility is a sign that all is not going according to plan. Markets become febrile when the consensus is challenged and with the US economy not behaving as expected in following a ‘normal’ path to recovery, doubts are setting in. From a macro point it is no surprise to me that we are not seeing a normal recovery; it was not a normal recession and deficits and surpluses remain imbalanced.
“Globally, no lessons have been learnt – there is no co-operation amongst policymakers: China refuses to allow any meaningful re-valuation of its currency and Germany is tightening the fiscal screw on the eurozone. Recent economic data from the US and elsewhere shows that the impetus of the huge economic stimulus during the crisis is fading. Despite my rather gloomy outlook, I don’t think the UK will fall back into recession – a so-called ‘double-dip’ – but growth will be muted for some while and it may feel like recession. I think that ultimately Greece and Spain will leave the eurozone: it will be positive for them as they can then revalue their currencies [down] which will make them more competitive and attract new business. The US could launch another stimulus package funded by borrowing and it’s likely that new debt will be bought by emerging market states like China. Emerging markets have propped up global growth and, although tightening in China is likely to slow its economy, growth will continue.
So the good news is that we are not going back to where we were at the end of 2008 and in spite of my prognosis I am very confident that I can achieve double digit returns for my investors over the next few years. The starting point is to divorce the economy from the markets: in 2000 the market was overvalued, with IT stocks enormously expensive. Conversely, old economy stocks were cheap so I was able to make money in the last decade by owning good quality but out of favour companies, even though the market has gone nowhere. The key driver for me is to look at company valuations and gauge how much of its ability to grow is already priced into the shares. I think the UK economy will grow at c1%-1.5% but there are companies out there that can do better; companies that don’t interact too strongly with discretionary spending which is going to fall next year onwards.
Consequently, I’m looking for businesses that are exposed to growth areas and who can expand: I then assess their value. You’d think that the growth prospects of these types of companies – utilities, tobacco, telecoms and pharmaceuticals – would already be priced-in. But they’re not. AstraZeneca trades on only seven times earnings (compared to 13 for the market), has good margins, huge cash-flows and no borrowing. I’m not predicating my view on the basis that the market will necessarily re-rate the shares either. Purely through dividends and buybacks I am likely to recoup my investment over the next 5 years and then still own the stock. Dividend yield on the portfolio is around 4.5% and I can see this growing at 10% per year plus with a little bit of capital growth. It’s quite feasible to see how you can achieve a 10% total return. So I’ll finish by reiterating that I remain convinced that there will still be opportunity to make money over the next few years despite some considerable economic headwinds”.
Funds for Uncertain Times
With stock markets continuing to be volatile, The Sunday Telegraph gave its readers some tips about how to position their portfolios during the current uncertainty. The paper focused on three sectors where potentially investors could reduce some of the volatility and make gains – absolute return funds, cautious funds and strategic bond funds. Absolute return funds aim (but do not guarantee) to deliver positive returns in all market conditions but the paper said that, whilst most managers failed this key objective, Mark Lyttleton of Blackrock had succeeded in doing so since the launch of his fund in 2005. In the cautious managed fund sector, the objective is again to beat cash over the medium to long-term by investing in a mix of equities and fixed interest. The final sector is strategic bond funds which invest in IOUs issued by companies. Corporate bonds are primarily generators of high levels of income and such funds can hold both blue-chip investment grade bonds as well as higher risk high-yield bonds. In the current environment it makes sense to diversify one’s portfolio as much as possible by investing across all the different asset classes including gilts, corporate bonds, commercial property and equities, according to your risk appetite.