In this week’s bulletin:
- Globally equity markets shook off uncertainty and generally advanced with the UK FTSE 100 achieving levels not seen for over four months
- As expected Bank of England Monetary Policy Committee maintained interest rates and quantitative easing at current levels
- Spectacular crash of Connaught, the building and support services firm, provided a stark reminder of the harshness of the current environment
- The debate between those favouring further easing and those seeking austerity continued as President Obama proposed further subsidies
- The Sunday Times reported investors in structured products were not receiving the returns expected
Markets shake off uncertainty
Last week saw a general rise in global markets, with the UK FTSE 100 achieving levels not seen for over four months. However, the overall gains masked continuing uncertainties, as financials and energy stocks ‘see-sawed’ throughout the week. Whilst the Bank of England Monetary Policy Committee’s decision to maintain interest rates and quantitative easing at current levels was widely expected, the rapid and spectacular crash of Connaught, the building and support services firm, provided a stark reminder of the harshness of the current environment.
Connaught went from a stock market value of £626m to bust in just three and a half months. A lack of clarity around the company’s reporting and true financial situation compounded by their reliance on local council spending, which is expected to be severely limited by governmental austerity measures, led to a run by creditors, finally resulting in Connaught running out of cash. None of the St. James’s Place funds had holdings in the company.
In the financials arena, the announcement of Bob Diamond as the new chief executive of Barclays Group prompted mixed reaction, somewhat surprisingly given his track record. This is a man who has been responsible for the development of Barclays Capital into a global financial colossus in just 13 years. His track record alone should have dispelled any fears. However, as an investment banker, he is regarded with suspicion by some shareholders and investors, who suspect his entrepreneurialism will lead to increased risk taking and greater potential for catastrophe. In the current environment of increased corporate governance and governmental regulation, it is unlikely that Barclays will be led to meltdown by an optimistic doer who has experience of building a global brand.
Cutters vs. Spenders
With the back drop of governmental austerity measures being indirectly linked to the Connaught decline the argument between the ‘cutters’ and ‘spenders’ continues, as reported by The Financial Times, both in the UK and in the US.
The argument against austerity measures has been recently joined by Ed Balls, Labour Party leader nominee. He argues that, with a credible economic alternative to the expected measures, the aggressive cuts could be avoided and the rug not pulled from under the fledgling recovery. Balls went as far as to suggest that the Government’s approach to spending is “economically misguided and dangerous”. However, what this fails to recognise is that the Coalition inherited a policy of fiscal tightening which they have simply accelerated in order to complete it, so that it does not spill into a new parliament. The short term aim was to reassure markets and regain fiscal credibility for the UK. The current low gilt yields would seem to reflect, at least in part, the confidence instilled by the announced measures, although the spenders will say that they indicate no crisis in the public finances.
In the US, it would seem that President Obama and his regime fall squarely into the camp of ‘spenders’. His new proposals, which include $50bn of extra spending on infrastructure, expanded tax credits and relaxed rules on corporate investment write-offs, would all seem to offer boosts to corporate U.S.A. However, it is highly likely they will be rejected or diluted. The current US stimulus package sits at $1 trillion and seems to have been largely ineffective, so what will an extra £50bn achieve? Whilst tax incentives may seem attractive, it is highly likely they will be replaced by other taxes. Many see the proposals as purely electioneering to try and stave off the march of Republican candidates in the mid-term elections in 50 days’ time.
The Federal Reserve Board’s business survey’s noted “widespread signs of deceleration (in growth) compared with preceding periods” are currently offset by increased consumer spending activity and a reduced trade gap. However, consumer and trading confidence may take a knock if government policy is further clouded by political infighting.
What cannot be denied is that the banks continue to hoard funds. Unless the financial institutions begin to lend more widely at reasonable terms, any further easing will simply improve the balance sheets of many banks.
End of Year Stock market predictions encourage
Encouragingly, The Sunday Times reported that City analysts are predicting a 10% share price rally by the end of the year. Although UBS downgraded their FTSE 100 forecast for the year end from 6250, they still targeted 6,000. This aligned with Citigroup, whilst Morgan Stanley upgraded forecasts from a rather pessimistic 5,000 to 5,800.
Expectation will be buoyed by improving US trade deficit data and a reducing number of unemployment benefit claimants in both the UK and US. At the same time, the Organisation for Economic Co-operation and Development (OECD) said Britain would be the fastest-growing economy in the G7 group of industrialised nations in the third quarter of this year.
Recent profit reports from a large number of big businesses have also boosted confidence. However, it cannot be ignored that a large proportion of these profits have come from cost cutting and streamlining in flat markets.
So which areas might lead the charge? Two possible opportunities highlighted, which are pursued by a number of managers of St. James’s Place funds, were banks and companies from developed economies with exposure to emerging markets.
Lloyds Banking Group led the FTSE rally last week after several analysts updated their outlook for the stock, noting a number of UK domestic banks still offer long term value.
With the wealth of conflicting comment, policy and data we asked Mark Lyttleton, co-manager of the St. James’s Place UK Absolute Return funds, which can take advantage of both falling and rising share prices, to comment. “Equity markets globally were weak last month as investors continued to wrestle with the fragility of the economic recovery, particularly in the United States. In our mind, the data is inconclusive. On the one hand, it is perfectly consistent with historic precedents that the rate of expansion should slow in the second year of recovery. On the other, the removal of stimulus and the need to reduce excess leverage understandably raises questions as to what the new normalised level of aggregate demand really is.
A good illustration of the uncertainty surrounding the economic outlook is US employment data. In August, private employment grew by only 71,000 and the previous month’s report was revised sharply lower, but the workweek continued to expand and hourly earnings also rose. On balance, we believe the evidence points to a mid-cycle slowdown rather than a prelude to a double-dip recession and are comforted by the vigilance of financial authorities globally. One particular illustration is the Federal Reserve’s announcement that principal payments from its agency and Mortgage Backed Securities holdings would be reinvested into longer-term Treasuries in a move designed to bolster growth and prevent the US economy from lapsing into recession.
Within the fund, we modestly reduced the net exposure (the value of our long positions less the value of our short positions) of the Fund over the month but our gross exposure (the combination of our long and short positions) remains high, reflecting the conviction we have in a number of different stock positions. We remain positively exposed towards the beneficiaries of increasing corporate discretionary expenditure and further healing of funding markets, but are more cautious on areas of the economy that remain over leveraged”.
Considering alternative investments
With the uncertainty felt by many and the average easy-access account paying “a measly 0.77%” (The Sunday Telegraph – source: Moneyfacts), The Sunday Times considered alternative investments.
They reported that thousands of savers who invested in products claiming to offer stock market returns without risks are finding that they are maturing and paying little more, or even less, than they would have got from cash on deposit.
Protected or structured products, which accounted for £13.9bn in investment in 2009, have been maturing this summer and many are only repaying the original capital invested. 5 year plans maturing this year have seen no stockmarket growth versus a rise in the retail prices index of 16.6% in the same period (July 2005 to July 2010). Concerns were also raised over the ability to exit early if conditions were unfavourable and the penalties for doing so. Shorter term products also came in for criticism.
The Sunday Times also carried an extensive article on the rush by many fund managers to launch bond funds, focussing on those offering a higher income or yield. Yields on traditional bond funds have been falling as institutional and private investors have moved into this area, as evidenced by the Investment Management Association’s data indicating the fixed income sector was the best selling in July.
It was interesting to note that whilst the article outlined high yield bonds, and funds investing into them, which offer higher potential returns but with bigger risks, no mention was made of Senior Secured Debt (SSD). These bonds seek to offer an alternative route to recovery if the company cannot maintain their interest payments to investors or repay the loan. The investor can call upon tangible assets such as property, machinery or even intellectual property rights in lieu of the debt. In this way the investor may recoup a greater proportion of their investment in the event of a default.