In this week’s bulletin:
- Ben Bernanke delivered his prognosis for the US economy
- The US dollar drifts again, with consequences for the global recovery
- Gold continues to surge upward, as demand stays strong
- The UK government announce significant changes to pension arrangements
- The UK Equity Income sector comes under the spotlight
All eyes on the US
The Chairman of the Federal Reserve, Ben Bernanke, had the attention of the world on Friday as he delivered a bleak prognosis for the US economy, firming up the likelihood of a further round of quantitative easing to battle economic slowdown and rising unemployment and head off the risk of a downward spiral in prices. As reported in The Times, speaking at a monetary policy conference in Boston, Mr Bernanke said that economic growth was less vigorous than the Fed preferred and that the risk of deflation was higher than was desirable. “There would appear, all else being equal, to be a case for further action,” he said. However, he also spelt out the risks of additional stimulus, as by buying long-term debt from the Treasury the Fed would force down long-term interest rates, which would make mortgages cheaper and encourage consumers to borrow and spend. Further down the line, it is feared that this would give companies licence to increase prices, leading to higher inflation. On the positive side for the Fed, it would be hoped that the increased revenue would encourage recruitment in the US, easing the current 9.6% unemployment rate.
This, in turn, has increased speculation of the UK following suit by pumping billions of pounds in to the economy, with The Sunday Times suggesting that this could be as much as £100 billion as early as next month. With the UK economy expected to slow over the winter, many fear a double-dip recession and economists suggest that the Bank of England will act to avoid such an event. The prospect of another round of gilt purchases has driven government debt yields sharply lower over the last month, starting when the Fed gave an initial signal of intent in September. The ten-year gilt yield has fallen to 2.94% from where it stood on the 20th of September at 3.14%.
Macroeconomic events may have overshadowed the start of the third-quarter earnings season for much of the week, but the results were generally greeted favourably as equity markets globally are now at their highest since September 2008. Despite a late dip on Friday, the FTSE 100 gave a rise of 0.8% on the week, now at a level 9% higher than the start of September; while Wall Street stocks closed ahead for the week after significant results from the technology sector.
Dollar under pressure
The prospect of further asset purchases in the US caused heightened tension in foreign exchange markets, as the week saw heavy dollar selling. In the moments after Ben Bernanke’s speech, the dollar drifted another 0.7% against a basket of major currencies, reaching parity against the Australian dollar for the first time since it was freely floated in 1983. The US currency sank to its lowest levels of 2010 including a 15-year low against the yen, and a nine-month low against the euro.
This dollar weakness saw a drive in global equity markets and commodity prices, most of which are priced in dollars. However, while the falling dollar may help struggling American exporters, The Sunday Times was quick to point out that there could be unprecedented consequences around the world should the push in commodity prices continue further, and posed the question: what does more damage, a weakening dollar or a stagnating America? With China the world’s biggest importer of raw materials such as iron ore and copper, a falling dollar makes these more expensive to import. This will push up the cost of everything that China itself exports, passing on the price increases to customers around the world.
Currency rows are rumbling all over the world. The Financial Times reported that the US is to publish a paper stating that China is a “currency manipulator”, and Brazil’s finance minister, Guido Mantega claimed that his country is a victim of an international “currency war” that is artificially inflating the Brazilian real. If America is perceived to be deliberately driving down the value of the dollar, this could add a new dimension to any row, but Ben Bernanke’s prime concern is American workers, as employment is one of the key objectives written into the Fed chairman’s contract. In addition to these disagreements, Japan accused China this week of attempting to make the yen artificially strong by buying Japanese government bonds. Japan’s reliance on exports makes a stronger currency a disadvantage, and government intervention has so far failed to stem the rise as the yen has strengthened more than any other currency (37.5%) against the US dollar since the start of 2008.
Rise and Shine
The surge in gold prices hit another high this week at $1,387 per troy ounce as concerns mounted over the global economic outlook. According to The Financial Times, this is causing mining companies across Australia, South Africa and Latin America to receive attention from buy-to-hold investors who subscribe to the view that metal prices will be driven higher for years to come. This view is generally due to soaring demand from the emerging middle-classes in China, India and Brazil. However, opinions vary on whether the superior way to gain exposure to this asset class is through mining stocks or through direct exposure to the yellow metal. The current rush to buy direct has been driven largely by investors seeking a hedge against inflation, or a currency play as foreign exchange markets have become increasingly volatile.
In spite of the gold price having quadrupled since starting the year 2000 at $280 per ounce, demand is expected to stay strong if central banks introduce further monetary stimulus programmes, weakening the value of paper currencies and increasing the risk of inflation in Western economies. The rally in gold has also helped push silver to a 30-year high of $24.90 per ounce, while base metals have also fared well with copper prices looking increasingly rosy due to shrinkage in supply.
The weekend press were united in their advice to readers this weekend, advising pension savers to review their pension arrangements after the government announcement that the maximum that can be paid into a pension and earn tax relief will be capped at £50,000 per year (from £255,000) from April 2011. Of course, for the vast majority saving for retirement this still presents a very attractive objective and opportunity. In addition to this, the lifetime allowance will be trimmed from £1.8 million to £1.5 million from 2012 onwards. The intention of this announcement is to reduce the cost of tax relief on pensions, which HM Revenue & Customs estimates amounted to £19.7 billion last year. According to The Mail on Sunday, this will affect more than 100,000 savers, but experts suggest this figure will increase over time unless the allowances rise in line with earnings. However, The Independent on Sunday also pointed out that this will also affect people such as middle earners who are in a final salary pension scheme, or business owners who planned to use their company assets to fund retirement. Anything over the £50,000 cap, including employer’s contributions, will be subject to tax, which could trap those in final salary schemes for whom the taxable benefit of a pay rise could exceed the gross salary increase. The message was clear though; these proposals could well affect pension savers as the plans firm up, so this is an area that should be reviewed regularly.
Patience could pay dividends
Income investing was under the spotlight in The Daily Telegraph, which pointed out that investors in this area have suffered during the economic downturn. Recent times have seen many UK companies with little choice but to cut dividend payouts and retain the cash on their balance sheets, while the Bank of England has slashed interest rates to 0.5% to keep the economy afloat. Bond markets have been spooked by quantitative easing, while property values have fallen as well. In short, there have been few options for income seekers; but, according to the paper, that could be about to change with equity income funds being the beneficiary of dividends making a comeback over the coming months. Research from the US shows that cash held on corporate balance sheets in developed countries is at the highest level for 60 years – three times higher than it was in 1982, before the equity market surge. The paper pointed out that so far in 2010, 210 FTSE companies have increased their dividend, while 55 have remained the same and only 30 have cut the amount paid to shareholders. This compares with figures of 156, 51 and 86 respectively for the same period last year.
The importance of dividends should not be underestimated. According to the 2010 Barclays Equity Gilt Study, £100 invested in equities at the end of 1945 would be worth just £241 today in real terms without the reinvestment of dividend income: but with reinvestment, that figure rises to £4,011. In the UK Equity Income sector, fund managers tend to believe that the most secure dividends are currently to be found in sectors that did not rally with the general market last year. The likes of the pharmaceutical, utility and telecom sectors are amongst the cheapest markets, but could they offer good value? Neil Woodford of Invesco Perpetual told The Daily Telegraph, “I look to invest in companies that can provide sustainable long-term dividend growth. If I can invest in a business when its growth potential is not reflected in the valuation of its shares, then this not only reduces the risk of losing money, but it also increases the upside opportunity.”