In this week’s bulletin:
- The government’s Comprehensive Spending Review had little impact on the markets last week – gilts, sterling and equities remained stable and marginally up on the week.
- China surprised the markets by raising interest rates 0.25% as a means to moderate growth which saw its economy grow almost 10% last quarter.
- Further exchanges in the currency war were met with calls for restraint and positive policies for co-operation at the G20 meeting held in South Korea last week. Ministers finally agreed not to engage in “competitive devaluation”.
- Neil Woodford of Invesco Perpetual discussed with the Financial Times his latest strategy around owning dependable stocks.
- Duncan Owen of Invista Real Estate sees opportunity in the top-end of the secondary commercial property market but sees returns flattening over the next 3-5 years with rental income the largest component.
Into the Unknown
That seemed to be the view of the majority of economists and financial commentators following the Chancellor’s delivery of the government’s Comprehensive Spending Review. In a nutshell, said The Financial Times, George Osborne has taken Britain’s largest economic gamble in a generation by betting that the country can withstand £81bn of public spending cuts at a time of global uncertainty, yet emerge stronger, fairer and richer. Whilst the cuts are widespread they will be introduced over a period of years in an attempt to avoid increasing the chances of the UK going back into recession. Around half a million public sector jobs are likely to go but the mood seems optimistic that private industry can take up the slack – the CBI and others were positive that its members could create new jobs at the rate of 200,000 a year. “Business has been clear: the deficit must be tackled, no matter what,” said David Frost, Director-General of the British Chambers of Commerce.
So what did the markets think about it all? With many of the cutbacks well advertised in advance, it was really no surprise that the news was received phlegmatically by the financial markets – gilts, currencies and equities were all flat as the Chancellor spoke. “At one stage while he was speaking it was as if the market was closed,” said David Jones of IG Index. The sectors where there had been some nervousness ahead of the review included outsourcing and infrastructure companies; but with the cuts not as bad as feared, there was a sigh of relief, with rail and bus operators rallying smartly. In fact, it was really a non-event from the markets’ perspective, with investors more focused on news from the emerging markets where China took everyone by surprise by increasing interest rates by 0.25%. In fact, by the end of the week, London, New York and leading European equity indices were all within a whisker of this year’s highs – last seen back in April.
Not that there aren’t signs of economic uncertainty. Last week it became clear that the traditional autumn pick-up in the UK housing market had failed to materialise, with news that the number of mortgage approvals fell for the fourth consecutive month in September to their lowest point since April 2009. Just 44,000 loans were approved by the likes of Santander, Lloyds and HSBC with net lending falling to just £1.1bn according to the Bank of England’s (BoE) credit conditions survey. Market experts blamed the malaise on uncertainty around public sector job cuts and the potential for further house price falls. But paradoxically, much to the surprise of many economists, the asking price of property actually rose by 3.1% last month as hopeful sellers flooded the market, according to online property company Rightmove. Mind you, this comes fast on the heels of recent data from the Halifax which said that prices fell 3.6%. Either way, the market is clearly difficult, which has hit builders hard with the latest survey from the Home Builders Federation making gloomy reading, according to The Financial Times. Added to this, retail sales suffered an unexpected decline last month with high street sales down 0.2% last month, according to the Office for National Statistics.
So what does this mean for the economy and what action are the policymakers likely to take? Minutes from this month’s interest rate setting meeting showed that for the first time in over two years, the BoE was split three ways on rates, indicating deep divisions within the Monetary Policy Committee (MPC). Member Alan Posen called for more quantitative easing (or QE2 for short) – another £50bn on top of the existing £200bn. Andrew Sentance voted for a 0.25% rate rise, with the remaining seven opting to leave rates unchanged and QE on hold. Economists said that on balance the minutes suggest the MPC is leaning towards restarting QE – in other words a further stimulus to the economy. With the latest money supply figures showing underlying weakness – the 0.9% rise in September was the lowest on record – Mervyn King, Governor of the Bank, is worried about anaemic growth. He said that some gauges of inflation were “extremely subdued” and that monetary policy remained a “potent” weapon. A further round of QE would boost gilts but could weaken sterling as a result of the increased money supply.
Over in the US, the Chairman of the US Federal Reserve, Ben Bernanke, has been more open about the likelihood of further QE as a way of boosting the flagging American economy. According to the Fed’s latest survey, its ‘Beige Book’ report, the US economy grew at a “modest” pace in September and early October, pointing to expansion in manufacturing and signs of life in consumer spending, although unemployment remains stubbornly high at 9.6%. The report was more upbeat than the previous one, although consumers remain focused on buying necessities, with most housing markets still weak. Whilst no decision about another round of QE has been taken by Mr Bernanke he has said there is a case for further action, although most observers don’t see any new policy being announced ahead of next week’s mid-term elections. The view is that Fed officials are weighing up an approach that allows more discretionary meeting-by-meeting decisions rather than the “shock and awe” stimulus it launched in the depth of the crisis back in 2008.
A Dollar, a Dime
Not one but potentially trillions more if a second round of QE does go ahead in the US and this lies behind the recent friction between some of the world’s most dynamic economies and their American trading partner. Ben Bernanke may not have formally announced more QE but currency traders already see it as a certainty and in response the dollar has fallen sharply in value – the greenback hit a fifteen-year low against the yen last week. This is good news for American exporters but bad news for the likes of South Korea et al who have seen some of their competitive edge eroded. China has caused most annoyance by engineering the yuan to fall in lockstep with the dollar, thus retaining its relative position, although an unexpected hike in interest rates last week gave its currency a temporary boost. The rate rise was seen as the most decisive step yet to scale back the huge stimulus that the Chinese injected into their economy during the crisis. Data out last week showed the economy still grew at a robust 9.6% in the third quarter but lower than the 10.3% in the previous one, thus allaying some fears of overheating.
But the impact of higher Chinese interest rates soon became history as the markets once more mulled over the positive outlook for the country’s economy whilst still fretting over a possible currency war. Last week the G20 finance ministers and central bankers met in Seoul to find a way of toning down the rhetoric which threatens to escalate tensions further. India’s prime minister said he was worried about the global situation and appealed for “a meeting of minds” to give more impetus to co-ordinated financial reform and rebalancing of the world economy. His concerns were echoed by Mervyn King who warned that tensions over exchange rates could degenerate into trade protectionism. “That could, as it did in the 1930s, lead to a disastrous collapse in activity around the world,” he said. Over the weekend the G20 finally reached agreement that member nations have promised to refrain from “competitive devaluation” of their currencies and would “move towards more market-determined exchange rate systems”.
Leading UK equity manager Neil Woodford took to the press last week to explain why he thinks some of the UK’s largest and most dependable stocks offer a huge opportunity. “There is no doubt in my mind that the economic outlook remains challenging. Deleveraging will remain a dominant theme for many years and growth will be lacklustre. It is interesting therefore that shares in some of the UK’s most dependable businesses currently trade at unusually low valuations – AstraZeneca, Vodafone and BAE Systems all trade on single digit price/earnings multiples. Dividends from these businesses look safe, are likely to grow and provide a yield that is very difficult to replicate from any other asset class. These businesses face challenges but they can influence their own destiny in a way that companies more vulnerable to the economic cycle cannot. In time, I believe companies with dependable characteristics will be valued more sensibly. Patience is required but in the meantime, the combination of dividend yield and dividend growth should result in very satisfactory returns for investors”.
The residential property market may be in the doldrums but in the commercial sector there is apparently a race to build new towers in the City of London, with news that Land Securities is set to build a 37-storey skyscraper, nicknamed the Walkie Talkie, in the heart of the Square Mile. So now seems a good time to weigh up the outlook for commercial property – fund manager Duncan Owen of Invista Real Estate shares his thoughts.
“The recovery in average UK commercial property values over the last year or so has exceeded expectations but is perhaps misleading. The secondary property market has seen a much weaker recovery than the prime end and more fashionable sub-sectors of the market have overcorrected and are now arguably overvalued. Consequently, I believe that there are less fashionable parts of the market that offer better potential for both income and capital growth over the medium to long term and we are focusing attention in these areas. For example, shopping centres, City of London and regional offices are now valued at between 9–19% below their 2002 levels. There may be better potential returns in selective parts of the secondary market with some properties now offering opportunities for low entry prices as well as active management upside in the short term.
“In addition, in a lower growth environment, the income return offered by commercial property will become an increasingly important contributor to total returns. We are currently forecasting average total returns for the UK commercial market of about 8% per annum over the next three to five years, dominated by the income component of that return. The monthly initial yield on the UK commercial property market as a whole is very attractive at 6.45% – especially when compared to the other main asset classes. Whilst I remain cautious on the outlook for the wider economy and its potential impact on the commercial property market, the portfolio continues to be well placed, with good relative performance and significant liquidity to acquire assets to add to long-term performance.”