In this week’s bulletin:
- Weak US economic GDP data last week raised the certainty of a new round of quantitative easing (QE) being announced by the US Federal Reserve at its meeting this week. Increased consumer spending was offset by declining construction activity.
- A second round of QE may well succeed in boosting the US economy but the outcome is uncertain and not all members of the Fed are supporters. Equity investors though have already begun to price-in the benefits of such a policy.
- In contrast the UK economy was given a boost with news that third-quarter GDP came in at twice the rate expected – 0.8%, boosted by the construction sector.
- The market’s reaction was that the BoE would put on hold for now a further round of QE which hit gilt prices but left equities steady. MPC member Alan Posen cautioned the optimism by saying that growth would be hit by the government’s austerity programme and that the BoE should proceed with £50bn of new asset purchases.
- Against a backdrop of stronger growth and lower pensions The Personal Money sections of the press interviewed fund managers focusing on recovery-based strategies, including Nick Kirrage of Schroders. The merits of both pensions and ISAs were discussed as a way of providing income in retirement.
Too Little, Too Late?
As international finance ministers headed home from their G20 meeting in Seoul last week, their upbeat message that they would collectively avoid competitive currency devaluations left the markets unimpressed. “On the whole, the G20 communiqué will not help to reduce the tensions between countries, notably on the issue of what constitutes appropriate monetary and currency policy,” was the view of Commerzbank. So it was no real surprise that once more the US dollar resumed its downward decline, heading towards a new 15-year low against the yen. The corollary of a cheaper greenback was that commodity prices – mostly priced in dollars – rose smartly, with copper reaching a 27-month high at $8,500 a tonne, and gold and oil following. Undermining the dollar’s strength was a continued expectation that the US Federal Reserve would embark on a further round of quantitative easing at its next meeting, due later this week.
The policy of printing even more money (colloquially known as QE2) as a tool to help the US economy has both its supporters and opponents; with the merits or otherwise of such a scheme having filled the press for weeks. However, as far as the markets are concerned, QE2 is a given. Economic data released last week showed that America’s economy is growing, but not quickly enough to chip away at its army of unemployed who number almost 10% of the workforce. Too little, too late was the view of The Times, meaning that although the data showed that consumer spending had quickened in recent months – private spending was up 2.6%, its fastest pace for almost four years – construction activity fell 29%. Exports are rising but at less than a third of the rate of imports and overall growth is still dependent upon federal government spending which rose sharply in the third quarter. The aggregate outcome was that gross domestic product in the world’s largest economy expanded at an annual rate of 2% in the third quarter, up from the previous figure of 1.7%.
Devil is in the Detail
So it’s not so much if but how much that economists and investors are speculating about. The attraction of more QE is simple. If the Fed were to embark on a $500bn purchase of assets (mainly government bonds) it “would provide about as much stimulus as a reduction in the federal funds [interest] rate of between half a point and three-quarters of a point,” commented William Dudley, president of the New York Fed. In other words, the rationale behind the policy is to lower Treasury yields, force banks to lend money and push investors out of government debt into riskier securities. Thus a further rally in equities and other risk assets translates into a “wealth effect” on consumers and companies, that in turn hopefully, said The Financial Times, boosts confidence and stimulates economic activity. But not everyone is convinced, including Thomas Hoenig, President of the Federal Reserve Bank of Kansas City, who warned that more QE would be a “dangerous gamble” and concluded that the move represented a “bargain with the Devil”.
However, the weight of opinion is that Ben Bernanke, Chairman of the US Federal Reserve, will announce a new dollop of money in the hope that, following the initial tranche of $1.2 trillion in 2008, this will do the trick. The difference this time is likely to be a more incremental policy of monthly injections rather than the ‘shock and awe’ tactics previously favoured. The detail is of course as yet unknown but apparently Fed officials are concerned by comments being made by the likes of Goldman Sachs who are saying that the size of the stimulus should correlate to the Fed’s inflation target of 2%; in other words, the Fed would need to buy some $2,000bn of assets. Anyway all, no doubt, will be revealed later this week.
No ‘Double-dip’ here
The ‘here’ being last week’s CBI conference in London which had an upbeat feel to it, with the Prime Minister delivering a positive message on economic growth and articulating supportive government policies. Whilst not all are happy with the plethora of regulations, most delegates, when asked, said they expected to add jobs in the coming year. Only one person, according to The Times business editor David Wighton, put their hand up when asked if they expected a double-dip recession. Industry’s confidence may also be percolating into the wider economy – according to the GfK NOP Consumer Confidence Index which showed that, whilst shoppers’ appetite for major purchases remains muted, overall confidence rose to -19; with the index once more remaining fairly stable. The CBI also announced that retail sales grew strongly in October, with an index reading of 36, not far off September’s six-year high. The same can’t be said though for confidence in the UK housing market, with news that house prices fell 0.7% in October, according to the Nationwide Building Society, coupled with a further fall in mortgage lending.
However, the best piece of news came mid-week with data showing that the UK economy grew twice as fast as expected in the third quarter, bolstering the government’s case that the economy is robust enough to withstand spending cuts. Growth came in at 0.8%, down from the previous quarter’s record 1.2% but double the 0.4% predicted. So far this year the UK has achieved aggregate growth of 2.4% – much in line with the annual trend rate but with the final quarter yet to come. The strong activity encouraged investors to switch bets that the Bank of England would not introduce a fresh round of QE here in the UK. In another boost, Standard & Poor’s, the rating agency, raised the outlook on Britain’s triple-A rating to “stable” from “negative”, offering a vote of confidence, said The Financial Times, in the government’s austerity programme. Of course, the reduced likelihood of more QE hurt the gilt market where yields rose above 3.0% on the ten-year bond, whilst equities held steady.
But you can’t please all of the people all of the time. Alan Posen, a member of the BoE’s Monetary Policy Committee, said last week that the coalition’s deficit-cutting plans will deliver a “material” hit to British economic growth over the next two years. He also took the opportunity to tell people not to get “too excited” about the latest GDP numbers, cautioning that the economy remains weak and reiterating arguments in favour of more QE. Dr. Posen, an expert on Japan’s two-decade period of low inflation and low growth, was the only MPC member to vote for a second round of QE last month. Saying he didn’t put a lot of faith in the data, Dr. Posen said, “The businesses I meet with in the property and construction sector don’t tell me we are having an historical boom right now”. Maybe not and it’s true that house builders’ share prices have fallen back, but the broad market held steady last week as investors digested the latest economic data and earnings figures from the corporate sector – 85% of which have come in above expectations. The London market closed down a little on the week, with the FTSE 100 slipping 1% to close at 5,675, mirroring similar performances in other global markets.
Green Shoots of Recovery
The better growth numbers for the UK encouraged the weekend money media to search out ways to capture future growth opportunities, with The Daily Telegraph talking to a number of fund managers who specialise in recovery strategies. One such manager is Nick Kirrage of Schroders who, alongside his colleague Kevin Murphy, targets companies which they believe are poised for recovery. “The fund is taking a longer-term view. If four or five years from now the economy is a lot better, then we are in a good position to do well,” said Mr Kirrage. “But if the double-dip does happen, we shouldn’t get wiped out either. We concentrate on buying shares in companies that have fallen out of favour and are trading at low valuations. At present this would include retailers, house builders and consumer-led companies, including banks such as Lloyds and RBS. We are trying to find companies whose share price has been dragged down by negative sentiment but which remain fundamentally sound businesses.”
Of course, equity investors can be forgiven for thinking that the world belongs to them – most people would know that the ‘Footsie’ is London’s index of the UK’s top 100 blue-chip stocks. But The Financial Times argued that it’s bonds – IOUs issued by companies – that really matter. Apparently, the global bond market is worth about $51 trillion compared with $32 trillion in global equity markets. In recent times, corporate bonds have been hugely popular with investors who are looking for higher levels of income. From time to time, it is also possible to make a capital gain – and also lose capital – the last three years are a good illustration as to the potential risks. Today, with the returns from deposits at very low levels and a balanced bond portfolio yielding c7.0%, it is no surprise this type of investment is attractive and some commentators believe certain parts of the bond market are overvalued. But as The Financial Times pointed out, not all bonds behave in the same way so it is important to have a fund manager who uses a multi-strategy fund which allows the manager – such as Paul Read and Paul Causer at Invesco Perpetual – to move up and down the risk spectrum.
Income in Retirement
The recent pension rule changes announced by the government will have a significant impact on most people in the UK over coming years. Most people aren’t saving enough – HMRC have calculated that some 758,000 people have cut back their pension contributions by almost £2bn during the credit crunch. But pensions aren’t the only way to save for income in retirement – Individual Savings Accounts (ISAs) are an efficient way to produce what is effectively ‘tax-free’ income – a point discussed by The Sunday Times. Both investments have their merits – once you have taken your tax-free cash, your pension fund can only provide income whilst an ISA allows access to capital at all times, as well as providing income. As ever, the most sensible strategy is to diversify – not just from an asset class standpoint as discussed above – but also in your choice of tax wrappers. In an age of increasing taxation, taking advantage of the tax-efficient vehicles available should be an imperative for all investors.
Daily Telegraph Wealth Management Awards
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