In this week’s bulletin:

  • Debt concerns for the eurozone reasserted a hold over markets 
  • Shares in RBS, Lloyds fell late last week pushing the FTSE 100 down from a two and a half year high 
  • Stories surfaced regarding the amounts of bonuses to be paid to RBS employees 
  • AstraZeneca experienced a significant fall as one of its key drugs failed to get approval for the US market 
  • The weekend press focussed on reviewing the various asset classes from 2010, and took a look ahead to 2011

No Christmas Spirit
With Christmas approaching, debt concerns for the eurozone reasserted a hold over the bond markets this week, as the recent sell-off in US Treasury bonds showed signs of slowing, and worries about Chinese policy tightening faded. Early in the week further evidence of accelerating economic growth in the US and Germany bolstered optimism over global recovery, with the UK market reaching its highest level in two and a half years. However, it was the renewed uncertainty about the eurozone periphery that provided the key price driver later in the week. Investors focused on rating agency actions after Moody’s issued an unprecedented five-notch downgrade on Ireland’s government debt to the same level as Trinidad & Tobago and Russia. The credit rating agency also warned of a possible downgrade in Spain, while a summit of EU leaders in Brussels saw the markets take little comfort from an agreement to establish a permanent crisis management mechanism from 2013 onwards. According to The Times, Germany ruled out adding to the interim €750 billion rescue fund, leaving markets to fret that existing resources could be inadequate to cope with the crisis should it spread to Spain.

Shares in Lloyds and RBS fell sharply on Friday pushing the UK market down, as the Bank of England warned of the threat to Britain’s banks of a continued euro crisis. As reported in The Mail on Sunday, Lloyds Banking Group also announced a sharp rise in its likely losses in Ireland. Lloyds, which is 41% owned by the taxpayer, has already taken a £1.6 billion hit to its profits from its portfolio of loans to Irish businesses and households, but on Friday they announced a further £2.7 billion in losses, blaming the sharp cuts in public spending which will slow the country’s economic recovery.

This announcement knocked the RBS share price down 6%, as the company has exposure of £53 billion in Irish loans and owns Ireland’s third biggest lender, Ulster Bank. While these two companies have significant exposure to Ireland, the next stage of the crisis is threatening to hit others. Portugal is seen as the next most vulnerable state, but a Spanish crisis would turn the City spotlight firmly on Barclays, who have so far avoided the Irish and Greek crises relative to other major banks. The bank holds a total of around £26 billion in Spanish government debt and residential mortgages, by far the highest exposure of the UK banking institutions.

Political woes
As well as the European issues surrounding RBS, The Sunday Times reported the bank’s plans to pay an estimated £1 billion in bonuses to its investment bankers early in the New Year, inflaming the political row over City pay. The Business Secretary, Vince Cable, has demanded additional disclosure of the pay packets of top bankers, and said that he will push for reforms despite threats of a City exodus. He told the paper, “Bonuses this year will probably be down, but we are still faced with this problem about the fact that they are excessive and unjustified. The key is disclosure and we’ve got to have strong disclosure rules.” Directors at RBS, in which the taxpayer has an 84% stake, have begun discussions on payouts in recent weeks, but no final decision will be made until January at the earliest. David Cameron warned on Friday that banks should prepare for further taxes if they plan to pay out these sums.

Astra slump
One of the UK’s most widely held shares, AstraZeneca, slid sharply on Friday as it looked increasingly unlikely that a blood-thinning drug, thought to be key to its future, will be approved for the US market. The US Food and Drug Administration told the company that it had not approved the medicine, Brilinta, asking instead for more information about its clinical trial results. AstraZeneca has pinned much of its hopes on a revenue boost from Brilinta as patents expired on some of its best-selling drugs, as analysts had expected that US sales of the drug would contribute around 10% of earnings per share by 2015. The drug has been approved for use in Europe but being unable to sell in the world’s largest drug market would limit Brilinta’s potential, while even if it is approved next year, this will reduce the amount of time that AstraZeneca is able to maximise revenue before the patents expire.

Winners and Losers in 2010
It is the time of year when the weekend press begins to reflect on 2010, producing a comprehensive review of the various asset classes. As pointed out in The Mail on Sunday, investors became less risk averse with regards to equities as the year progressed, and despite fears of a global double-dip recession, the year has been a rosy one for equity investors. This general upwards trend masked some sharp falls, as the FTSE 100 started the year at 5,412 and now sits within reach of the 6,000 level, but dipped below 4,800 as recently as July. As reported in The Sunday Telegraph, the Emerging Markets performed best, with Asia unsurprisingly the next best place you could have placed your equity investment this year. Europe showed slightly positive returns, but given the shaky currency and the ongoing debt problems, any positive return would perhaps be a surprise to many. Looking ahead, if inflation continues to be a concern for investors, then for equity markets it is generally good news as companies can increase their prices to keep pace.

Ian McVeigh of Jupiter recently reported “We think that equity markets in general have substantial upside potential provided that there is a reasonable economic outcome. There are clearly risks around, principally the ongoing uncertainties in the eurozone and the biggest concern of all, Chinese inflation. Although we need to watch the situation in China closely, we are optimistic that the country can sustain its strong growth and, along with a recovery in the US, continue to drive the global economy. Provided this happens, we believe equities can make significant further progress.”

Perhaps the investment story of the year was the rise in commodity prices, but while gold and oil have risen the most and are the highest profile commodities generally, there were other winners such as copper, cotton, corn and cocoa. While this has stoked inflation and caused food prices to rocket, those who invested directly in commodities have made good returns. While there are serious fears over a commodity bubble in 2011, demand from China and India does not look like slowing and this is partly what is driving prices upwards.

For every winner, there is seemingly a loser. The Sunday Times reported that more than £5 billion has been wiped off the real value of British savings in 2010, the only year since the 1990s that average savings rates have not kept pace against inflation. Savers have been hit with rock-bottom interest rates and rising inflation, with this year being even worse than 2009, with banks and building societies chipping away at rates and inflation eroding the value of the money. According to Moneyfacts, there are just three accounts paying a real return on savers’ money, while for higher-rate taxpayers there is only one. A basic-rate taxpayer currently needs an account paying an annual equivalent rate of 4.13%, while a higher-rate taxpayer requires a rate of 5.5%. The one silver lining is that rates on cash ISAs have risen slightly, although the average instant access account is still paying just 0.8%. Looking ahead to 2011, the Governor of the Bank of England is on record as saying he does not expect inflation to fall in the short term, while interest rates look set to remain low for the foreseeable future, with some analysts not anticipating a rise until 2012. Inflation looks likely to continue to creep up as the impact of a 2.5% hike in VAT in January takes effect. This could encourage the Bank of England to increase the base rate by a small amount, but opinions among economists remain divided.

One of the most popular sectors in the investment world recently has been the bond market, with investors seeking income and wary of stock market volatility. Some £19.3 billion has been invested into this area in the past three years. The performance of the sector has not been as impressive as 2009, but returns have still been reasonable and good-quality corporate bonds are still yielding significantly more than cash.

There have been increasing fears of a bond bubble forming, due to the ongoing concern over inflation and the prospect of rising interest rates, so we asked Paul Read and Paul Causer of Invesco Perpetual for their thoughts. They reported optimistically, “In terms of strategy, we continue to favour higher-yielding investment-grade names and better-quality high-yield issuers. We believe that with many high-yield credits still offering attractive yields and corporate issuers in a recovery phase, there remain opportunities. Demand for high-yield paper remains strong, there has been a collapse in the default rate and it has been a record year for issuance. Elsewhere, despite November’s weakness, we continue to see value in banks and other financials. Market volatility saw us add to some positions with attractive yields, such as Parpublica, a Portuguese state holding company. We also participated in the new issue in Pipe, a manufacturing company, at a yield of 9.5%, as well as adding to our position in financials through the purchase of Lloyds.”

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