This week’s Bulletin which contains:
- The unravelling of Greece’s economy continued last week and overflowed into the Spanish and Portuguese bond and stock markets as investors fretted over the chances of sovereign debt default
- However, the EU indicated that it would support the Greek government and dismissed any likelihood of an IMF bailout
- The problems of the eurozone’s most fragile economies was enough though to worry investors around the world and most major stock market indices suffered falls
- The US dollar and US Treasuries benefitted as investors flew to quality
- US job data whilst positive, left the immediate outlook unclear for the world’s largest economy and here in the UK there are signs of increased job recruitment
- The Bank of England’s decision to withdraw its policy of quantitative easing caused little reaction in the gilt market with prices unmoved
- John Wood of JO Hambro explains his approach to investment and how he picks stocks for his portfolio
What looked like becoming a Greek tragedy appeared to abate at the beginning of last week, well at least according to The Daily Telegraph, which told its readers that investors’ flight from southern European debt markets had begun to subside as EU political leaders moved closer to some sort of rescue for Greece. And indeed, on Tuesday, the country’s prime minister announced that he had forged a partial consensus with opposition leaders in an effort to prevent social unrest over the prospect of three years of economic austerity. Mr. Papandreou said he would continue to support the socially vulnerable and improve employment prospects for the young, but also promised a crackdown on tax evasion. Mid-week EU pressure on Greece was stepped up as the country was ordered to cut public spending and spell out details of its austerity plan as a price for support which, unsurprisingly, went down badly with the country’s labour federation which called for a general strike. So by Thursday, cracks began to appear in the markets once more as investors voted with their feet and headed for the exit, selling equities, bonds and the euro; sending up the cost of credit risk of 15 Western European countries. Over on Wall Street, its so-called fear gauge, the Vix Index, rose sharply. The flight to safety saw a sharp rise in US Treasuries and the dollar which jumped four cents against the euro – the eurozone currency has fallen almost 10% against the greenback since December last year. Finance ministers from the G7 countries said at the weekend that there would be a “European” solution to the problem and that there was no need for an IMF rescue, despite Germany’s hawkish stance that it would not bail Greece out.
But the problem wasn’t contained within Greece. Growing fears over the health of Europe’s weakest economies meant concerns spread to Portugal and Spain – data released during the week showed the latter’s jobless rate passing the 4m mark – resulting in heavy stock market falls on their respective bourses. The Financial Times pointed out that with many governments having been focusing on measures to stimulate their economies, they have failed to explain how they intend unwinding these emergency measures.
As a consequence bondholders have become jittery and as Deutsche Bank commented “It seems that the market wants to accelerate an issue that the authorities were hoping time would heal”. But investors’ concerns meant that there was a ripple effect across both Asian and the US markets which all saw sharp falls, although a late rally on Wall Street Friday evening saw the Dow Jones Industrial Index reverse earlier losses and end with a small gain. Over in Hong Kong, economic strategists pointed to the transmission mechanism – with Asia so dependent on exports to the developed world investors are worried that, if these governments cannot fund their stimulus spending, they will not grow and Asian exports will suffer. So by the end of the week all the major stock market indices had given some ground, with the focus particularly on the eurozone. London was less affected, with The Daily Telegraph saying that, although the UK was facing similar debt issues, it was protected by its currency independence.
Occluded – Chance of Rain
Away from Europe the economic outlook – particularly in the US – remains a little cloudy following the latest jobs data released on Friday. Whilst the US unemployment rate fell to a five-month low of 9.7% last month, revisions to earlier data showed the economy losing almost 1m more jobs than previously thought since the recession began – some 8.4m Americans lost their jobs during the downturn. The government report contained conflicting signals on the health of the labour market, said The Financial Times, because although unemployment dipped, the economy still lost 20,000 jobs in January whereas economists had been expecting a small increase. The reason for the fall in those registered unemployed was apparently down to 136,000 ‘discouraged’ workers who took themselves off the register. There were more encouraging signs from the service sector industries – the bulk of American jobs – where there was an increase of some 48,000 new jobs and which helped cheer investors, enabling Wall Street to recover its poise in late trading. Here in the UK, job vacancies increased last month at their fastest rate for over two years, according to the Recruitment and Employment Federation.
QE Sets Sail
Whilst no real surprise, news that the Bank of England was to suspend its programme of printing money to purchase assets (predominantly government bonds) was received with equanimity in the gilt market last week, with prices little changed. The quantitative easing (QE) initiative launched last March was unprecedented and aimed to boost the stock of money and spending in the economy, although there is wide disagreement amongst economists as to whether the policy was successful or otherwise. The Bank’s Monetary Policy Committee said the £200bn of assets purchased would “continue to impart a substantial monetary stimulus to the economy for some time to come”. Which is probably just as well because, according to a survey by the British Chambers of Commerce, three-quarters of British businesses say they do not feel like the recession is over, even though the economy has started to grow again. David Frost, director general of the BCC said “It is essential that the government demonstrates a real determination to support wealth-creating companies throughout 2010 and beyond”.
On the consumer front though confidence rose again in January as people became more upbeat about the state of the economy and its outlook, according to the Nationwide Building Society confidence index which rose from 70 to 73. “Positive signs from the manufacturing sector and labour market may have helped boost confidence but it is likely to remain fragile for some months” said the society’s chief economist. In the housing market, prices managed to edge higher last month – up 0.6% according to mortgage lender Halifax and 9.9% higher than the trough in April last year. The outlook for the property market looks unclear though, according to some economists, especially as credit conditions remain tight. According to the BoE, there was a surprise fall in mortgage approvals for new house purchases in December – the first for almost a year. One of the reasons credit is tight is that, according to the Building Societies Association, Britain’s mutuals suffered a net £30.2bn contraction in funding last year, with their share of the market falling to 13%. However, fierce competition amongst the banks has seen some of the gap filled with mortgage rates dropping back and higher loan to value products becoming more plentiful.
Looking for Value
Fund manager John Wood of JO Hambro Capital Management specialises in UK equities and is known for his contrarian views. Last week he shared his thoughts on the markets and how he goes about creating long-term value for his investors. “My philosophy has evolved over many years and honed from experiences learnt from the dotcom bubble a decade ago. I don’t use the index to create a portfolio and I don’t use any form of relative value. The market consistently underestimates the value created by well-managed companies reinvesting wisely. This is what ultimately drives the direction of a company’s growth as opposed to liquidity, which is the short-term driver of share prices. So where I want to be is owning high quality businesses that are undervalued – or to use an analogy, I want Waitrose at Aldi prices. This way I believe we will be in a ‘Heads we win, tails we don’t lose too much’ situation. One of the mistakes many investors make is to run their losses and try and compensate by chasing the latest fashion; in other words the main risk to performance is to hold ‘bad’ shares, not missing out on ‘good’ shares. The portfolio will comprise between 35-40 stocks, predominantly FTSE350 with some smaller stocks and can invest up to 10% overseas. Usually I start with a 1.5% holding and build to the optimum level of c3% – I don’t average in or out of a stock and my time horizon is 2-4 years.
My approach is to identify trends and themes – to identify structural growth areas where companies operate in an industry where barriers to entry are high for the competitors. For example, defence electronics where I own Cobham; outsourcing where I own Capita and Compass, and ageing population via Smith & Nephew. Another good example is Bunzl, an international distributor of plastic containers – such as those used in fast food – where its suppliers are disparate and don’t have economies of scale. The company brings cohesion to the industry and through its extensive and well-run distribution hubs, delivers to its customers in an efficient way with high margins. In the defence industry, entry barriers are high and intellectual value carries premium margins – so I own Babcock, VT, Cobham and British Aerospace. In the emerging market space, companies like Unilever and Diageo are growing sales and revenues quickly and relatively cheaply. Whilst I believe in the long-term attraction of emerging markets I think there needs to be a rebalancing in the global economy. The likes of China need to consume more and export less – 95% of GDP is currently capital expenditure related. The markets have focused on the BRIC economies and completely overlooked companies that don’t appear to fit with this – as a consequence it is possible to buy very high quality companies at what I believe are very cheap prices. We are currently in the situation where the UK market is very undervalued relative to other international markets, offering unusual opportunity. The portfolio will have defensive qualities as we move ahead and should be resilient if there are any setbacks”.
John Wood jointly manages the St. James’s Place UK & General Progressive Fund.
Use It or Lose It
With only a few weeks left of the current tax year investors are being advised to take advantage of this year’s Individual Savings Account (ISA) allowance before it is too late. For those aged 50 or over the allowance has been increased to £10,200 – for everyone else it is still £7,200 but increasing to the higher limit from next tax year – and is an efficient way to shelter savings from higher rates of income tax and capital gains tax. The Times reminded its readers about the importance of spreading across different asset classes within the ISA to reduce risk – investors can choose to own property, bonds and shares within their stocks and shares ISA. The Sunday Telegraph took a similar view and also highlighted fund managers who they rated ‘Best of the best’ – high fliers who have consistently proved they are able to deliver superior returns. One of those mentioned was Nick Purves of Schroders who manages UK equity income portfolios, including funds for St. James’s Place.