In this week’s bulletin:
- Banking bonuses were in focus again, as RBS and Lloyds TSB are expected to pay large bonuses to senior employees
- The Bank of England continues to be put under pressure to curb inflation
- The major players in the retail sector report this week, with excuses being given in advance for poor profits
- Problems in the eurozone continue to be of concern, particularly Portugal’s levels of debt
- Andrew Green gives his view of current market conditions
New year, same news
The change in year does not necessarily mean a change in news as it was reported that Stephen Hester, the chief executive of Royal Bank of Scotland, is to be paid almost £7 million this year in bonuses, salary and other payments. These annual earnings come just two and a half years after the state-controlled bank was bailed out by UK taxpayers to the tune of £45 billion, and the bank is still 84% owned by the government. After foregoing his expected £1.6 million bonus last year, Mr Hester is expected to accept his cash and shares bonus of £2.5 million when it is allocated to him by the board next month while, overall, the bank will pay £950 million to senior employees. The Sunday Telegraph reported that the announcement is expected to cause controversy at a time of government austerity measures, particularly as there have been signs that ministers are unlikely to take any action to curb bonuses. Vince Cable, the Business Secretary who is one of the most vocal critics of large bonuses, has been unable to persuade George Osborne that a crackdown is necessary.
The coalition government is poised to allow Britain’s five biggest banks – RBS, Lloyds TSB, Barclays, HSBC and Standard Chartered – to allocate as much as £7 billion in bonus payments over the next two months. Despite most top executives foregoing some, or all, of their 2009 bonus, with some donated to charity instead, it is understood that the likelihood is for full bonuses to be accepted this year, including by Eric Daniels, the outgoing chief executive of Lloyds. As The Financial Times opined, there is a feeling in the City that these previous gestures were unappreciated by politicians and the general public, and bankers have been emboldened by the apparently fading influence of the Liberal Democrats after veiled threats from both Vince Cable and Nick Clegg came to nothing.
Away from the UK banks, amongst the global banking institutions there is also an increasing appetite to return to the much-maligned bonus culture. It is expected the 6,000 London staff at J.P. Morgan will receive in excess of £1.2 billion, while Goldman Sachs, Citigroup and Morgan Stanley are expected to announce similar remuneration within the next two weeks. The Sunday Times reported that, despite an expected 40% drop in profits, Goldman Sachs will announce that it has paid staff more than $13 billion, an average of $370,000 for its 35,000 employees around the world.
Eyes on inflation
A critical 12 months kicks off this week for the Bank of England’s Monetary Policy Committee. With inflation expected to continue to run above target and having done so since November 2009, there is pressure for action to be taken, with the living standards of millions being squeezed, reported The Mail on Sunday. At every monthly meeting since October, the MPC has been split three ways, with votes for both tighter and looser monetary policy, and the majority voting for no change. Analysts suggest that it is these mixed messages that is undermining the MPC’s position. The Bank has also said inflation, as measured by the Consumer Prices Index, is likely to stay above target for the whole of this year, pushed up by the increase in VAT to 20%, and higher import prices resulting from the fall in value of sterling.
Snow excuses for retail sector
Figures to be released this week are expected to show that retail sales in December 2010 were only 1% lower than in 2009. As reported in The Sunday Telegraph, the minor impact that the snow has played will cast doubt on chief executives’ claims that the weather caused havoc with sales in the run-up to Christmas. HMV Group, Next and Mothercare were among the high-street names to have issued dire trading updates in which they were attributing blame to the snow for poor sales. However, experts believe that the bad performances could be more to do with deeper-rooted structural issues at some chains rather than the weather. The stock exchange announcement from HMV Group that the company was not going to meet profit targets, and may break banking covenants, caused the share price to fall 20% within half a day of trading. While the chief executive, Simon Fox, was quoted as saying that HMV “remains a profitable and cash-generative business”, the debate soon began over whether the company had a long-term future. With over 50% of music sales now being transacted online, and book sales increasingly going the same way, the management team are keen to establish the business as more of an “entertainment brand”, moving more of its product range into electrical products such as iPads and MP3 players, a product area which made up around 9% of total product sales last year.
This week, in contrast, some of the UK’s largest retailers including Tesco, Marks & Spencer, J Sainsbury and Debenhams will report on Christmas trading, with sales for most expected to actually increase. Retailers that have already reported positive data include John Lewis, Waitrose and Majestic Wine. The pre-emptive excuses from some companies have drawn criticism from analysts, according to The Independent on Sunday, with many pointing out that there are high-street retailers claiming record profits, and the snow may have simply given investors the chance to pick the winners from the losers in the retail sector.
While 2011 will no doubt be tough for all retailers, with consumer spending cut back by the VAT hike and higher unemployment, the good businesses will survive. However, exactly how tough was speculated upon by The Mail on Sunday which discussed the possibilities of major retailers adopting a round of savage job cuts to combat rising costs and the threat of commodity price increases, particularly in food, cotton and fuel. Both Tesco and M&S have said they have not confirmed spending plans as yet, but with a series of senior management changes at major retailers due in coming months, new bosses are expected to review operating and staff costs.
Investors still moving away from relative safety
While diversification is the key to steady long-term returns, the start of the year is traditionally the time when investors are drawn to thinking about asset allocation, according to The Financial Times, and judging by the first week of trading in 2011, decisions are being guided by “a delicate mix of fragile economic optimism and financial fear”. Market movements and trading data shows that equities and commodities continue to be the most popular areas, while investors are clinging less to the relative safety of bonds and gilts. Certainly for the first week this looked a good decision as UK equities returned 1.4% and European equities increased in value by more than 2%.
Over the last quarter of 2010, there was seemingly a dramatic change in investor sentiment as stock markets have rallied, with the overwhelming opinion from analysts that equities are heading higher in 2011. The majority of equity strategists have year-end targets for the FTSE 100 in excess of 6,500, with some venturing into the record 7,000 levels. However, there are two areas in global markets that continue to be of concern to investors. Firstly, in emerging markets, the key issue is whether developing markets can successfully rein in inflationary pressures without curtailing growth. China raised interest rates over the Christmas period, and is now attempting to curb its fastest inflation in two years. Secondly, closer to home in the eurozone, the cost of insuring the debt of peripheral European governments continues to rise, with Citigroup believing there is further debt restructuring to come throughout the year, claiming Portugal the most likely to be the next to approach the EU cap-in-hand. According to The Times, Citigroup has described the country as “quietly insolvent” after Lisbon’s costs of borrowing rose to a prohibitive 7.38% (rising 0.59% over the week) amid signs that the flurry of activity from last year has given way to wrangling and uncertainty, pushing Portugal to the rates seen by Greece and Ireland before they sought rescues. Jose Socrates, the Prime Minister, insisted last week that his country would hit its goal of cutting its 2010 deficit, but the country still has to raise up to €20 billion on bond markets and there are serious concerns that it will struggle to refinance the €9.5 billion of debt maturing in April and June.
As pointed out by The Telegraph, diversification is vital to creating a portfolio which limits the shocks that will inevitably occur within each and every asset class, and it is crucial that your portfolio suits your attitude to risk and your overall objectives. Without regular reviews, your portfolio may well be taking too much or too little risk based on the original allocations being distorted by performance over a number of years.
The truth is that no-one knows what will happen in the coming year within the eurozone, or when the economic and monetary stimulus is withdrawn from the system. Andrew Green recently reported, “Markets have continued to climb the wall of worry accompanied by the requisite hand-wringing and declarations of doom-laden scenarios. Even recent fears that the equity markets have been getting ahead of themselves have been assuaged by the US Congress approving the continuation of tax cuts for another year, with little regard for what such a move means for fiscal stability longer term. The background of eurozone fragility has kept pressure on financial stocks in Europe, and German machismo has created a stand-off that somewhat impedes a market-friendly solution. Strong corporate profitability has enabled the equity market to maintain conviction in the economic recovery thesis.
“There is an assumption of better growth prospects for 2011, but this will result in more competition for capital than previously assumed. Markets may continue their upward move, since equities are the default beneficiary of current economic conditions, at least whilst bond yields remain low by historic standards. However, different alternatives may beckon if inflation and higher bond yields combine to reveal that future growth has already been discounted. In such circumstances, stock selection will be key and, as a result, our portfolio will continue to focus on situations where visible growth is undervalued or there is a strong internal restructuring or recovery theme.”