In this week’s Bulletin:
- The ‘big news’ story for the week was the latest economic data from China, showing the country’s economy recording a huge spurt in the final quarter of last year and achieving GDP of 10.3% for the year as a whole.
- The data raised fears that Beijing is losing control of its rampant economy and will be forced to take aggressive counter-action in the form of higher interest rates – as a consequence global equities sold off as investors moved to the sidelines.
- There was better news from the US where an improvement in the housing market and jobs sector helped sentiment, coupled with better-than-expected earnings from bellwether stock General Electric.
- In the UK the economic picture remains mixed albeit on a positive uptrend – the economy is expected to have grown at 2.3% last year although there is some evidence of a slowdown in the last quarter of last year.
- Higher UK inflation data has spooked some large institutional investors – as a consequence their appetite for government bonds is likely to wane. On the flip side, investors are reminded of the ability of equities to shelter against inflation.
- Finally Cato Stonex, a principal of THS Partners explains their current investment strategy.
So Good, It’s Bad
Good news! Your economy has grown faster than expected during the last quarter of 2010 – up by 9.8% and way ahead of everyone’s expectations. This means that when added together with the rest of the year’s growth, the economy has grown by a dazzling 10.3%. As one of the world’s largest economies you are contributing to almost half the globe’s total economic growth and you’ve helped create some 14m jobs worldwide. Sound’s like a great success story. And that, it seems, is the worry – China’s continued explosive growth has now become so good that international investors are concerned that Beijing has lost control of one of the world’s most dynamic economic stories: a bubble waiting to burst. The latest economic data released last week showed that China’s rate of growth in the final quarter of last year increased rather than slowed – defying expectations that the People’s Bank of China’s tightening of monetary policy, by increasing interest rates and raising liquidity requirements for the banks, would act as a brake to the red-hot economy.
China’s thriving economy has fuelled significant commodity price rises in the last few years as its factories suck in ever-greater amounts of raw materials and the country’s growing middle classes change their diets from rice-based to a more protein-based one – to say nothing of their appetite for BMWs and the like. So the latest news has increased fears amongst some investors that, in response to what appears unchecked growth and rising inflationary pressures, monetary policy will be tightened further. “The solid growth outlook suggests that inflation is likely to remain uncomfortably strong in the months ahead. We continue to expect more rate hikes – and risks are skewed to more aggressive action,” was the view of RBC Capital Markets. If the Chinese authorities do decide to take more robust action, the fear is that this will have a significant impact on global growth. Hence the reason that global equity markets fell sharply on the better-than-expected economic data, with most major indices ending the week around 2% lower. The Financial Times made the point that with mining and energy companies accounting for around a third of the value of the FTSE 100, it was no surprise that the UK blue-chip index was disproportionately impacted.
Meanwhile, back here in the West, there are some promising signs that our own developed economies may be back on the road to sustained recovery, albeit patchy. Despite China’s elevation to near top of the GDP table, the US remains the world’s largest and most important economy. Last week there were some signs that the two areas most troubling for investors – housing and jobs – offered some scope for optimism. Existing home sales jumped 12.3% in December and ahead of forecasts, while the number of new jobless claims fell to 400,000 last week, the largest drop for almost a year. Sentiment was also given a boost by better-than-expected fourth-quarter earnings figures from behemoth General Electric – the company is seen as a bellwether for the global economy. GE’s chairman told investors that “the economy gets stronger everyday. The environment continues to improve. It is broader and deeper as we look across our portfolio”. The news helped boost Wall Street which bucked the global trend and helped the Dow Jones Industrial Index to end the week almost 1% higher.
Over in the eurozone there is somewhat of a dichotomy. Whilst the Mediterranean economies continue to struggle, the region’s heavyweight economies continue to bear the load comfortably – particularly Germany. Last year the country enjoyed stellar growth of 3.6% and, according to economists, both the German and French economies continue to power ahead. Whilst last year’s recovery was export-led there are hopes that the two countries could be less dependent on overseas exports as they are each other’s largest export markets. The optimism seems to be well-founded with data from France, Germany and Belgium all showing sharp rises in business confidence – the German Ifo index hit an all-time high of 110.3 this month.
Not that investors see just blue skies ahead – the eurozone sovereign debt crisis continues to lurk in the background, although even here there are signs that European leaders are set to get to grips with the issue as a whole, rather than dealing with it incrementally, as it has thus far. In Brussels, European leaders are considering a plan to allow the region’s €440bn bail-out fund to lend money to struggling peripheral countries, so they could buy back their own distressed bonds. But, notwithstanding its economic success, Germany has made clear to the rest of the zone that it is not prepared to see an increase in the size of the bail-out fund.
The Flip Side
Whilst the residents of India and China are among the most optimistic about the way things are going in their country, it’s rather a different story in Mexico and Spain, where people are the most dissatisfied with the outlook. Neither outcomes of a recent MORI survey are surprising given the respective economic backdrops. Here in the UK it’s a mixed picture. Whilst the New Year has opened with a surge of optimism – consumer confidence jumped last month as people became more upbeat about the outlook for our own economy – sentiment among small businesses fell. Whilst the property market in London continues to do well, a different story emerges in the shires, with the latest figures revealing that mortgage lending slumped to its lowest point for a decade last month. Unemployment numbers have resumed their upward trend with a near 50,000 increase in the last quarter, with the construction industry still mired in recession according to the Federation of Master Builders. But whilst an ill-wind blows for some, hundreds of new jobs will be created by Siemens’ decision to build a huge wind turbine factory in Hull. Overall the UK economy is expected to have grown a respectable 2.3% last year, although figures due from the Office for National Statistics are likely to show a slowing of growth in the final quarter of 2010.
It seems, according to The Financial Times, that some of the world’s leading investors have become increasingly concerned about the growing danger of inflation. Data released last week showed the UK’s Consumer Price Index (CPI) hitting 3.7% last month (the Bank of England’s target is 2%) and the Retail Prices Index rising to 4.8%. For followers of The Daily Telegraph’s ‘real inflation’ index, the level is 5%. Last month petrol prices rose at the fastest pace on record, reflecting a surge in oil prices over the last year to almost $100 per barrel. There is plenty of anecdotal evidence of inflationary pressures and the CBI warned in its latest survey that “domestic prices are set to rise strongly over the next three months”, as the upward pressure on raw materials for manufacturing remain “intense”. Higher inflation has two potential impacts – firstly, it puts pressure on the BoE to raise interest rates and, secondly, investors tend to eschew government bonds, a point made by Bill Gross who runs the world’s largest bond fund at Pimco. To date the BoE has resisted pressure to raise interest rates as this could potentially derail Britain’s economic recovery, insisting that the latest rise in inflation is down to one-off factors such as the raising of VAT. This is the view taken by other well-known institutional investors such as Anthony Bolton who told The Financial Times that “My central view is that the current concern [about inflation] will die down somewhat over the coming months”.
So what choices do private investors have and what actions can they take to protect their wealth from inflation? Advice from the weekend personal financial columns, including The Sunday Times, was diverse but the overall message was one of the need to review existing strategies and to ensure one had a diverse portfolio, invested across a number of different asset classes. If emerging markets have become too expensive in the short term, then switching into Japan for example, which has lagged for many years, might offer some opportunity, opined the paper. One of the key things to remember is that historically, according to data collated by Barclays in its Equity Gilt Study, dividend income has risen at a faster rate than inflation. Looking at it another way, the real return (adjusted for inflation) for cash has been 1.6% pa over the last twenty years. The report also showed that the real return from UK equities (with income re-invested) was 5.9% pa over the same period. Currently, the FTSE index of the UK’s top 350 high-yielding companies yields 4.2% – and remember that this figure is net of basic rate tax.
A Strategy for 2011
So what are the professionals doing? Cato Stonex, principal of THS Partners, shared his views on THSP’s current strategy. “We continue to like equities for valuations and fund flow reasons; we think the European situation will improve and we are cautious about emerging market valuations. Although we believe the emerging market story is real and durable, some slowing in China could occur, with pressure on the resource sector. But we remain enthusiastic about our other themes: consumption and credit growth in the emerging world, a recovery in the US housing market, a transfer of value in media towards content owners, the rising value of oil production in the safer parts of the world, the value of specialist data and information technology businesses and increasing spend on healthcare in the West.
“We are keeping a watchful eye on inflation – at the very least high inflation should direct some flow into equities from [government] bonds. Inflation has been running ahead of the UK target for two years; is now ahead of the ECB’s target within the eurozone and is a more pressing problem in many emerging markets with fast-growing economies starting to apply the brakes. Erratic and unpredictable inflation is no panacea to economic concerns, but strong companies with the ability to raise prices will provide better earnings protection than fixed-income securities in an inflationary scenario. Our portfolios will continue to be built in the same way as we have constructed them in the past. We now have a portfolio of global equities which collectively have a prospective price/earnings ratio of 11.3, with a dividend yield [net] of 3.4%. Indeed, valuations for the market as a whole are towards the lower end of their 15-year range. After a period of higher markets, we now believe it is particularly important to focus on both valuation and growth; and the portfolio displays these underlying characteristics.”