- Global equity markets enjoyed a mini-bull run last week – one of the best since the Japanese earthquake – enabling most major indices to return to two-year highs with Wall Street leading the way.
- Better-than-expected US employment data reinforced optimism that the economic recovery is gathering further momentum.
- Whilst some believe current US equity values are justified, others take the view that it is only the US Federal Reserve’s QE2 policy that is keeping the economy going and this is due to finish in June.
- Eurozone woes hit the headlines – Irish banks are being bailed-out once again to the tune of €24bn and Portugal is also expected to ask for help via the newly established European Stability Mechanism.
- Economic data showed that the Japanese economy had, unsurprisingly, taken a huge downturn following last month’s terrible earthquake.
- Star fund manager, Neil Woodford of Invesco Perpetual, believes now is the best time for a decade to buy British shares and he explains why.
Markets Spring into Action
Global equity markets enjoyed one of their best weeks since last month’s horrendous earthquake in Japan, enabling key indices to close near or at two-year highs and meant overall markets had one of their best quarters’ performance for more than a decade. Boosting sentiment was news of better US employment data, coupled with receding geopolitical fears. “Fading concerns over potential global growth risks from turmoil in the Middle East spreading into major oil producers as well as reduced fears of a more serious fall-out from the nuclear crisis in Japan led to a pick-up in global risk appetite last week” was the view of RBC Capital markets. Whilst investors may have a spring in their step, the week was not without a few niggling worries – the eurozone sovereign debt crisis remained in focus and oil prices continued their seemingly inexorable climb with Brent crude rising three dollars to end the week at almost $120 per barrel – a new twelve month high.
But first the good news. Wall Street took heart from the latest US Department of Labor data which found that the jobless rate fell to 8.8% in March (its peak was 10% a few months ago) while non-farm payrolls jumped by 216,000; the largest monthly gain since last May. The employment figures were stronger than expected, with growth recorded in the healthcare, hospital and mining sectors – manufacturing saw a more muted increase and government payrolls fell 14,000. Economists believe the figures add further credibility to the view that America’s economic rebound is gaining momentum and is sustainable. The employment numbers were one reason that oil prices climbed – a belief that industry will need to consume more energy. Against this back-drop equity prices advanced steadily with the Dow Jones index coming within a whisker of a two-year high and the broader-based S&P500 index not far behind.
However there are some who are worried that stocks may have got ahead of themselves, despite the undeniably better economic data over recent months. According to The Financial Times data, the S&P500 has doubled from its March 2009 nadir and now trades on a multiple of about 24-times average earnings for the last decade – its long-term average is 16. Rising confidence has seen US companies return to strategic deal making which in turn has boosted global mergers and acquisitions and with it, share prices. M&A activity grew by 26% in the first quarter of this year and the US accounts for half of all deals, suggesting confidence among US chief executives and boards, has bounced back faster than elsewhere.
Writing in The Sunday Telegraph, Fidelity fund manager Tom Stevenson pointed out that the American index has outperformed the FTSE100 (by about 16%) since last September despite both economies facing similar difficulties. Are prices justified? Well, he noted that all will be revealed in just a few short weeks as America’s companies release their much-awaited first quarter earnings figures. Mr Stevenson noted that the US economy has benefitted from the huge boost of cheap money and lower taxes – policies pursued by President Obama. Despite higher oil prices it is likely that US companies will once again be healthily positive and he concluded that investors’ sanguine response to March’s upheavals looks rational.
More Money Please
There are those though who think the US economy is heading for trouble. Economist Liam Halligan, also writing in The Telegraph, thinks that America’s economic ‘sugar rush’ will end in a serious financial headache. His view is predicated on the fact that euphoria on Wall Street is being fuelled by the spectre of more quantitative easing (QE) and tax cuts the country can’t afford. The US Federal Reserve is currently in the middle of a second round of QE – $600bn – due to expire at the end of June, adding to the original $1,700bn programme already completed. This huge flow of cheap money has boosted asset prices but also antagonised the likes of China who have seen the value of their dollar-based investments (they own a huge slice of America’s treasury bonds) devalued. Xia Bin, long-standing adviser to China’s Central Bank, recently wrote that “As long as the world exercises no restraint in issuing dollars, then the occurrence of another crisis is inevitable”. For now though, investors are giving Fed Chairman the benefit of the doubt, taking the view that there will be an orderly exit once QE2 has expired.
And talking of pumping more money into things – the Irish government announced that following another round of stress-tests for its beleaguered banking system, it would inject another €24bn of capital into the sector. This is the fifth attempt to draw a line under the Irish banking crisis, according to The Times, and will take the total amount pumped into lenders to €70bn. The plan will see the sector restructured into two major players. Following the news, Bank of Ireland looked to be the winner – its shares surged 40% – whilst traders dumped shares in other banks heading for nationalisation, such as Irish Life & Permanent.
Rate Rises for Euroland?
There is also the ongoing view that it is only a matter of time before the eurozone sovereign debt crisis claims another victim – this time Portugal is expected to step up and ask for more money to be pumped into its ailing government finances. “There is no doubt that the debt situation in Portugal is rapidly getting worse. With Portugal facing bond redemptions of about €9bn in April and June this year, the need for a bail-out seems more and more certain” said Swiss & Global Asset Management. However, expectations that the European Central Bank (ECB) is poised to raise interest rates helped support the euro, despite Portugal’s woes, as investors’ attention was diverted. After two years with rates at a record low of 1%, the ECB is expected to announce a quarter-point rise this Thursday – despite fears that this could tip some countries back into recession.
Jean-Claude Trichet, president of the ECB, has taken a hawkish stance, saying last month that the bank would show a “posture of strong vigilance” against rising inflation. Inflation has risen to 2.6% across the region because of rising commodity prices. But with Europe experiencing a two-speed recovery the move could tip the likes of Spain back into recession think some economists. News that unemployment fell for the fourth straight month in February, falling below 10% for the first time since 2009, whilst welcome, masks what has been an uneven recovery with core countries such as Germany racing ahead of the struggling peripheral ones such as Greece.
Elsewhere there are mixed messages emerging from global economic activity. It came as no surprise that the first release of Japanese economic data since the March 11 earthquake devastated the country’s north-eastern seaboard offered markets an unsettling glimpse of a mighty manufacturing sector in terrible distress. Activity as measured by the purchasing managers’ index plunged 6.5% – its worst fall since surveys conducted by data company, Markit, began a decade ago. There are also worries that the figures could be worse, as the survey was based on far fewer responses than usual, implying that the very companies worst affected failed to respond. Equity investors appeared to take a sanguine view though, focusing on the longer-term benefits of reconstruction which helped support share prices: the Nikkei 225 index advanced almost 2% on the week.
Here in the UK, economic recovery momentum is mixed. The manufacturing sector slowed last month with new orders rising at their weakest pace since last October according to the Markit/CIPS Manufacturing index. With 19 months of consecutive input price rises manufacturers are trying to pass these on to buyers, accounting for the fact that selling prices surged to new highs. However, notwithstanding the latest data, the overall reading for industry was well above its long-run average and showed that manufacturing, with a reading of 57.1, was still firmly in growth territory. In the service sector there was welcome news that output recovered from December’s weather-induced setback. The largest part of the economy grew 1.3% in January according to the Office for National Statistics (ONS) and the pick-up in services activity raise the possibility that first-quarter growth will be back on track. Not that it will be plain sailing – UK households suffered their first drop in income for 30 years last year, as rising inflation bit deeply into finances, according to the ONS.
According to one of the UK’s most successful fund managers, Neil Woodford of Invesco Perpetual, British companies are offering some of the best investment opportunities in 10 years. Talking to the financial press over the weekend, Neil Woodford explained why he felt now was the time to buy British, even though he is gloomy on the outlook for Britain’s economy. Having resolutely eschewed owning technology stocks during the late nineties, Mr Woodford also avoided banking stocks in the run-up to the financial crisis and he is still negative on the banking sector because of continued worries over their balance sheets.
Today he is also avoiding mining stocks, preferring to own pharmaceutical companies. “The biggest negative contributor to my performance has been holding pharmaceuticals and the biggest attributor has been not holding mining shares. I’m not going to compound that error by moving to mining shares. These companies are generating supernormal returns on the back of supernormal commodity prices and I don’t believe those prices are sustainable” he said. Mr Woodford believes that pharmaceutical stocks offer extraordinary value. “I’m actually looking to increase my exposure to this sector [currently 25%] because this reflects the degree of conviction I have in it . . . there have only been a few occasions in my 25-year career where I have seen the opportunities that I now see in the pharmaceuticals sector. Valuations are depressed even if you discount no further innovation or new drugs coming to the market” he said.
Neil Woodford is not alone in liking British shares it seems. According to recent data from Capita Registrars, private investors have upped their holdings of shares to a three-year high – it means that the share of UK plc held in retail hands stands at 11.8%, its highest level since summer 2009.