In this week’s bulletin:
- With the Greek debt crisis continuing to take the headlines there was some progress last week as the government survived a no-confidence vote, taking it one step closer to receiving a second bail-out from the EU/IMF.
- Bigger picture: The eurozone sovereign debt market was given the thumbs up when China’s prime minister said his country would continue to be long-term, large investors in eurozone debt.
- Economic data out last week showed that the world’s major trading regions are slowing including China, the US and parts of the eurozone. A down beat statement from US Federal Reserve Chairman Ben Bernanke, lowering estimates for growth this year, didn’t help investors’ mood.
- With US growth slowing the response of American policymakers has diverged – the Fed confirmed it will stop printing money but President Obama is determined to keep spending, particularly with election year approaching fast.
- Quite unexpectedly, the International Energy Agency announced that it would be releasing 60m barrels of oil over the next 30 days to replace the loss of Libyan supplies – the price of oil plunged on the news, registering its largest one-day loss ever.
- Adrian Frost of Artemis explains his strategy
Chinese to the Rescue
Sovereign debt markets continued to take centre stage last week as policymakers went into overdrive to ensure a solution to the Greek debt crisis. Investors watched with bated breath at the start of the week to see if the Greek government survived a crucial vote of confidence which would then enable it to forge an agreement with the EU and IMF for a second bailout – conditional though on a five-year austerity plan. The politicians had little choice, despite the rhetoric, but to say aye and Greece’s prime minister survived the day, which meant financial markets could relax – a little. Analysts warned that there was yet another hurdle insofar as the austerity measures still have to be passed by parliament this week before the next tranche of bailout funds could be paid. Not that the outcome is guaranteed and some investors decided that the allure of safe havens such as German and US government bonds, along with the Swiss franc was a better short-term alternative to the euro and Greek bonds. As an indication of nervousness, five-year Greek credit default swap spreads – a gauge of the cost of insuring against a sovereign debt default – climbed above 20% as the country’s crisis worsened.
The scale of the problem has been debated by the markets for a very long time so a stark warning from the chief executive of Pimco, the world’s largest institutional bond investor, that debt default is the only solution for Greece, was met with equanimity. But it seems that not everyone has lost confidence in the eurozone and specifically the raft of debt issued by its club-Med economies. At the weekend the Chinese premier Wen Jiabao threw a lifeline to the eurozone, pledging to buy billions of euros of European debt. “China is a long-term investor in Europe’s sovereign debt market. In recent years we have increased by quite a big margin our holdings of government bonds. We will consistently continue to support Europe and the euro,” he said. His comments came during his visit to Europe when he signed a number of deals with member countries, including Britain. Jim O’Neill, chairman of Goldman Sachs Asset Management said the eurozone should look east for a solution to their continuing debt problems. “Perhaps Europe’s leaders should try to put some of their differences aside and offer Asia’s yield-hungry investors an even bigger kicker to help solve the crisis,” he commented.
Away from Greece there were other issues for investors to mull over – not least of which were signs of slower growth in the world’s largest powerhouses: America and China. HSBC’s flash Purchasing Managers’ Index, which tries to forecast the likely position of both the full index and the official Chinese version, showed expansion in China’s manufacturing sector grinding to a near standstill in June. It seems that this was a result of falling global demand and Beijing intensifying its efforts to suppress a potentially destabilising credit boom. Whilst there is no concern about whether China continues to grow, the question is whether the slowdown will cause a ‘soft’ or ‘hard’ landing. Analysts at HSBC dismissed fears of the latter scenario because year-on-year industrial production in China is growing at a double-digit percentage pace. The country’s slowdown may be impacting elsewhere too – growth in the eurozone has also slowed in recent weeks, according to the ECB, and without relatively strong performances by Germany and France, the region’s private sector would have shrunk.
But it was the more subdued message from the US that investors found most disconcerting. The Financial Times noted that last week’s meeting of the US Federal Reserve’s FMOC left a pretty downbeat impression of weaker than expected growth for the country, with the market’s worries compounded by disappointing weekly labour data. Not that it was all bad news – growth for first-quarter GDP was revised up slightly to 1.9%, albeit still down from the robust 3.1% in the last quarter of 2010. Whilst businesses continue to restock, slower export growth and cuts in government spending offset this. Higher inflation is also beginning to make itself felt, as shopping and fuel bills rise, causing consumers to cut back; although overall spending still grew by 2.2% during the period.
Oil on Troubled Waters
American economist Irwin Stelzer, writing in The Sunday Times, put the current situation neatly into context by contrasting the Fed’s policies with those of President Obama. Fed chairman Ben Bernanke has obligingly printed and spent a further $600bn, buying the President’s IOUs (colloquially known as QE) in the expectation that the economy would grow at 3.5% and that low interest rates would boost the troubled US housing markets. Neither has happened and the result has been costly: the budget deficit is around 10% of GDP (almost in line with Greece) and the Fed’s own balance sheet has mushroomed to $3 trillion. Unemployment is still over 9% and, as said, growth is only
1.9%. By its own admission the Fed is nonplussed, with Mr Bernanke saying, “We don’t have a precise read on why this slower pace of growth is persisting” and consequently has downgraded this year’s growth forecast to 2.9%. However, Mr Bernanke has stuck to his promise not to print more dollars and has confirmed that the current QE programme will end this month.
Contrast this with Mr Obama’s own policies which are predicated on the idea that deficit spending will get the economy moving again. So the peace dividend from troop reductions in Afghanistan will be spent on infrastructure and green energy. He continues to resist calls by the Republicans to cut spending and not to raise taxes. Stelzer opined that it was no surprise that with this level of partisan dispute, businesses and consumers were nervous and unlikely to start spending in the way Mr Obama would like, which would boost growth and cut unemployment. So what to do? Well, the markets found out late last week as news broke that, for only the third time in its history, the International Energy Agency (which includes the UK, US, Japan et al) decided to release some of its strategic oil reserves – 60m barrels over the next 30 days. The reaction was immediate – oil prices plunged, with Brent crude falling by 8.5% as traders were caught off-guard.
The ostensible reason for one of the Agency’s most daring moves ever was that it was necessary to replace the high quality oil being lost from Libya. But it became clear that the move was intended to tackle the damage being done to world growth by the $100-plus per barrel cost of oil. The task had obviously required delicate diplomacy, said The Financial Times, with Washington needing to be sure Saudi Arabia would not tighten supply to push up prices. Western policymakers were no doubt pleased with the outcome, although there was speculation that whilst bold, the move would only give temporary respite. Either way, the timing of the announcement has coincided neatly with the start of America’s ‘driving season’ when most of the population take to their cars and go on holiday. It could, thought The Sunday Telegraph, also be the start of President Obama’s re-election campaign. Over in the financial markets the news caused little immediate reaction outside commodity prices, with stock markets continuing their weekly meandering. By the close of business it was easy to see the winners – most of Asia’s major indices advanced substantially over the week, led by China’s Shanghai Stock Exchange Composite Index which was up almost 4%. In contrast, Europe followed Wall Street marginally lower as investors ruminated over slower US growth and sovereign debt issues.
Confidence with Caution
Against the backdrop of choppy markets it’s useful to have an insight into the thoughts and actions of professional investors who, on a daily basis, have to interpret the ebb and flow of both good and bad news alike as part of their job. One of the City’s most respected fund managers, Adrian Frost of Artemis, explains his strategy. “High level, my investment style is to concentrate on income so my strategy is not strongly based on the global, macro issues although I do, of course, observe these and have to weigh up how economically sensitive a stock might be. I’m looking for companies that are good quality, have good growth prospects and can increase their dividends. The portfolio currently yields around 4.1% [net of basic rate tax] and with good cash flows, I have been able to add the stocks I like – I’d rather buy on days when the market is down as it helps average-in costs.
“The portfolio is centred around what the market calls a ‘risk-off’ approach – in other words, safer, lower-risk companies who can grow their businesses even if the economic environment becomes less favourable. For example, Deutsche Post has all the characteristics I like. It is a market leader in logistics, delivering globally with particular emphasis on emerging markets. It is a market leader in e-retailing (Amazon) and at home has a core income because of state requirements for utility bills and bank statements to be posted to customers. Currently it is about half as profitable as its competitors but has recently invested heavily in its business and it is enjoying parcel growth of 10% – every new parcel added is highly profitable. I also own capital goods company Melrose which, like many of its competitors, is experiencing some slowdown. However the company has two main businesses – manufacturing power generators which is a growth sector as businesses invest in gas, and Bridon which is geared into energy via the development of oilfields in Brazil.
“The outlook for dividends is positive with a likely increase across the board of c5%–10% – ahead of inflation. In fact, dividends have increased at around 8% per annum over the last decade, despite the recession. I think there is a low probability that good quality companies will cut their dividends in the way they did during the financial crisis. Then they were wrong-footed and some found themselves having to refinance corporate bonds at very high levels. They have learnt their lesson and the type of company I deal with is determined not to get caught out again, hence the high levels of corporate cash we currently see. This gives me a lot of confidence going forward that I can expect dividends to be maintained or increased. Also there is increased merger and acquisition activity – the portfolio could benefit on both counts as some of my holdings could be acquisitors because they are cash rich and, conversely, become attractive to a larger business because they are cash rich – one holding, Laird Group, is currently subject to a takeover bid. Geographically the portfolio is heavily weighted toward the UK but the income element is very diverse, with much being derived internationally including emerging markets, which itself accounts for c15% of earnings, so there are good growth prospects for investors over the medium to long term.”