· Commodity prices suffer their worst week for two and a half years on fears of stalling global recovery
· Positive US jobs news helps equity markets recover some ground
· Threat of Greek default sparks another round of eurozone uncertainty
· Bank of England holds interest rates as austerity measures and higher prices bite
· Income opportunities remain for savers prepared to take additional risk
This weekly Briefing Note aims to pick out some of the key financial and economic issues touched on in the press over recent days and from time to time includes the views of some of our independent fund managers.
Silver loses its shine
Taking a rare position on the front pages, silver proved the catalyst for the commodities rout that dominated the week. What started on Monday as a quiet reversal of silver’s recent rally turned into a rush for the door by investors on Thursday, when commodities markets suffered one of their largest ever one-day falls, tumbling 4.9% as a group. Silver fell more than 30% over the week, dragging with it other commodities such as oil and copper, whose prices are critical to the global economy. Brent crude oil, the global benchmark, was down more than $15 a barrel in two days – the biggest two-day drop on record in absolute terms.
The slump was put down to a number of factors that raised fears of the global recovery being choked off: weaker than expected US economic data, worries about the impact of high oil prices on consumer sentiment, tightening monetary policy in emerging markets – both China and India raised interest rates in the week – and a 1.6% rebound in the dollar. The Sunday Telegraph suggested that the indiscriminate nature of the correction pointed to a ‘generalised blowing away of the froth’ and that the structural case for commodities remains strong. Reinforcing again the importance of the developing economies to global growth, China’s share of world energy consumption is expected to rise from 10% a decade ago to 25% in ten years’ time. It was certainly the view of Helen Henton, head of energy and environment at Standard Chartered, that the fall in oil prices was a correction rather than anything more fundamental. “The news has very much been driven by macro sentiment. It started with the death of Bin Laden, and then the European Central Bank’s indication that rates will not rise anytime soon.”
The end result was that commodity prices had their worst week for nearly two and a half years despite a rebound on Friday as traders speculated that losses may have been overdone. Global equity markets were similarly afflicted, with the ‘recovery-off, risk-off’ trade culminating in the biggest weekly losses for two months. However, a surprisingly upbeat US jobs report at the end of the week pulled investor sentiment from the doldrums. The non-farm payroll figures from the Labor Department showed that 244,000 jobs had been added last month, ahead of the 185,000 expected by economists. As The Daily Telegraph reported, job creation has been the Achilles’ heel of America’s recovery from its worst recession since the Second World War – only 1.5m of the 8.5m jobs that were lost during the downturn have been replaced and the figures were not enough to prevent the unemployment rate climbing to 9% from 8.8% in March. However, markets were largely prepared to take encouragement from the report and the news provoked a rebound on Friday for equities and the dollar and halted a slide in Treasury yields. The S&P 500 Index ended the week down 0.75%, whilst the FTSE 100 Index posted a loss of 1.53% for the week.
Commodities bubble or breather?
The sell-off in commodities markets coincided with announcements from Glencore, the world’s largest diversified commodities trader, of its planned flotation later this month. The $10bn (£6bn) initial public offering will be the biggest ever seen in London and will catapult the company to the upper reaches of the FTSE 100 Index. Index tracker funds will have to buy into Glencore automatically, leaving millions of investors more exposed to commodities than they may realise. As The Sunday Times revealed, mining, oil and gas companies already account for 34% of the FTSE 100 Index and the week’s events in volatile commodities markets highlighted the potential dangers of over-exposure to the sector. Whilst comparisons are inevitably being drawn with the dotcom bubble in 1999, the article opined that the technology stocks crash was caused by the overvaluation of the sector on unrealistic expectations of earnings growth – many dotcom stocks had price/earnings ratios of more than 50 at the turn of the century, whereas many mining companies are currently trading at multiples of 7 to 8 times earnings, although admittedly with earnings at historic highs.
Greek woes worsen
The danger of the crevices in the eurozone opening into yawning chasms was highlighted amid rumours on Friday that Greece will be forced to default on its debts – or even abandon the euro. Speaking over the weekend, the Greek prime minister, George Papandreou, reacted angrily to reports that Greece was preparing to quit the eurozone, but European Union (EU) finance ministers acknowledged that the country needed bailout help, likely to result in a restructuring of the €110bn (£95bn) rescue package it was granted in May last year, when it was the first member of the single currency block to fall. The Greek government is struggling to reduce a €327bn sovereign debt pile, which equates to 160% of national output, and is facing a general strike this week as the popular revolt against austerity measures intensifies. The reports sent the euro down 1% against the dollar and the cost of insuring Greek debt against default to a record high.
As The Sunday Times reported, Greece’s future in the eurozone will be determined by a crucial International Monetary Fund (IMF) report due next month. “It’s quite clear that Greece’s debt position is unsustainable,” said one senior European financier. “What’s less clear is whether the IMF is willing to state that at this point in time, while Europe remains very fragile. After all, one of the IMF’s roles is to aid financial stability.”
Last week also saw Portugal become the third eurozone country to secure aid, following Greece and Ireland, as it accepted a €78bn bailout from the EU and IMF, about a quarter of it to prop up its ailing banks. The terms of the rescue deal will require Portugal to cut its budget deficit from 9.1% of gross domestic product last year to 3% in 2013. That will cause the economy to shrink by 2% in both this year and next, according to the country’s finance minister, Fernando Teixeira dos Santos, under the impact of spending cuts and tax rises.
Whilst less worrying at the moment, the health of Spain and its banks will inevitably come under scrutiny. Writing in The Sunday Times, David Smith opined that if Spain had to be helped out, not only would that use up most of what is left in the rescue fund, but attention would then turn to the next most vulnerable, perhaps Italy or Belgium. In the long term, Smith went on to suggest, Europe will need a new currency arrangement, as the assumption that economic convergence, and importantly convergence of costs, would follow euro membership has proved false.
Tighten your belts
At their meeting on Thursday, the Bank of England’s Monetary Policy Committee (MPC) voted to keep interest rates at 0.5% – the 27th consecutive month that the UK’s base rate has been held at a historic low. Only a few weeks ago, some analysts had predicted rates would rise in May, but market expectations are now that it will be December at the earliest before any move is likely and it could even be delayed until 2012. The Bank fears that raising rates too soon could halt growth and make it even more difficult for the government to cut the budget deficit. The Sunday Telegraph reported expectations that the Bank of England (BoE) will revise down its economic growth forecast when it publishes its quarterly Inflation Report on Wednesday – the second quarter running that it has been obliged to do so. Whilst at odds with those who see the record oil price fall as a temporary blip and expect prices to be back near all-time highs within a year, Mervyn King, governor of the BoE, is expected to say that the rise in prices caused by higher energy prices is a short-term phenomenon, supporting his view on inflation and hence the MPC’s strategy of keeping rates on hold. However, the downgrade is likely to be accompanied by a slight rise in the BoE’s inflation forecast. As The Sunday Times observed, the combined impact of higher prices and the government’s austerity measures has tightened the worse peacetime squeeze on disposable incomes since the 1920s.
The Financial Times picked up this theme and highlighted again the plight of savers who, tired of waiting for interest rates to rise and seeing the effect of inflation eroding the value of their savings, are turning to more adventurous assets in the search for income. According to figures from Defaqto, the average interest rate for instant access accounts is 0.96%. This rate has risen by just 0.07% in the past two years. The reality is that increased income requires additional risk to be taken and the paper highlighted the importance of diversification across income-producing assets. The average yields available in sectors such as UK equity income, and corporate and strategic bonds are over 4%, which is unmatched by any cash account except for five-year fixed rate bonds. Bill O’Neill of Merrill Lynch echoed the view that high-quality, reliable, dividend-paying companies “are set to move into the limelight” and highlighted in particular stocks in the energy, tobacco and telecoms sectors.
Kiss of life
As the tasteful bunting was packed away following the royal wedding, The Daily Telegraph questioned whether investors in home-grown companies could benefit from global interest in this latest wave of ‘Cool Britannia’. The consumer goods sector appears an example of the so-called two-speed economy, with sales in the luxury market continuing to surge ahead while the mainstream market remains depressed. The royal wedding certainly did no harm to the profile of these luxury brands overseas. The article reminded investors that British companies rely heavily on overseas demand to drive profits – more than half of the earnings generated by FTSE-listed companies come from overseas. Whilst emerging markets may provide the long-term growth story, ’there are many great British companies making things that the parts of the world with stronger growth need’, and the UK market, particularly larger blue chips, remains attractive for those seeking less volatile investments and wanting a secure dividend income.