In this week’s bulletin:
- With the exception of the US market, global equities advanced over the week as riskier assets ended a turbulent third quarter with a small rally.
- Looking ahead to this week, after two years the Bank of England may well recommence its Quantitative Easing programme on Thursday. Previous minutes have signalled that the committee may restart printing money to boost the economy if conditions did not improve.
- The German parliament voted by an overwhelming majority in favour of measures to bolster the €440 billion eurozone rescue fund, giving it new powers to buy bonds and recapitalise weak banks.
- The European Commission announced its legislative proposal for a Financial Transaction Tax in the EU. This particular issue has been in the pipeline for around 40 years, but with the unfolding of the financial crisis four years ago, political pressure has slowly built in favour.
- With gold maybe not the panacea that many would have hoped, and the ongoing tribulations of equities and high-yield bonds, the volatility of any portfolio can be reduced by spreading the exposure across several asset classes, which can include cash, fixed interest, property, commodities and equities; a central tenet to the St. James’s Place investment approach.
Goodbye to an ugly quarter
With the exception of the US market, global equities advanced over the week as riskier assets ended a turbulent third quarter with a small rally. Perceived ‘safe-haven’ assets were sold off as Germany approved enhancements to the European Financial Stability Facility, with speculation that more firepower would be added to the bail-out fund. Over the week, European markets gained 4.7% after hitting a 26-month low as financials such as Societe Generale surged upwards despite broker downgrades. Closer to home, the FTSE 100 index gained 1.2% but this didn’t mask the losses seen in the third quarter amounting to 14.4%, its sharpest fall since the deflation of the dotcom bubble in 2002.
The gains were seen as a respite from the onslaught of volatility since the beginning of August, with global equities experiencing their worst 3 month period since the tail-end of 2008. The quarter ended with encouraging US data around GDP and unemployment, but will be remembered for lack of a long-term solution in the eurozone, the debacle over the US debt ceiling, and possible quantitative easing in the UK and US. The S&P 500 suffered its largest post-Lehman quarterly fall at 14.4%, with major European markets posting negatives of around 17%, while Hong Kong completed its worst quarter since 2001, falling 21%.
The uncertainty is not necessarily restricted to this asset class. In government bond markets, it will come as no surprise that US Treasury and German Bund yields have fallen sharply as investors sought the ‘safer’ options. However, more of an eye-opener is that peripheral nations in the eurozone have seen an increase in demand for their debt. Greek yields have been in demand over the short term, but one of the best performing assets in the third quarter has been Irish government debt, with yields falling from 14.07% to 7.52% in a remarkably short period of time.
At the time of writing, UK and European shares had moved lower after draft budget figures showed Greece would miss its deficit targets this year and next, which may result in the need for more funding. Irrespective of this being no surprise to anyone, market concern was of the potential unwillingness of international lenders to step in, and equity markets have reacted accordingly. The draft budget approved by the Greek cabinet on Sunday predicts a deficit of 8.5%, short of the 7.6% target. The GDP forecasts that were announced, which includes a shrinking of 2.5% in 2012, were in line with the expectations of the International Monetary Fund, although much worse than predictions used to calculate the €109 billion bailout in July. Whilst the Greek situation should be no surprise to anyone, markets have again reacted negatively in our view, triggered by ongoing concerns over the speed of any political solutions.
QE2 to return to the UK shores?
Looking ahead to this week, after two years the Bank of England may well recommence its Quantitative Easing programme on Thursday. Previous minutes have signalled that the committee may restart printing money to boost the economy if conditions did not improve. Economists are of the opinion that if it isn’t this week, it will be in November once the third quarter figures are made public, and will be in the region of £50 billion initially, with several more billions to be committed over several months. Across the English Channel, the European Central Bank is believed to be under pressure to announce their own further measures, with many believing that they will allow major banks to post a broader range of assets as security for emergency loans. Economists are also forecasting that interest rates will be reduced again, down from the current 1.5% in an attempt to offer more liquidity to their banking system.
But what direct impact could QE2 actually have on the UK economy? Keith Wade, chief economist at Schroder Investment Management, reported, “We have in the past been sceptical about the impact that quantitative easing has had on the real economy. The Bank of England suggests that the £200 billion programme resulted in between a 1.5% and 2% increase in the level of real GDP, and between 0.75% and 1.5% higher Consumer Price Index inflation. Comparing the estimated effects from the paper to the Bank of England’s models the analysis concludes that the QE programme was equivalent to a 150 to 300 basis point cut in the bank rate. In our view, QE in the UK has had some positive impact on the economy, but we doubt it has done much to generate growth directly. It has been successful in boosting asset prices and lifting confidence, which have helped facilitate the recovery, but given the current mood on the economy, clearly the impact was transitory. The £200 billion stock of purchases is still on the Bank’s balance sheet, and so in theory, is still serving as a stimulus. However, recent falls in equities and close to record low consumer confidence levels no longer reflect this.
Europe – Germany to the rescue….
While the result of the vote was somewhat inevitable from the outside looking in, the German parliament voted by an overwhelming majority in favour of measures to bolster the €440 billion eurozone rescue fund, giving it new powers to buy bonds and recapitalise weak banks. The decision was greeted in Brussels as removing a big potential roadblock, and despite a small jump in equity and bond markets on the news, the package still needs to be signed off by several other eurozone parliaments. Officials said the vote, which was won by the margin of 523 to 85, would strengthen the hand of the government and revive confidence in Angela Merkel’s centre-right coalition.
The measures could well be tested within the next few months, with the potential Greek default still hanging over the eurozone. Senior officials from the International Monetary Fund, the European Commission, and the European Central Bank have reopened talks in Athens regarding the terms of Greece’s next €8 billion tranche from the country’s €110 billion rescue programme. If they cannot agree terms, the payment will be delayed, meaning that Greece will be unable to pay pensions, civil servants and interest on its debts. Berlin officials are adamant that if there is a wider financing gap, it cannot be filled by public money, and must instead be funded by private creditors agreeing to take a bigger writedown on the value of bonds.
Financial Transaction Tax
This week, the European Commission announced its legislative proposal for a Financial Transaction Tax in the EU. This particular issue has been in the pipeline for around 40 years, but with the unfolding of the financial crisis four years ago, political pressure has slowly built in favour. The proposal is to raise as much as €55 billion per year but the move is definitely not in the interests of economic growth, with the negative long-term impact estimated to be as much as 1.76% of GDP. This seems like a strange time to put forward such a motion, with countries such as Ireland, Italy and Spain trying to find ways of stimulating growth, and implementation of this tax would not be viewed as advantageous. To put the problems into context, 12 months ago the UK ended the quarter growing by 0.1%, a figure wildly celebrated and we were seen as one of the stronger EU member states.
Financial markets have so far reacted negatively to the proposal, seen as destabilising and costly at a time when the financial services sector needs a boost. British Chancellor George Osborne has said that the UK will only join if the proposal is global, while US Treasury Secretary Timothy Geithner was far from complimentary when the issue was addressed two weeks ago. The main arguments against are that the increased tax would be taken from customer pockets rather than institutional profits, or that such a move would force institutions to move outside the EU, fatally harming the economy further. At this moment in time, the UK will veto this proposal, but the 17 eurozone members will be put under massive French and German pressure to apply the tax. This would give Britain a significant advantage over financial centres such as Ireland, Luxembourg and the Netherlands.
So why might this be seen as a good idea? With elections looming large in France and Germany, Nicolas Sarkozy and Angela Merkel are anxious to agree this as soon as possible, believing it to be popular with voters who want to see bankers faced with sanctions. The Commission is due to present this proposal to the G20 at the start of November, and it will be interesting to see what the reaction will be, given the lack of positivity so far.
Is gold losing its sheen?
For months investors have been bombarded by media comment that gold is the place to be for anyone seeking security or consolidation of their portfolios. There was a time when you could not read a financial newspaper without an expert speculating that gold would hit previously unseen levels within the next year, and for a short time, the price was rising these people were correct in their assertions. However, since gold hit its record high of $1,920 per troy ounce three weeks ago, it has fallen 20% to $1,534 per ounce before crawling back to its current level of $1,620. This is not the volatility associated with a safe haven for investors, and will have shocked investors who moved to precious metals in the hope that protection would be offered from the summer’s volatility. In that time, silver has also fallen 41% from its August highs. However, going further back, the build-up in the gold price since 2008 more reflects the loss of faith in governments to maintain the value of money, and investors have sought an alternative.
Warren Buffett, the American billionaire investor, frequently points out the insanity of absorbing the costs of digging up, refining, and shipping the precious metal around the world, only to bury it again in expensive vaults. He also points out that it yields absolutely nothing, so over the long term is a very limited asset and investors can only rely on other investors being willing to pay more for it at some point in the future – in our view this is not a sound investment strategy. The demand is clearly still there, as record levels of buying were experienced last week, but there is no guarantee of a rapid reversal of the fall – three times over the last decade, gold has fallen in excess of 20% and each time took at least 18 months to recover those losses.
The importance of diversification and a long-term view
With gold maybe not the panacea that many would have hoped, and the ongoing tribulations of equities and high-yield bonds, it can be tempting to encash investments to avoid further paper losses. Yet such drastic action could prove a costly mistake, especially if the objective of the investment remains a long-term one. The volatility of any portfolio can be reduced by spreading the exposure across several asset classes, which can include cash, fixed interest, property, commodities and equities, a central tenet to the St. James’s Place investment approach. In practice, when one asset class performs less well, other areas can counteract that performance and help smooth out returns. In the short term, no-one can consistently predict which asset class is the place to be but investing across more than one asset class reduces the risk and therefore the volatility over the longer term.
Despite the recent stockmarket volatility, St. James’s Place fund managers have maintained conviction in their portfolios, believing that the stocks they hold continue to offer long-term potential to provide real growth in excess of inflation. While, of course, past performance can never be considered a guide to future returns, historically markets always recover over time, as illustrated by the graph below showing the performance of the FTSE Allshare index over the last 40 years. Of course, history has also revealed opportunities. On Black Monday in October 1987, the FTSE 100 fell 31% but grew 120% in the subsequent five years. After the 9/11 attacks in 2001, the fall was 11% followed by a 57% gain by September 2006. As the St. James’s Place approach to investment management underlines, it is time in the market, not timing, that is the key to a successful long-term investment strategy.
FTSE All Share index – take the long-term view