In this week’s bulletin

  • Financial markets were led by the bulls last week – equity and commodity prices raced ahead on the back of good economic data and high demand as investors set aside the previous week’s geopolitical worries
  • UK economic data was particularly strong as manufacturing and construction bounced back
  • In the US, lower job growth was overshadowed by a fall in headline unemployment to 9% and comforting words from US Federal Reserve Chairman Ben Bernanke
  • With the tax year-end ever closer, the press reminded people to maximise use of available tax breaks, including ISAs
  • Dividend income is once more on the rise again with increased payouts outstripping inflation and acting as a good hedge against inflationary pressures
  • The commercial property sector is back on track according to fund manager Duncan Owen and for cash buyers, there are plenty of opportunities around

Onwards and Upwards
The bulls were out in force last week, sweeping aside any concerns caused by political unrest in Egypt and other parts of the Middle East, preferring instead to focus mainly on a swathe of positive economic data. Even potential disruption to oil supplies through the Suez Canal was seen as positive, enabling traders to mark up the price of Brent oil to just over $100 per barrel. With global demand for raw materials running at record levels it was no surprise that any threat to production caused by Cyclone Yasi hitting Australia saw copper and tin prices hit record highs – $10,000 and $30,790 per tonne respectively. News that China’s manufacturers appeared to pause for breath last month is unlikely to give commodity markets any respite though: a solid flow of new orders and a rising backlog of work mean the rapid pace of expansion has not cooled.
Higher commodity prices continue to feed through into inflation but its impact is felt more keenly in the developing economies, where people spend a greater proportion of their income on food staples. In China, consumers are complaining about day-to-day increases in the cost of familiar items – even fast food outlets have had to succumb by increasing prices, including the likes of KFC whose crispy chicken burger is apparently a must. Is the impact of higher food, raw materials and energy prices a ‘blip’ as suggested by some central bankers? Maybe, but not everyone is convinced. Fidelity’s Tom Stevenson, writing in The Sunday Telegraph, pointed out that the demographics of the developing world suggest price rises might be here to stay. According to the UN’s World Population Prospects database, between 1950 and 2050 the population of the developed world will have increased from 800m to 1.3bn while that of the developing world will have risen from 1.7bn to 7.9bn. The World Bank says food demand will rise by 50% from current levels by 2030 – a key driver is increased meat consumption primarily because it takes seven kilos of grain to produce one kilo of beef.
Economy Watch
After the shock news that the UK economy contracted in the last quarter of 2010 owing in part to poor weather, data showing that manufacturing, construction and the key services sector had once again resumed growing last month was well received by the market. Sterling hit a near three-month high on the news that the Purchasing Managers’ Index, a closely watched measure of economic activity, jumped to 62; the highest level since records began in 1992. Manufacturing companies reported rising demand from domestic and overseas markets, with new export orders rising sharply. “UK manufacturing steamed ahead in January. This is the much-needed kick-start to 2011 everyone in the sector was hoping for,” commented David Noble of The Chartered Institute of Purchasing and Supply. Construction has bounced back too, according to the latest Markit/CIPS survey with all the main areas of activity – housing, civil engineering and commercial construction – growing. The only downside to a stronger recovery is that economists believe the Bank of England may take action to tackle rising inflation by raising interest rates sooner than expected. The markets are now pricing in a quarter-point rate increase in May.
Small Gains
Snow and statistical revisions left economic policymakers struggling to judge the health of the US labour market last week following a confusing January jobs report. The Bureau of Labor Statistics estimated that the US economy managed to create only 36,000 jobs last month – well down on the 146,000 expected – but, oddly, the unemployment rate plunged from 9.4% to 9.0%. Investors decided the glass was half-full. “On balance we’d take it as a positive, – although with some caution,” said Standard Chartered, with their economist adding, “The labour market as a whole is definitely looking better.” Wall Street agreed, with the Dow Jones index rising smartly. But the numbers will, thought The Financial Times, create a dilemma for the US Federal Reserve because the current second phase of its $600bn programme of quantitative easing depends, in part, on the health of the labour market. Fed chairman Ben Bernanke was quick to reassure though, saying, “Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established.” The US bond market, however, read between the lines and decided that a rise in interest rates is now closer than ever, so Treasury yields rose to their highest level since last May.
Large Gains
By the close of business on Friday, it was self-evident that investors felt in buoyant mood and positive about the outlook for the global economy. Most of the major indices advanced on the week – London was up 2% and the S&P 500 even more. With the eurozone sovereign debt issue assigned to the backburner, European equity markets gained momentum, led by the financial sector. Whilst many Asian markets were closed for much of the week for the lunar new year, Tokyo rallied almost 2% as investors returned to the equity market. On the currency front, the pound attracted most of the attention in response to positive economic data and enabled the Sterling Index to jump more than 1%. Taken together, the FTSE All-World Index reached a 30-month high for a 1.7% gain on the week.
Taking the Offensive
Investors are currently battling on two fronts – trying to avoid rising taxes and also to combat the threat of rising inflation. With the end of the tax year approaching fast, the press is urging people to maximise the use of as many tax-breaks as possible by boosting their pensions, crystallising capital gains to utilise the Annual Exempt Amount (currently £10,100) and to ‘max-out’ their Individual Savings Account (ISA) allowance of £10,200. You might even go for a double whammy by using the ‘bed-and-ISA’ strategy, which enables tax-free capital gains to be sheltered from CGT and income tax going forward.

On the inflation front, equities have historically helped investors maintain the real, inflation-adjusted value of their capital and income. The Daily Telegraph reminded its readers that dividends are often overlooked as a component of the returns from equities. But receiving and investing dividends is by far the largest source of investors’ return over the long term. If you do need income then the good news is that company dividends are on the up once more following the cuts seen in 2008–09. Data from the Dividend Monitor shows that dividends from the FTSE 250 rose 16.3% last year whilst those from the FTSE 100 rose 6.8%. Whilst both beat inflation, it also illustrates the need to diversify your income portfolio across a broader number of shares. In total, some £56.5bn was paid out in dividends by British companies during 2010 and this year the figure is expected to rise 11% to £63bn, which will be good news for those seeking to protect their income from inflation.
Property Matters
It’s not just shares and commodities that have been enjoying rises in the last couple of years – commercial property has also been in recovery mode. Fund manager Duncan Owen, of Invista Real Estate, last week explained why he is feeling a lot more confident about the outlook. “The UK commercial property market has experienced a remarkable polarisation post the financial crisis. At its worst point the asset class had fallen some 44% – an unparalleled event and worse than the early 1990s. Since the low point about eighteen months ago, there has been a recovery in prices as buyers return to the market but most of this activity has been confined to the very top or prime end of the market.

As a result of keen interest from foreign investors and sovereign wealth funds, ‘trophy’ properties have been bid up to the extent that they are now back to, or have exceeded, 2007 prices, driving some rental yields down below 4%. West End London offices are a good example; values have soared and rents are probably double where they were just a few years ago. In contrast, the prices of property perceived to be less glamorous have remained virtually unchanged, with risk-averse investors avoiding this secondary part of the market, despite the extraordinary high yields of close to double digits. So, unlike the equity markets, there has been no ‘dash for trash’ whereby investors have been happy to snap up distressed but fundamentally sound companies again.

So, where we are today is that the ‘shiny’ property is very expensive and the ‘less shiny’ is still languishing. In amongst the latter are some very good properties which, whilst not ‘trophy’, are attractive with good tenants and income streams, so we have spent a significant amount of time and resource searching for these. The strategy for your fund has always been to concentrate on owning prime property with blue-chip tenants. Today, with substantial cash levels within the fund, now is a good time for us to deploy some of the war chest, picking up some of these overlooked properties, often at a significant discount. We are able to do this because, with banks still risk-averse, it means their lease/yield criteria remain very strict, precluding about 50% of potential buyers from being able to participate, leaving cash buyers a clearer playing field. Our recent purchase of the Novotel Hotel in Bristol is a good example; Accor is a blue-chip tenant and the property yields 7.2%. Another example is a retail development in Plymouth, which yields 9%.

Overall, the market has stabilised and we do not have the problems of over-supply that plagued the asset class back in the 1990s. There is another aspect to the asset class that is often overlooked – the ability of commercial property to act as a part-hedge against inflation, which is now becoming increasingly worrying for investors. All of the properties within your portfolios are on ‘upward-only’ rent reviews, which enable us to link these to inflation, thus helping protect the income in ‘real’ terms.”

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