In this week’s bulletin:
- Markets get Moody – credit rating agencies Moody’s and Standard & Poor’s felt the wrath of politicians last week, as their respective decisions to downgrade Portugal’s credit worthiness and potentially place Greece in default upset investors.
- Dancing to the Tune – investors continue to be frustrated by the slow rate of economic growth in the developed Western economies, with the exception of Germany. Economic data out last week showed Britain growing at a much slower rate than hoped, despite bright spots in the housing and services sectors.
- Pennsylvania 1600 – poor US employment data out last Friday upset global markets with only 18,000 new jobs created – well down on the expected 100,000. Stock markets reacted predictably, with prices falling in New York. In response, President Obama called for more infrastructure spending, to create jobs but is facing fierce opposition from the Republicans.
- Rally Fades – after the previous week’s meteoric bounce it was no surprise that equity markets slowed on the disappointing US data but they still managed to end the week slightly ahead with the Far East the favourite.
- Markets set to Bounce? – Notwithstanding the economic backdrop, professional investors are expecting global equity markets to bounce back in the second half of the year noting that globally, shares are trading on very low valuations. The UK market, on current ratings, is one of the cheapest in the world.
Markets get Moody
The previous weeks’ meteoric rise in global markets proved too much for investors – last week they suffered an attack of vertigo and decided, mostly, to take a step back and reflect on latest events. There have been three key worries for the markets this year – a spluttering US economic recovery, the eurozone sovereign debt imbroglio and a slowing Chinese economy. Last week the former two issues dominated, although news that China’s inflation rate hit 6.4% jangled a few nerves – willBeijingmanage a ‘soft’ landing by gently slowing growth or will it be a ‘hard’ impact? For now, the markets are assuming that the world’s second largest economy will stay on track and growth will be tempered. As for theUSand the eurozone issues, both took the headlines once more.
Efforts to rescue Greece hit a new roadblock after rating agency Standard & Poor’s declared that a French plan to involve the private sector (banks) would effectively constitute a ‘selective default’ by Athens. The immediate concern was that if the policy were to be echoed by other rating agencies then it could mean that the European Central Bank (ECB) might refuse to accept Greek government debt as collateral. That would then cut off the lifeline the ECB has been providing to the stricken country. Analysts said policymakers would have to go back to the drawing board for a solution but officials argued that if the ‘selective default’ period was brief then refinancing arrangements with the ECB would remain intact. Meanwhile, financial markets trod water as investors mulled over the implications.
But hard on the heels of S&P’s warning came another, unwelcome, intervention on the part of the rating agency world – Moody’s announced mid-week that it had slashedPortugal’s credit rating to junk status: Ba2 to be precise. This move left the country’s financial status on a par with the likes ofEl SalvadorandArmenia, causing the euro to slide against the dollar and sterling. The decision heightened fears that there would be contagion across the euro region, withSpainandItalyalso being seen as vulnerable, whilst also exacerbating ongoing talks overGreece. Moody’s justified its move to downgradePortugal, citing “the growing risk that [it] will require a second round of official financing before it can return to the private sector”. So, in the circumstances, it was no surprise that the credit rating agencies were immediately hit by a ferocious political backlash inEurope, with EU officials accusing the agencies of anti-European bias and signalling that powers could be introduced to suspend ratings on countries in receipt of bailouts.
Dancing to the Tune
‘Slow, slow… quick, quick, slow’ just about describes the economic recovery in the developed West – with the primary exception being Germany where the country is enjoying boom conditions: so much so that it is seen as the land of opportunity by the young unemployed in the eurozone, attracting skilled immigrants from struggling peripheral countries such as Spain, Greece and Portugal, where unemployment levels are anything up to 21%. It may actually be a solution toGermany’s longer-term demographic problems; stemming from the country’s low birth rate and ageing population, which is constraining growth. The working-age population is set to fall from around 54m to under 50m by 2025, according to the OECD. But red-hot growth from the eurozone’s largest economy will not, on its own, solve what is clearly a bigger problem.
Here in the UK it’s a story of stop, start, with a mixture of better than not-so-good news. The property market perked up last month, according to the Halifax, with prices rising 1.2% in June. “Low interest rates, an increase in the number of people in employment and some tightening market conditions earlier in the year, are likely to have been the main factors behind the recent improvement in price trends,” commented Halifax housing economist, Martin Ellis. Of course, this figure hides huge regional variations, with northern regions hit by public service cuts but the south-east enjoying more buoyant conditions, with London leading the way. Indeed, the sharp rise inCentral London’s prime residential market has, according to research, kicked off a development boom, with £21bn in schemes planned during the next nine years. The dominant services sector also performed better than expected last month, with the Markit/CIPS services index edging up to 53.9 – anything over 50 denotes growth.
But it seems that this is not enough to enable the broad economy to gain traction and The Sunday Times reckoned that the UK economy is likely to start shrinking again, with economists downgrading growth to as little as 0.1% during the second quarter. The downgrade was a result of disappointing US employment figures on Friday which caused the likes of J.P. Morgan and Royal Bank of Scotland to downgrade their earlier forecasts, with the latter estimating growth of just 1% for this year; much lower than the government’s official growth expectations. What does all this mean? Well, economists now believe that the Chancellor’s plan to wipe out the bulk of the structural deficit in the public finances by the end of this parliament is unlikely to succeed. Part of the problem is the pressure on household expenditure – higher inflation is eating into discretionary spending, causing people to spend less; and the outlook is not good, it seems. According to the Bank of England (BoE), inflation was 4.5% during April and May and is likely to rise further to 5% as it revised upwards its inflation forecast to reflect higher energy costs. So it was no surprise that the BoE also held interest rates at 0.5% once more – bad news for savers, struggling to get a positive real return.
Pennsylvania Avenue One Six Zero Zero
This is the home of the White House, which is the source, according to Irwin Stelzer, writing in The Sunday Times, of much of America’s current economic woe. After a flying start back in late 2009 and 2010, the world’s largest economy is struggling, despite the infusion of a massive stimulus package introduced by President Obama and help from the US Federal Reserve to the tune of $2.3 trillion via its QE programme. Whilst no-one expects the recovery to go in a straight line, last week’s US payroll figures were very disappointing – just 18,000 jobs were created in June, well below the expected 100,000. “June’s employment report doesn’t have a single redeeming feature. It’s awful from start to finish,” was the view of Capital Economics. The poor numbers meant that unemployment edged up from 9.1% to 9.2%. In response, The Financial Times commented that theUS government is looking for new ways to inject life into its sagging economy.
The White House renewed its call for the establishment of an infrastructure bank to invest in new roads, bridges and railways. “Right now there are over a million construction workers out of work after the housing boom went bust, just as a lot of America needs rebuilding,” said President Obama. The trouble is his push for new spending has encountered fierce resistance from Congressional Republicans who argue that previous efforts to stimulate the economy failed to create jobs. Whilst politicians argue, Main Street America is worried about its own future, with millions unemployed and millions more only able to work part-time. Stelzer noted that more than 16% of the workforce, some 25m, is affected. But the positive news, he said, is that the sluggishness of the recovery is due in part to policies that can be reversed. Red tape is stifling job creation it seems. Companies are prevented from taking on unpaid interns, regulators have prevented drilling for oil and gas at the cost of 100,000 jobs, emission cuts are impacting on nuclear waste storage sites and regulators are seeking to stop Boeing opening a new plant on the grounds it wants to shed unionised labour. Finally, new health arrangements have left small businesses wondering what their healthcare costs will be in future. The real headwinds, Stelzer concluded, are coming from 1600 Pennsylvania Avenue.
So against this changing economic backdrop, it was unsurprising that global equity markets took a breather after their strong performance the previous week. The US payroll figures were undeniably the catalyst for traders to bank some profits which resulted in stock market falls on Wall Street and in Europe. Finding favour were US Treasury bonds and commodities – oil continued its rise, with Brent crude rising 6% to $118 a barrel – as investors moved in. But whilst the headlines may have made for dramatic reading, the reality was that most Western stock market indices remained little-changed on the week. In their place, investors decided to rotate into Far Eastern markets where the Nikkei 225 enjoyed its best week for months, driving the index back over 10,000 and nearly back to where it was beforeJapan’s terrible earthquake.ChinaandHong Kongwere in favour too with their respective markets both adding around 1.5% on the week. And despite additional worries over the eurozone, investors appeared phlegmatic. The VIX Index – known asAmerica’s ‘fear gauge’ – remained close to its low for the year.
Markets Set to Bounce?
With financial events dominated by the three key concerns discussed earlier, it’s worth thinking about what might happen in the second part of the year. Year to date, the results from investing in equities have been mixed – Wall Street tops the leader board, up 6%.Londonis up 3% but China is flat and emerging markets down slightly. But according to some of the experts – including Fidelity fund manager Tom Stevenson – investors should prepare for a third-quarter bounce in stock markets, despite the poor economic news from the US. Apparently, fund managers and professional investors have been steadily buying shares in anticipation of a rebound, with equities trading at their cheapest for several decades. One measure used to gauge whether stocks are cheap or dear is the price–earnings ratio (p/e) – in other words, comparing, as a multiple, a company’s current share price against its current earnings. The lower the number, the greater the potential opportunity for capital gains. According to Citigroup, the average p/e ratio of global shares is 14.2 – the lowest, apart from the 2008 bear market nadir, since the mid-1980s. UK companies are trading on around ten times expected earnings, making the UK one of the cheapest markets in the world. Of course, one shouldn’t take a six-month view on equity investing: it’s for the longer term; and thinking about how mixed the results have been year to date, it is important to have a spread in geographic terms. This is also in addition to diversifying at an asset-class level too – it helps reduce risk and volatility.