In this week’s Bulletin:
- Markets shrug aside Middle East tensions on mounting recovery optimism
- Investors’ appetite for risk continues as interest rates on US high-yield debt hit an all-time low
- G20 seeks solutions to global inflationary pressures and the threat of protectionism
- Latest RPI figure means not a single savings account in the UK pays a real return
- Speculation continues over whether, or when, the MPC will raise interest rates
- ISA season in full swing as investors are reminded of inflation-proofing options
Markets weather sandstorms
The turmoil in the Middle East intensified during the week, with a brutal crackdown in Bahrain and Libya’s Colonel Gaddafi reminding the world that he is no soft touch either. Investors appeared to shrug aside these escalating tensions and focused on mounting optimism about the prospects for economic recovery, prompting global equities to continue their march higher. US equities recorded a third successive weekly advance; the S&P 500 set a sequence of 30-month highs and hit a level twice the cyclical low of March 2009. The FTSEurofirst 300 Index reached a 29-month peak and the Nikkei 225 Stock Average managed a gain of 2.2% to record its highest level for more than nine months. The UK market also registered a third straight week of gains, despite the FTSE 100 being dragged down on Friday by sharp losses for mining stocks, and ended the week up 0.33%.
Elsewhere, there was evidence that markets were becoming troubled by geopolitical risks, as the traditional safe havens of precious metals and the Swiss franc gained ground. Gold hit a five-week high above $1,390 per troy ounce and silver prices followed suit to reach their highest level since 1980. Amongst other commodities, copper hit a record high of $10,190 per tonne earlier in the week before falling back after China tightened its monetary policy, and Brent crude oil breached $104 per barrel – its highest level for two-and-a-half years. The result was more misery for motorists, with The Times reporting that the average petrol price had hit a record high of 128.8p per litre.
Analysing further the rise in the US equity market, The Financial Times studied the speed and extent of the climb and compared it to previous bull markets to see what lessons could be learned from history. The S&P 500 index took just over 500 trading days to rebound from the lows of March 2009; faster than in any comparable rally in the last 75 years. The developed western markets are also currently the beneficiaries of money being rotated out of emerging markets – last week saw developed market equity funds enjoy their biggest inflow for 30 months, according to data provider EPFR. Needless to say, in terms of how much further the rally might have to go, history throws up arguments supporting both the bulls and bears. One statistic suggests it should last at least until October: that is when the third year of the US presidency ends: a year which almost without exception has delivered strong gains. The S&P 500 is up 17% since 1st October. Chris Blum of J.P. Morgan Asset Management counselled that it will last as long as the economy is improving: “Follow the data. As long as it continues to get better, it is hard to bet against.”
The price of junk
Another indication of investor belief that a US recovery is under way came with news that interest rates on US high-yielding debt, or ‘junk’ bonds, have hit an all-time low of 6.8%. The Financial Times reported that investors’ continued appetite for riskier assets saw a record inflow of $1.4bn into US high-yield funds in the first week of February, driving yields lower. This has been helped by a sharp reduction in corporate default rates – the global rate fell to 2.8% in January from 12.6% a year ago. January also saw no new defaults, the first such month since June 2007. The strong demand for this debt has meant that even the riskiest of companies have been able to borrow money at historic low rates of interest. However, the drop in yields means investors have a smaller cushion against rising interest rates or an economic shock, although the spread to benchmark treasuries remains well above the lows reached at the height of the credit crunch.
However, a stark reminder of the dangers to the US recovery came in news over the weekend that an all-night session in the Republican House of Representatives had agreed to slash the federal budget by $61bn. The Sunday Telegraph reported that US Treasury Secretary Tim Geithner immediately condemned the news, speaking at the G20 summit in Paris, “The continuing resolution as passed by the House would undermine and damage our capacity to create jobs and expand the economy.” On the other side of the argument, the House Speaker, John Boehner, said the legislation was part of Republican efforts “to liberate our economy from the shackles of out-of-control spending”. President Obama pledged to veto the aggressive cuts package and the proposal will now be debated by the Senate, where Democrats hold a slim majority. If a compromise short-term spending deal cannot be struck the government will be forced to close; something which last happened in 1995 in a budget row between President Clinton and House Speaker, Newt Gingrich. Such paralysis is likely to damage US economic prospects and therefore the chances of a continuing global recovery.
As The Sunday Times reminded its readers, inflation is the world’s most pressing economic problem and the factor which continues to dictate the thoughts and actions of policymakers, corporations and consumers around the globe. Price rises are being driven by big macroeconomic factors and the commodity price boom risks crushing the global recovery. So were the warning words of the Chancellor, George Osborne, at the G20 conference, who went on to advise fellow ministers that soaring food and fuel prices are the biggest menace to growth after the public debt crisis that has afflicted nations around the world. The G20 countries together account for 85% of world economic output and at the two-day meeting France was leading a call for greater transparency and regulation of commodity prices and derivative trading to stop markets being driven by speculation rather than demand. There was also pressure to agree measures to monitor and so begin unwinding the huge trade imbalances that have built up in the world economy and pose a significant threat to stability. In a week which also saw China overtake Japan as the world’s second largest economy, the globe’s biggest exporter was baulking at measures which would increase the pressure on it to let its currency appreciate significantly, thus making its exports less competitive. However, a last-ditch Chinese deal enabled the G20 nations to agree a first step towards greater co-operation, with “indicative guidelines” to be agreed by April. In spite of this, Capital Economics was amongst those organisations fearing that progress on this issue will move at glacial speed, increasing the likelihood of a serious escalation in protectionism in 2012.
On Friday, China intensified its crusade against inflation by raising the banks’ required reserve ratio (RRR) another 50 basis points, in a move designed to drain the equivalent of £34bn from the financial system. The RRR forces banks to deposit a fixed proportion of their wealth with the central bank, which can be touched again only if the ratio is lowered.
Feeling the squeeze
Back in the UK, the Office for National Statistics announced that inflation, as measured by the Consumer Price Index (CPI), had jumped to 4% in January, double the 2% target. The Retail Prices Index (RPI) rose to 5.1%, which for many is the more realistic gauge of how prices are rising. Mervyn King, the Governor of the Bank of England, stated he had “enormous sympathy” for people whose household income was facing the biggest squeeze since the 1920s, but that the squeeze “was going to happen one way or another – it’s the price we are all paying for the financial crisis.” He also cautioned that Britain will have to get used to slower growth if people want to avoid longer-term rising inflation. As The Daily Telegraph opined, it is not just income but also savings which are losing their spending power. According to Moneyfacts, not one savings account in the UK pays sufficient interest to earn a real return after tax and inflation (as measured by the RPI). For a basic-rate taxpayer, just 23 accounts make the mark against the CPI measure, of which 21 are cash ISA accounts, into which only a limited amount can be deposited.
The news sparked renewed speculation about whether, or when, the Monetary Policy Committee (MPC) should raise interest rates and, as The Times reported, prompted MPC hawk Andrew Sentance to openly dismiss the Bank of England’s latest inflation forecasts as “too optimistic” and claim that rate increases were “overdue”. Mervyn King went as far as to acknowledge that, “It is clear that at some point the Bank rate will have to go up”, but otherwise left the markets guessing – the interest rate futures market is implying three quarter-point rate rises in the next 12 months.
Inflation and ISAs shared the headlines of the weekend press – The Sunday Telegraph suggested ways to combine the two to your advantage by investing in the reinvested dividend potential of equities, which has historically provided the lion’s share of returns. The paper pointed out that one way to beat inflation was to invest in what was causing it by buying energy and food-related shares and funds. This theory helps explain the current popularity of equity income funds amongst ISA investors, as a route to generating tax-efficient growing income that can keep ahead of inflation. With the bank base rate stuck at 0.5%, the average yield of more than 4% on equity income funds looks quite attractive. Other sectors that came under the spotlight for ISA opportunities were pharmaceuticals and financials. Sanjeev Shah of Fidelity commented, “The drugs sector is cheaper relative to the broader market than at any point in the past 15 years and valuations are underpinned by strong cash generation”; meanwhile, financial stocks had “not been so cheap in the past 25 years”.
Continuing the ISA theme, The Telegraph provided a reminder of the potential folly of chasing performance when making your ISA selection. It reflected on the fact that the most popular funds currently tend to be those with decent recent performance, yet there are many examples of winners one year becoming also-rans the next. These observations are backed up by a study from Cass Business School and Barclays Wealth, which found that timing decisions by private investors since 1992 had lost out on returns averaging 1.2% a year because they had chased performance. The message was that, if your decision to invest in a fund was only down to what it had done in the past, then it was wise to think again.
2011 FT/Investors Chronicle Wealth Management Awards
You may like to know that you can vote for this year’s FT/Investors Chronicle Wealth Management Awards, to identify the best wealth and investment managers in the UK. By doing so you will also be entered into a prize draw (being sponsored by the FT) for the chance to win £1000. Simply visit www.icwealthawards.co.uk/voting.