Monday 28th February 2011

In this week’s bulleting:

  • The Libyan crisis caused sharp volatility in equity and commodity markets this week, as investors sought less risky assets
  • Trading on the London Stock Exchange was halted for four hours as problems arose with the new trading platform, which had only been in use for two weeks
  • Lloyds Banking Group announced a profit for 2010, but the City was unimpressed
  • The dangers of structured products were highlighted, outlining the amount of protection offered by the Financial Services Compensation Scheme
  • An overview of the power of dividend income was once again offered, with comments from Neil Woodford

Libyan unrest sparks sell-off
Savage swings in the oil price dominated market action this week, as fears that supply disruptions in Libya could spread across the Middle East triggered a broad flight from risk. The Financial Times reported that these concerns were largely played out in global equity markets where volatility rose 30% on the VIX Index; but base metals, copper in particular, and the credit market also suffered. Emerging markets equities slipped to their lowest levels in three months as nervous investors sought safety in US Treasuries (the yield of which fell 16 basis points to 3.43%), gold and ‘safer’ currencies such as the Swiss franc and the Japanese yen. Crude oil prices rose to two-and-a-half-year highs of around $120 a barrel on Thursday. their highest level since August 2008, but subsequently eased after Saudi Arabia signalled that it was prepared to increase supplies to make up for the Libyan shortfall. The Sunday Times warned that this crisis was driven by fear rather than fundamentals of supply and demand, pointing out that the International Energy Agency has enough reserves to cover the Libyan shortfall for a number of years as the country makes up only around 2% of daily consumption. This steadier tone to end the week allowed equities to recoup some of the losses, with the FTSE 100 closing just 1.3% down for the week at 6,001.20 and the S&P 500 closing the trading week down just 2%.

However, it was warned that, for as long as the Libyan turmoil continues, it is Britain and Europe which will feel the most pain as European refineries are built to process their particular crude oil rather than the sulphur-heavy Saudi Arabian version. Andrew Ovens, chairman of Greenergy, one of Britain’s biggest fuel suppliers, said, “We are going to see prices rise more in Europe than in North America or Asia, but once that happens, demand will haemorrhage just like last time.” As The Independent on Sunday highlighted, it is Italy which will suffer most from the shortfall as more than 25% of its oil imports are affected, followed by France and Spain. Britain relies on Libya for less than 10% of its supply, and is likely to have to bid for replacement supplies on the open market.

With speculation over the possible spread of dissent across the region, The Financial Times pointed out that the last five global recessions have all followed sharp jumps in oil price, so it is perhaps understandable that analysts would be concerned over the weekly rise of 16%. However, the increase is not as large as those seen during previous oil supply shocks. During the first Gulf War in 1990–1991, oil prices rose by 150% in three months, whereas in the 1970s, when oil supply was hit by a series of events including the Iranian revolution, prices increased by 200% in a matter of months. Despite the continued uncertainty over the future of oil prices, most analysts agree that volatility would continue to be high since the removal of the Libyan supply reduces the market’s buffer against further shocks.

Away from the obvious effects on the oil price, what effect does the unrest have on UK companies, was the question posed by The Sunday Telegraph. The paper advised that there are several major business projects that would be affected, involving household names such as HSBC, Standard Chartered and GlaxoSmithKline. Up until the crisis in Libya erupted last week, the companies were part of the 120 members of the Libyan British Business Council which were trying to grab a share of the £102 billion of infrastructure investment that the Libyan government had committed to over the next two years. While the likes of HSBC and Wood Group are reducing exposure to the country, GlaxoSmithKline may find this difficult due to the nature of its business supplying medicine to the country’s people.

Millennium bug
Just to add to the uncertainty, it was made impossible to trade last week as dealing on the London Stock Exchange (LSE) was halted for four hours on Friday morning. Shares in companies listed on both the main market and the AIM market could not be bought or sold on the Stock Exchange Electronic Trading Service, and market-makers were unable to conduct their business; therefore no prices could be set. Traffic typically worth a total of around £4.5 billion each day ground to a standstill as, just before the open, the LSE announced there were problems receiving real-time data from its new Millennium trading platform which launched two weeks ago. Overall, the trading volumes for the day were down over a third and, according to The Times, this had leading stockbrokers describing the situation as “a shambles”, and claiming that it had cost their individual businesses significant revenues.

Lloyds fails to impress City
Lloyds Banking Group announced its 2010 results, showing a £2.2 billion profit for the year after the £6.3 billion loss in 2009. However, investors were disappointed as Britain’s biggest retail bank indicated that profit margins would be lower than expected because of funding costs, and because the company has already enjoyed most of the benefit of increasing prices on mortgages and other products. Lloyds’ shares fell 4.5% on the day of the news, closing at around 62p; while for the government to be in profit, the price needs to reach 73.25p. As pointed out in The Daily Telegraph, these results risk heightening public anger after the state-owned lender admitted it will not pay any corporation tax in the UK until it makes another £15 billion of profits. Lloyds, which is 41% owned by the taxpayer, is able to avoid corporation tax as it has billions of pounds of deferred losses that it can write off against tax liabilities. Barclays was criticised the week before after revealing it had paid only £113 million in tax in 2009, despite making pre-tax profit of £11.6 billion.

This coming week sees HSBC expected to unveil the largest profit generated by a British bank since the start of the financial crisis, reported The Sunday Times. HSBC is expected to announce a £13 billion pre-tax gain for 2010, just 20% less than its record profit for a calendar year. The company makes about 80% of its profits overseas, and with a market valuation of £126 billion, HSBC is worth more than RBS, Lloyds and Barclays combined. The UK’s fifth largest bank, Standard Chartered, which performs most of its business in the Far East, is also expected to announce a record profit this week and because it is not part of the Project Merlin deal with the government, is expected to reveal a rise in bonuses paid to top employees.

No guarantees
The dangers of investing in structured products were highlighted by The Sunday Times, pointing out that savers often invest in the belief that they get the same security as with a deposit account, but that they do not have the same protection from the Financial Services Compensation Scheme if the bank underpinning the scheme goes bust. The protection offered is different due to banks using complex financial instruments to provide the ‘guaranteed’ market-linked returns, and as such, the promise to return your money is only as good as the financial strength of the institution that guarantees it. Thousands of investors lost money when Lehman Brothers collapsed in 2008, while more suffered in 2009 when Keydata went bust. Despite this chequered history, structured products are still being released and described as ‘guaranteed’, ‘protected’ and ‘secure’, and investors should make sure they fully understand the product in which they invest their money.

Hot topic
At a time when corporation tax is being widely discussed, The Sunday Telegraph reported that BP is suing the Government for almost £300 million plus compensation, claiming for tax it paid “by mistake” more than a decade ago. The oil giant is accusing HM Revenue & Customs of wrongly charging stamp duty reserve tax when it took over a US rival in 1999, and the company is already expected to pay much less tax over the next four years as it meets the costs of the Gulf of Mexico oil spill. Before the events of last summer, BP paid worldwide tax at the effective rate of 33% on profits of £15 billion, and of the total tax paid in 2009, more than £900 million was to the UK government. The tax paid in that year was worth as much to the UK as from its entire transport and communications industries combined.

Dividends still the key
It is not news to any investor that income seekers have had a torrid time over recent times with cash delivering very little, and UK dividends falling in 2010 as a result of the BP oil spill in the Gulf of Mexico. However, as highlighted in The Sunday Telegraph, if you take BP out of the equation, then dividends actually rose by 7.5% over the full year. The latest Barclays Equity Gilt Study shows that £100 invested at the end of 1899 would have been worth just £180 in real terms at the end of 2010, but when dividends are reinvested, then that figure is boosted to £24,133. While there has been an element of criticism that 38% of all UK dividends came from 5 companies last year, and 61% from the top 15 companies, the paper highlighted the tactics used by the top income managers in the UK. One of the highest-rated managers in the sector is Neil Woodford of Invesco Perpetual. He said, “I look to invest in businesses that can provide sustainable long-term dividend growth. If I can invest in a business when its growth potential is not reflected in the valuation of its shares, this not only reduces the risk of losing money, it increases the upside opportunity. In the short term, all sorts of influences buffet share prices, but over longer time periods fundamentals shine through. Dividend growth is the key determinant of long-term share price movements; the rest is sentiment.”

2011 FT/Investors Chronicle Wealth Management Awards
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