Please find attached this week’s Bulletin which contains the following points:
- A stream of US economic data caused a flight to safety by investors, including an increase in unemployment to 9.1%.
- The International Monetary Fund is due to give their assessment of George Osborne’s economic policies.
- India looks likely to open to overseas retailers, giving the likes of Tesco an opportunity to expand further into emerging markets.
- Despite attention being on the rest of the eurozone, the economic strength of France and Germany is in focus.
- Hugh Young gives his opinion on how a long-term approach should be taken in equity markets.
Mounting economic concerns
The outlook for the global economy continued to look decidedly murky last week, triggering losses on developed market equities, while the US oil price dipped back below $100 per barrel. Investors once again turned to traditional safe havens such as government bonds, gold and the Swiss franc following a string of unsettling data releases, particularly with regards the US economy. The recovery concerns were triggered by weak indicators, including the US unemployment figures increasing to 9.1%, the highest this year. The news culminated on Friday with a much lower than expected headline figure in the May non-farm payrolls report. At just 54,000, the increase in jobs was the smallest gain in eight months. This run of weak data prompted analysts to scale back their expectations of policy tightening by the Federal Reserve, with some speculation in The Financial Times that the US central bank could even embark on a fresh round of asset purchases to support the economy after its current quantitative easing programme closes this month. The surge in risk-aversion gripped equity markets, with falls of around 2% on Wall Street leading to the fifth straight week of falls in the US. In the UK, the FTSE 100 fell 1.4%, closing at 5855.01.
There was a slight contrast in the eurozone, as recent concerns over the debt crisis showed signs of easing, with increased optimism over a fresh bailout for Greece. Officials from the European Union, the European Central Bank and the International Monetary Fund said Greece was expected to receive the next instalment from the €110 billion fund in July. Jean-Claude Juncker, the leader of the EU finance ministers, said he expected eurozone members to provide additional funding with the condition that it would include a ‘voluntary’ role for private sector investors. This news strengthened the euro to a four-week high against most major currencies.
Chancellor on report
This week, the credibility of George Osborne will be on the line, according to The Mail on Sunday, as the International Monetary Fund (IMF) gives its verdict on his economic policies. The Chancellor will find out if the IMF still broadly backs his plans or whether he will have to suffer the humiliation of being urged to change course. Late last month, the 34-nation Organisation for Economic Co-operation and Development (OECD) backtracked on its previous enthusiasm for Mr Osborne’s policies, suggesting Britain needed a slowdown in its deficit reduction programme. The IMF was also a supporter in its last report issued in November. However, since that report, the IMF has become more outspoken after the situation in Greece; and there has been a change at the top with John Lipsky, the temporary replacement for Dominique Strauss-Kahn, having no known political ambitions and therefore no reason to tread carefully with elected leaders.
The coming week will see inflation come under the spotlight once again, as the Monetary Policy Committee holds its June meeting to set interest rates. Money markets are currently suggesting that any rate rises will not be until later in the year, meaning that borrowing costs are set to be kept at an all-time low for the 27th consecutive month, despite the Consumer Price Index remaining above its 2% annual target every month since December 2009. The Bank of England has argued that inflation has been temporarily caused by the increase in VAT from 17.5% to 20%, the rise in import costs and high energy prices, and believes inflation will subside as the year goes on. The Sunday Telegraph reported that the Bank of England could destroy the ‘last vestiges of credibility’ if it raised interest rates too quickly, as switching opinions after prolonged inaction would call previous decisions into question, especially with the economy slowing once again.
Boost for retail
The Indian commerce minister revealed to The Sunday Telegraph that India will finally open its doors to overseas retailers within the next four months. Prime Minister David Cameron led a Cabinet delegation to India last summer in an attempt to boost trade with the second fastest growing economy in the world, and to persuade India’s leaders that Britain could play a part in the country’s development; but since then little has improved where Britain is concerned. However, with India the world’s largest producer of milk, and the second largest producer of fruit and vegetables, 30% of all produce rots before it reaches the market. The Indian government believes that overseas supermarkets such as Tesco, Carrefour and Wal-Mart can play a vital role in revolutionising the sector and investing heavily in logistics. It is highly likely that new entrants will be forced to invest in back-end warehousing, food processing and refrigerated transport networks, and create jobs in rural India. Tesco has made no secret of its desire to enter this market, attempting to do so for six years, but has so far been restricted to franchise agreements with several local hypermarkets. This new legislation would mean increased opportunities for a number of leading global retailers.
House price speculation
According to The Sunday Times, after rises in 2009 and 2010, house prices in the US have fallen around 7% in the last six months. This has led to an assessment by Morgan Stanley, the investment bank, which says the UK property market could follow suit over the course of the next year. Such views have increased concerns over the impact this will have on Lloyds Banking Group, Britain’s biggest lender, which would be hardest hit by any potential falls as more people fall into negative equity and real disposable income continues to decrease. After the £3.2 billion hit the bank took from the PPI mis-selling scandal and the further losses suffered on its Irish loans, it certainly does not need a significant proportion of its mortgage book to be in negative equity. Negative equity mortgages have higher arrears rates, resulting in higher loan losses and lower earnings for Lloyds. However, Morgan Stanley acknowledged that a correction could probably be avoided by the Bank of England deciding to leave interest rates on hold for longer.
While this is just one opinion from one investment bank, with Morgan Stanley having a notoriously pessimistic view on the UK economy, The Financial Times reported that the general consensus from the City is that the best that a UK homeowner can hope for is that prices will stagnate and remain level over the next two years.
Old Europe paving the way
Despite the widening fiscal crisis in the eurozone and the emergence of the East, France and Germany are still the fourth and fifth largest economies in the world. As The Independent on Sunday reported, the two traditional powerhouses were desperately out of fashion in the 1990s and the early part of this century, being seen as behind the times because their economies were based on manufacturing and selling, rather than packaging financial services. While the likes of Portugal, Italy, Ireland, Greece and Spain dominate the news agenda, these economies only amount to a small fraction of the European economy and equity market. The paper opined that Germany is benefiting massively from Chinese growth due to its strong trade links, which is in stark contrast to somewhere like the UK. Less than one person in twenty owns a car in China, and the likes of a Mercedes or BMW are seen as aspirational items. Along with French wine and handbags, these top-quality, high-end brands are being seen as vital for European prosperity going forward.
Stuart Mitchell of S.W. Mitchell Capital, manager of the St. James’s Place Continental European funds, reported that: “Germany is the paragon of economic virtue in Europe. There are current account deficits in Britain and America, but Germany is running an enormous surplus driven by its incredibly efficient and competitive export industry. Labour costs are low as Germany has kept its unit labour costs much more closely under control than certainly the rest of the Eurozone, but also than Britain or America. German companies have fought very hard, post all the problems with reunification, to be extremely competitive.
“Our geographic exposure is solely stock-led by trying to find the best companies in Europe. Our large weighting in France is simply because most of the companies we’re invested in are large, international companies that happen to be headquartered in France. They’re not really affected by local government issues. The other reason is that France, along with the UK, has a history of equity funding that is much more developed than it is in Germany, Holland or other countries that haven’t had that sort of buccaneering, entrepreneurial history over the last 200 to 300 years. We have been consistently very positive and surprised that markets haven’t done better, although many would say that they’ve actually been surprised that markets have been so resilient. We’ve tested on the downside, but there hasn’t been enough food for the bears because economic growth has just been too strong.”
Long view pays off
As highlighted in The Financial Times, short-term concerns should not matter when investing in the equity market, and it is the long-term approach that pays dividends. The paper drew attention to the approach of Hugh Young of Aberdeen Asset Management, manager of the St. James’s Place Far East funds, who has followed this philosophy since 1987. As an example of this investment style, Hugh has held some of his top holdings for over ten years, only changing around three or four stocks per year from his 66-stock portfolio. One of the top holdings is Rio Tinto which has been held for 15 years, increasing in price by around five times over that period. Rather than being concerned with the volatility of commodity prices causing swings in share price, he prefers to concentrate on the way a company operates. Hugh told The Financial Times, “Too many people in this business worry about short-term performance, then panic and sell something that’s a good company just because the share price isn’t doing well. We don’t chase performance, we just try to find the best companies in Asia, and make sure we don’t pay too much for them.”