- Once more it was Greece that stole the limelight in the financial markets as investors watched nervously for a solution to the country’s plight and measures to deal with possible eurozone contagion.
- EU policymakers and leaders stepped up to the plate by announcing a wide-ranging deal, which was at the aggressive end of the markets’ expectations. It involved more money for Greece, giving more powers to the EU bail-out fund and cutting borrowing rates for Greece, Portugal and Ireland.
- The initial relief rally petered out though as investors fretted, once more, about slow economic growth in the region, with the exception of Germany.
- Signs that the UK economy is also struggling is leading economists to warn of low, slow or no growth for some time yet. Official GDP figures are due out tomorrow and the figures could potentially scupper the Chancellor’s hopes of seeing Britain enjoy a decent recovery.
- In the US, continued political squabbling between the Republicans and Democrats means the country’s borrowing limit cannot be raised, which could have serious consequences and possibly the loss of America’s AAA credit rating.
- Star fund manager, Neil Woodford of Invesco Perpetual gives his views on the economic outlook and how this is shaping his current investment strategy.
It’s All Greek
Investors’ nerves were stretched almost to the limit last week as eurozone policymakers wrangled over the details of the second bailout for the region’s ailing and most problematical member,Greece. Pressure had been piled on by the markets over the preceding days as it became clear that, unless decisive action was taken immediately, there was a real threat of financial contagion spreading across European – and potentially global – sovereign debt markets. Eurozone ministers, led byGermanyandFrance, rushed to cobble together a deal that would satisfy all participants: the markets, bondholders, politicians and, not least, taxpayers. The last-minute deal was reached after President Nicolas Sarkozy ofFranceagreed to shelve a proposal for a €50bn tax on eurozone banks. Taxpayers of course will pick up around two-thirds of the final bailout bill which totalled some €109bn. The other group to take a haircut were private sector bondholders (of mostly German and French banks) who were forced, atGermany’s insistence, to agree to debt swaps or to rollover existing holdings into longer duration paper.
But the bailout package didn’t stop there. Policymakers were under no illusion that the markets also needed to be reassured that fears over possible contagion – involvingSpainandItaly– were unfounded. So the deal went further and contained three key components. First was the €109bn. Second was a revamp of the existing European Financial Stability Facility (EFSF), the EU’s €440bn bailout fund, to give it powers to make short-term loans, provide funds to recapitalise banks and, in “exceptional” circumstances, even buy back bonds of debt-laden governments. One of the key features is that the fund will be able to act pre-emptively thus preventing eurozone contagion. The final aspect is to be more generous to existing borrowers from the EFSF –Greece,IrelandandPortugal– by cutting the interest rates they have to pay by between 100 and 200 basis points and also doubling maturity periods to 15 years. Mr Sarkozy said the changes were tantamount to the creation of a European monetary fund.
So, did it work? Well, the package was initially seen as at the aggressive end of expectations so it was no surprise the equity and bond markets rallied smartly – with, unsurprisingly, banking stocks benefitting most – as investors breathed a sigh of relief. But by Friday jitters had returned to European markets, snuffing out the relief rally, causing Italian and Spanish bond yields to rise (as prices fell) and the euro to fall against the dollar. Economists took the view that the crisis will only be on its way to full resolution when it becomes clear that the eurozone has achieved satisfactory growth. But, notwithstanding this, global equity markets ended the week positively with most major indices advancing around 1.5%. InLondonthe blue-chip FTSE 100 index came close to the 6,000 level once more before slipping back. And for those investors who remained anxious there was always the perceived safe haven of gold where prices closed at $1,602 per troy ounce – close to its record high. Elsewhere in the commodity markets, oil crept ahead with Brent crude closing at almost $120 per barrel, just seven dollars shy of its own record high.
Growth Remains Elusive
There are three major issues currently worrying investors. Aside from the eurozone, the others are anaemic economic growth across the developed economies (apart from Germany) and political squabbling in the USover raising the country’s debt ceiling (more about which later). The point about achieving satisfactory growth is not peculiar to the eurozone. USgrowth is faltering and causing great angst not just at the Federal Reserve but also in the White House which is gearing up for next year’s presidential election. Here in Britain it is a similar story and analysts et al are keenly awaiting official GDP figures, due to be released this week by the Office for National Statistics, which will show how much growth the UK achieved in the second quarter of the year. There is much speculation that the recovery will be shown to have stalled, with some economists, according to The Sunday Times, predicting the economy actually shrank over the past three months and calling for Plan B from the Chancellor, George Osborne.
This is highly unlikely – in an interview with The Sunday Telegraph the Chancellor made it clear that, whilst growth is a clear priority, the government will not riskBritain suffering the same fate asGreece and the like by not cutting the deficit as it has promised. However, Mr Osborne’s hopes for recovery are being battered by sluggish consumer demand, low bank lending and the eurozone crisis and, according to some, the growth slump could last a decade. This gloomy prognosis came from Erik Britton of Fathom Consulting, formerly a Bank of England economist, who said the UK would have to become used to a “new normal” where growth would hover between zero and one percent. “We are definitely talking about the new normal. It is very hard to pin the weakness of growth on austerity. Government spending has not fallen yet,” he said. Not all agree. Some economists argue that the weakness is attributable to an extended Easter break and the royal wedding and expect a robust third quarter.
With the Treasury sticking to its view that the recovery was always going to be choppy, the Bank of England is also maintaining a cautious outlook, it seems. Minutes of the July meeting of the Monetary Policy Committee showed that Britain’s recovery continues to disappoint, saying that “There were early indications that underlying growth might soften in the third quarter”. As a consequence, the MPC decided to keep interest rates on hold once more and analysts now expect rates to remain at 0.5% well into next year and possibly 2013. The MPC also took the opportunity to set expectations about inflation, saying it would “rise above 5% in the coming months” as a result of higher food and energy prices. The one bright spot is that consumers were lured back to the high street last month by the heavy discounting of household goods – retail sales volumes rose 0.8%, better than forecast.
Over in theUS, all eyes are on Capitol Hill where Republicans and Democrats are locked in battle over raising the country’s deficit limit from its present level of $14.3 trillion. It seems that failure to find an agreement will mean the American government will technically run out of cash by 2 August and potentially theUScould lose its coveted AAA credit rating, with all the associated ramifications. In the past, the limit has been raised without much debate but this time both sides seem determined to take it to the wire: the Republicans want to cut expenditure whilst the Democrats won’t agree to cuts for healthcare and want higher taxes on the rich. Anxiously watching the impasse is President Obama who wants to be re-elected next year. Over the weekend he resorted to raising the spectre of market turmoil if the political battle is not settled. In the meantime there is frantic activity behind the scenes as leaders from both parties attempt to thrash out a solution and some Republican senators have joined Democrats in the chamber to try to forge a bipartisan deal. Like the eurozone, it seems time is running out.
A Perpetual Favourite
The Sunday Telegraph took the opportunity to remind its readers that investment outperformance doesn’t come in a straight line and that even the most successful investment professionals will go through periods of underperformance. The key is to be patient, with the paper highlighting the performance of starUK equity manager Neil Woodford of Invesco Perpetual, noting that up until the last few months his performance had lagged the market over the last couple of years. However, much has changed recently and with the markets becoming more nervous, Mr Woodford’s defensive strategy has come into its own, bringing outperformance. By coincidence, Neil Woodford shared his views with us last week. “Current events really come as no surprise to me. I have expressed the view for a long time that the ramifications of the financial crisis would be both long-lasting and far-reaching. The economic recovery will continue to feature low inflation – despite the recent spike – low interest rates, sporadic quantitative easing and low growth in the indebted West. At some point theUS, too, will have to embrace fiscal austerity.
“At the centre of this remains a dysfunctional banking system which is hoarding the supply of new money created by QE, stopping it from reaching the real economy and business. QE has had some unintended consequences: it has created the ‘wrong’ sort of inflation. For example, it has fuelled commodity prices, which has hindered growth. It has also impacted in the fast-growing emerging economies, creating unwanted social and political pressures, meaning markets are watching anxiously for a soft landing inChinafor instance. As to the eurozone I continue to think thatGreecewill ultimately default but that this could, potentially, be a major buying signal for equity investors.
“There exists extra value in some asset markets – not government bonds – but the equity risk is not evenly distributed. This is a tough environment but one in which fund managers should be earning their corn, seeking out value opportunities. The portfolio is positioned for reality as I continue to seek out undervalued assets and take a three- to five-year view on profitability and earnings growth potential. Whilst my investible universe is large, the number of opportunities I see today is probably the lowest in my entire career. This has led to me having a very focused and concentrated portfolio which sits around some extraordinarily undervalued sectors – pharmaceuticals being the major one. Having sold out of my regulated utility stocks – due to increasing regulatory pressures and influence – I reinvested the proceeds mostly into the pharma giants AstraZeneca and GSK. These companies have been totally ignored by the market to the point of loathing – the argument against them is well-rehearsed: the patent cliff, a dearth of new products in the pipeline and so on. Their share prices are rock bottom yet their balance sheets are strong, they have high yields and dividends are well-covered. They are priced on the basis that we have reached the end of medical discovery, which is nonsense. In the long-run the market gets it right, but in the short-term the market can get it very wrong and therein lies the opportunity.
“The outlook for dividends remains positive – my portfolio yields around 4% plus and I see these growing by high single digits giving prospects of low teen total returns. My final point is to say that, looking ahead, whilst I do see lots of problems, I also see opportunities in the ways I’ve talked about.”