Two Way Pull

In this week’s bulletin:

  • Two Way Pull – investors were encouraged by strong manufacturing data from the UK, Europe and US but continued to fret over rising oil prices. For the most part, global stock markets ended the week flat.
  • Powering Ahead – with global growth strong, inflationary pressures are building and central banks appear to have broken ranks. The Fed has said low rates will remain but the ECB is saying that eurozone rates may rise as early as next month.
  • Back to Work – strong employment numbers and a falling headline unemployment rate boosted confidence in the US last week.
  • China’s Chatty PM – during an on-line ‘chat’ with his country’s citizens, China’s premier promised to tackle rising inflation by slowing growth over the next five years.
  • Tax-efficiency – savers are being reminded not to miss out on this tax year’s ISA allowance and to make use of other tax-efficient wrappers.
  • The Long and Short of it – fund manager Mark Lyttleton of Blackrock explains his ‘Absolute Return’ strategy and how he can produce positive returns with less risk and lower volatility.

Two-way pull
Global financial markets ebbed and flowed last week as investors juggled the dichotomy of better-than-expected economic data with worries over oil prices which continued to be stoked up by the Libyan crisis. The net outcome by the end of the week was that stock prices finished little-changed in the developed economies whilst those in the East played catch-up – share prices in China and India have struggled so far this year despite their booming economies. But behind the short-term noise there are some clear lines of engagement being drawn up by investors focused around possible stagflation or, on the other hand, continued recovery in the global economy with inflationary pressures a mere blip on the path to progress.

Most immediately, the unravelling of some of North Africa’s incumbent political leaders is, unsurprisingly, causing tension in the oil markets – driven for the most part by the potential for a larger disruption of energy supplies rather than what is actually happening at present. Libya accounts for around 2% of global supply which could easily be replaced by Saudi Arabia upping output, yet crude oil prices are still edging closer to the $120-per-barrel level again – they were up around $3 on the week. The ramifications are clear – higher petrol pump prices and more pressure on the consumer who may need to make cuts in spending elsewhere, which could impact upon economic recovery. Will higher oil prices slow the global recovery? “I am concerned,” says the IMF’s managing director. “The hike to something which is between $110 and $120 a barrel is something which may affect [growth] if it lasts too long.” But Mr. Strauss-Khan added that oil prices are unlikely to be hitting growth yet. “We are not there today.”

Economists believe that with oil consumption accounting for about 5% of the world’s GDP, the recent 20% increase in prices is likely to raise total expenditure by 1% – with a corresponding reduction in demand for goods and services. This would not affect global growth if the oil producers spent their extra revenue, said The Financial Times, but it seems that they have less of a propensity to spend than their oil-consuming customers, meaning a possible slowdown in recovery. This needs to be put in context, though – the IMF reckons that global growth is close to record levels of around 5%, so it is more a slowdown than reversal.

Powering ahead
Here in Britain, the manufacturing sector’s renaissance is continuing – several of the UK’s best-known exporters reported booming profits last week, including GKN and Cookson. They are not alone, fortunately – last week the closely watched PMI Index (which measures confidence in the sector) remained steady at 61.5, with any number over 50 being positive. It’s a similar story elsewhere around the world – in the US its own corresponding ISM Index rose to its highest level since 1983 and in the eurozone the index jumped to 59, with strength beginning to broaden out to include Italy, Ireland and Spain.

However economists said the recent data highlighted Britain’s ‘two-speed’ economy; while exporters are thriving, consumer demand remains muted amid a rapidly rising cost of living. Citigroup commented that, “The data highlight the extremes of Britain’s two-speed recovery – strong growth in manufacturing but sluggish trends in money and credit. We expect this to continue.” If you want evidence of consumers under pressure, you need go no further than your local branch of Primark. Last week, one of the UK’s retail success stories told investors that its bargain-basement clothes stores have suffered a sharp drop in demand over recent weeks, adding to fears that the recovery here at home may be faltering. The rise in VAT, amongst other things, is being blamed for consumers turning more cautious.

Back to work
One of the strongest US payroll reports in months raised hopes last week that the economic recovery is finally leading to steady growth in jobs. Non-farm payrolls rose by 192,000 in February, with hiring spread across a broad range of industries; and figures for previous months were revised up. Crucially, the unemployment rate fell again from 9% to 8.9%. But the better job numbers are unlikely to push the US Federal Reserve towards early interest rate rises because wage growth, which feeds through to inflation, was slow.

Signs of sustainable job creation make it highly unlikely that the US Federal Reserve will expand its ‘QE2’ programme of asset purchases due for completion at the end of June. The Fed’s chairman, Ben Bernanke, also made it clear that it would keep interest rates at near-zero for much longer than its Western counterparts. Mr. Bernanke said that the bank would keep rates “exceptionally low” for an “extended period”. This was not good news for the US dollar which hit a 13-month low of $1.63 against the pound as investors took the view that interest rates are likely to rise sooner in the UK and eurozone. Indeed, the ECB surprised the markets towards the end of the week as it warned that interest rates may rise as soon as next month to combat rising inflation. Its president, M. Trichet, effectively called time on two years of ultra-loose monetary policy, saying that an “increase of interest rates in the next meeting [April] is possible”.

China’s chatty PM
But if inflation is not seen as a problem in the US, the same cannot be said for China. In an online ‘chat’ with his nation’s citizens, premier Wen Jiabao said the world’s second-largest economy can no longer “blindly” pursue unsustainable expansion. Mr Wen reduced China’s annual growth target from 8% to 7% for the next five years in an effort to curb soaring food and house prices. He acknowledged that the gap between the country’s official rate of inflation of 5% and the cost of food and housing (food prices are climbing at a rate of 10%) is making life difficult for hundreds of millions of Chinese people. Not that many believe growth will fall back in line – last year it was 10.3%. “The road map is clear but the extent to which the political will and power is sufficient, remains to be seen,” said China analyst, Alistair Thornton.

Whilst the Far East has been one of the most dominant investment themes of the last decade, as savers look to tap into the Chinese growth story, not all investors in the region are as bullish on China. Veteran fund manager Hugh Young of Aberdeen is a good example – his concern about the country’s inflation problem has meant that he has limited his funds’ direct exposure to China to just 5%. Hugh Young adopts a long-term buy-and-hold strategy which has served his investors well, as The Daily Telegraph pointed out, saying that, whilst he typically lags his peers in sharply rising markets, he better protects capital in downturns.

Tax-friendly
With the end of the tax year rapidly approaching, investors are being reminded not to waste their annual allowances across a number of tax regimes. FT Money reminded its readers to utilise their annual £10,200 Individual Savings Account (ISA) allowance and also highlighted the benefits of specialist arrangements such as Enterprise Investment Schemes. As a reminder, ISAs are free of CGT and can provide income free of any further tax liability from a wide-range of investments, whilst an EIS offers income tax relief, CGT deferral and offset plus CGT-free returns; although it must be remembered that EISs are classified as being higher-risk.

The Long and Short of it
Few investors need reminding about the stock market volatility witnessed in recent years. One of the traditional approaches to managing this issue has been to diversify a portfolio across a number of different asset classes; by geography, by fund manager style and also by risk. One type of investment that has become increasingly popular with investors is the ‘Absolute Return’ fund which aims to produce, but not guarantee, better-than-cash returns in all market conditions. Fund manager Mark Lyttleton of BlackRock Investment Management is recognised as a market leader in this specialist investment field.

“I see the role of this type of fund as about reducing volatility and controlling risk. The aim of the fund is to create a positive return over all meaningful periods – by that I mean 12 months – or in other words, whilst the fund may fall in value, making money for clients whatever the market conditions. It’s about slow, consistent returns with low volatility. If you take the period 2007–09, the market returned zero whilst the fund produced 19.5%. It’s important to remember, though, that if the market is very bullish we are likely to underperform; but for investors who want lower risk and to be able to sleep at night, then this is a solid place to put your money.

“The way we can achieve this involves three components. Firstly by going long – in other words buying shares we like, to make money. Secondly we can short stocks: selling shares we believe are overvalued and likely to fall in price. We also combine the two strategies, which is known as pairing: buying one share and selling another share, usually in the same sector of the market. For example, pharmaceutical stocks where you could buy GSK but sell AstraZeneca. This takes out both the market and sector risk. Lastly, the fund can hold cash – up to 100% if we want to.

“Currently we have a mixed approach in terms of themes. We believe there is a solid global recovery taking place with signs of the US recovery being stronger than expected. The stock market as a whole – using all measures including profitability – is in rude health, with companies having cut costs early on and enjoying high profit margins. The question is how much of the good news is already priced in; and that’s my job to identify the opportunities. So the fund currently holds many cyclical stocks which are benefitting from the current environment. Wolseley is a good example – a company operating in Europe and the US which embarked upon an aggressive acquisition strategy but was wrong-footed during the recession. Today it has a new management team which has been actively cutting waste, has improved its balance sheet, and is able to grow its market share as recovery takes place and to operate more efficiently.

“So the current positioning of the fund is very diverse, from real estate and asset management to industrials and energy stocks. The fund is currently ‘net’ long – in other words after offsetting the short positions we are in a positive position. I am confident the fund will continue to meets its objectives of delivering steady returns with lower levels of risk.”

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 (sponsored by the FT) for the chance to win £1,000. Simply visit www.icwealthawards.co.uk/voting.

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