In this week’s bulletin:
- Despite 2012 being only three weeks old, the FTSE 100 has delivered its best start since 1989. However, a cloud still hangs over equity markets where many private investors are concerned.
- Over the weekend a team of negotiators flew out to Athens for talks over plans to wipe out up to 70% of Greece’s debts. However, hopes of a quick settlement faded.
- Pension investors have been given some protection against further cuts in their income after the government put into place measures to stem the damage from falling gilt yields.
- A debate seems to be emerging regarding the future growth prospects of China, after the country posted its slowest economic growth for two and a half years.
- The key event in the UK this week will be Wednesday’s release of the Quarter 4 GDP figures
The week that was
Reflecting on the year so far, despite it being only three weeks’ old, the FTSE 100 has posted its best start in 23 years, according to market analysts. Whilst we are sceptical about forecasting, David Schwartz, the stock market historian, reported that “Rallies in January are a good indicator of stock market performance for the rest of the year. Since 1945, there have been 45 years out of 67 when the market rose in January, with the market closing the year ahead in 37 of those years – an 82% success rate.” However, a cloud still hangs over equity markets where many private investors are concerned, despite the negativity in the media slowly falling away to make room for stories such as those seen in the last week.
A series of successful eurozone sovereign debt auctions, encouraging global economic data releases and better earnings from the US banking sector all combined to boost equity markets last week, maintaining their upward momentum. The FTSE 100 pushed ahead to a six-month high, breaking through the 5,700 level and closing at 5,728.55, while European markets advanced for a fifth successive week, with banking stocks leading the way. In the US, five-month highs were reached as earnings reports continue to build optimism over the future of the world’s largest economy. The S&P 500 closed the week at 1,315.38, a gain of around 4.3% for the year to date. Notable names to beat analyst expectations were Goldman Sachs, Bank of America and Morgan Stanley, boosting sentiment across the board.
Perhaps most notable is that the VIX index, the measure of volatility which is often described as Wall Street’s ‘fear gauge’, registered its lowest level since July of last year. The past week certainly gave the impression that last weekend’s downgrades of European nations had already been priced in to markets. To emphasise this, debt auctions in France and Spain saw encouraging levels of demand, with investors ignoring the opinions of the ratings agencies for now.
Weekend talks stall
Over the weekend a team of negotiators flew out to Athens for talks over plans to wipe out up to 70% of Greece’s debts. The country will default on its debt on 20 March unless a deal can be done to secure a fresh debt agreement. However, the Institute of International Finance (IIF), a trade body representing banks owed €47 billion by Greece, left the talks on Saturday morning, with hopes of a quick settlement fading. It had been hoped that an announcement would be made ahead of this week’s meeting between finance ministers, as the debt restructure is a key condition for a new rescue package from the European Union and the International Monetary Fund. The proposal on the table would see maturing debt exchanged for new bonds that will be paid back over the next 30 years. The interest rate charged would be lower in the short term to ease pressure on Greece’s budget deficit, and then increase to average around 4%. It had been thought that agreement was close, and indeed markets are viewing it that way however, there have been repeated warnings by those involved that it will take weeks to draw up legal paperwork, though there is an expectation that Greece will be allowed a temporary settlement on the €14.5 billion maturing on 20 March.
Pension investors have been given some protection against further cuts in their income after the government put into place measures to stem the damage from falling gilt yields. The yield on 15-year gilts is important to investors who have their retirement fund locked in ‘capped drawdown’ as it is one of the factors used to determine how much money can be taken from the fund each year. The higher the yield, the more income can be taken; but since April of last year, yields have fallen from 4.5% to 2.5%, largely in response to the eurozone crisis. It has been estimated that each gilt yield fall of one percentage point is the equivalent of an 11% loss of income for a 65-year-old male. However, the Financial Times reported that with gilt yields falling to levels not envisaged by HM Revenue & Customs, it has been confirmed that any falls below 2% will be disregarded.
What will happen to gilt yields going forward? Haluk Soykan of Wellington Investment Management, manager of the St. James’s Place Gilts funds, recently gave his opinion. “Gilt prices were supported in December by the purchasing program of the Bank of England as well as continued investor risk aversion resulting from the sovereign crisis in Europe. This resulted in yields being kept low. The EU summit in December failed to reassure the market that policymakers are committed to a cohesive fiscal stance; therefore, investors continued to seek safety within the gilt market. Our outlook for the UK economy remains fairly unchanged into the start of 2012. We believe the economy is still in recession and given that real disposable income has fallen at its fastest pace since the 1970s, we anticipate seeing further contraction in consumer spending throughout the year. We also expect to see further quantitative easing from the Bank of England. Given the UK’s plan to reduce its fiscal deficit, it is currently avoiding scrutiny from ratings agencies; but with the Autumn Statement indicating a weak growth story and with the deficit set to grow, this combination means the UK is not immune from a rating downgrade at some point. This could well result in yields rising once again.” As we have frequently stated, investors should seek to build a diversified portfolio and, despite some perceiving them to be a risk-free asset, this is also true of gilts, even after last year’s record performance.
Focus on China
A debate seems to be emerging regarding the future growth prospects of China, after the country posted its slowest economic growth for two and a half years. China saw the economy grow 8.9% in the final quarter of 2011, better than analyst’s expectations, but slower than at any point since mid-2009. In 2011, the Chinese stock market fell around 20%, on the back of continued concerns over inflation and sustainable growth. While the main investment banks expect growth to slow further, amongst the main emerging economies China still grew ahead of India (7.2%), Russia (3.9%) and Brazil (2.8%),
Despite the long-term arguments for investment into the Chinese market, Hugh Young of Aberdeen Asset Management Asia, told the Sunday Times, “I believe the impact of the eurozone crisis will have a severe effect on China, reducing its growth rate to around 7%, a rate last seen in 1999. This slowdown, a knock-on effect from the reduced demand from the West, is further encouragement for us to avoid adding to investment in China while the government struggles to replace the international demand for its exports. In addition, investments into Chinese firms are riskier than other emerging markets because of a lack of corporate governance. We find few mainland Chinese companies meeting our quality criteria, and have seen a spate of problems brought about from the relative lack of experience from senior management.”
Overall, there can be no denying that China has been the phenomenal growth story of the 21st century, and investors who bought into the story early will have reaped handsome rewards. As the years have gone by, more investors have made significant returns, but it is important to recognise the increased risk involved. It is still possible to take advantage of Chinese/emerging market growth without incurring the direct risks involved in emerging markets, by investing in companies taking advantage of overall emerging market growth, which supply these countries with the goods and services they need for continued growth. This is exactly the investment strategy of Jonathan Asante of First State Investment Management, whose fund only holds one direct Chinese stock. A diversified portfolio across geographical regions is essential to access this growth potential whilst helping manage risk.
Christmas sales rise
According to the Office for National Statistics, the country’s retail sector saw the strongest final-quarter increase in retail sales in eight years, as volumes rose by 1.1% from Q3 to Q4. Shoppers were lured by hefty discounting, but also the retailers themselves benefited from an extra trading day compared with 2010. Comparing December 2010 with December 2011, sales rose by an impressive 2.6%, which should come as some light relief to George Osborne who has been preparing for the upcoming GDP data due out on Wednesday. However, sentiment was quickly dampened by a raft of economists keen to emphasise the dismal weather experienced in 2010 which would have flattered annual comparisons. This point, when added to news that pay increases are averaging just 1.9% and unemployment is rising, means there is little to suggest this upward curve can continue.
The week ahead
The key event in the UK will be Wednesday’s release of the Quarter 4 GDP figures; the last few weeks of 2011 have provided some optimism that the country’s economy may have avoided a contraction. However, given the weakness of official data in October and November, it is still unclear exactly what the preliminary data will show. Among City economists, expectations are mounting that the Bank of England will have to resume its money printing operations if there are signs the economy will shrink going forward. Weak growth figures, coupled with falling inflation, could well pave the way for further quantitative easing (QE). The minutes from the last Bank of England Monetary Policy Committee meeting will be released on the same day as the GDP figures, and it will be interesting to see how many members voted for further QE in addition to the £75 billion of gilt purchases the Bank embarked on in October of last year.
Around the world, other notable events taking place in the coming week include the Federal Reserve publishing its interest rate projections for the first time, as well as an inflation target and perhaps a target for the unemployment rate. Given the recent relative strength of the US economy compared to many other developed countries, it will be interesting to see the stance taken by the Federal Reserve. In Europe, Monday and Tuesday sees the latest meeting between eurozone finance ministers, with approval expected on bringing forward the start date of the European Financial Stabilisation Mechanism to mid-2012. Greece’s second bailout is also expected to be on the agenda, with the results of these talks integral to keeping markets on the more stable path as experienced over the past month.
Macro economic news is set to continue to dominate the markets over the coming week.