In this week’s bulletin:
- Asian markets boosted by Japanese election results and better economic news from China suggesting the ‘hard landing’ has been avoided.
- As an eventful but reasonably rewarding 2012 draws to a close, eurozone integration, China and the US economy will continue to set the agenda for investors; diversification and regular review remain the watchwords in the year to come.
- This is the final Market Bulletin of the year. The next edition will be issued on 2 January
- Investors remain on the sidelines pending a deal on the US ‘fiscal cliff’
- Asian markets surprise on the upside as investors’ appetite for risk increases
Global markets were mostly becalmed once more as investors continued to sit on the sidelines, awaiting a deal on the US ‘fiscal cliff’, which is needed to avoid a possible recession next year. Whilst President Obama has remained bullish about the prospects of an early agreement between Democrats and Republicans, the reality appears somewhat different, leaving markets rudderless in the short term. The one exception was China where, after months of poor performance, the Shanghai stock market seems finally to have come back to life: the leading index rose over 4.0% as investors’ risk appetite increased, buoyed in part by better economic news. In Tokyo the stock market advanced further – it has risen some 11% in the last few weeks – as investors bet on a change of government. In the government bond markets, yields ticked marginally higher; whilst on the currency front it was mostly quiet too, although the euro managed to climb three cents, ending close to its 12-month high against the US dollar, supported by slightly better economic data from the region.
A yen for change
- Liberal Democratic election victory in Japan boosts the stock market as the yen falls
In Tokyo, shares rose this morning and the yen dipped after the Shinzo Abe-led Liberal Democratic Party won Japan’s general election. The Nikkei 225 Index rose 1% and the Japanese currency fell to a 20-month low of 84.48 yen against the US dollar. Mr Abe has said he will implement measures to help revive the world’s third-largest economy, which has been battling years of sluggish growth, and is on the verge of falling back into recession: the fifth in 20 years. Japan’s economy has been hurt by a variety of factors over the past few years, not least the strength of its currency, the yen. A strong yen makes Japanese goods more expensive to foreign buyers and also hurts the profits of the country’s exporters, which rely heavily on foreign sales for growth. Before the election, Mr Abe had said that he will implement measures directed at weakening the yen and fighting deflation. Commenting on the results, Kyohei Morita, chief economist at Barclays Securities Japan, said, “The Liberal Democratic Party’s big victory is in line with market expectations and it will help to keep the yen weak and share prices high, at least for now.”
Another year-end approaches and 2012 has been eventful: financial markets have demonstrated volatility, but also remained remarkably phlegmatic; and most investors will have seen gains in asset values, some surprisingly strong given the uncertain backdrop. As ever, investors will be looking ahead to next year, wondering where the markets might end. It is traditional at this time of year for the major investment and trading houses to share their forecasts for the UK’s largest blue-chip index, the FTSE 100. If history is anything to go by, it is probably best to ignore these: most will be wildly wrong and, in any event, often subject to revision depending on which way the market is moving. More helpful might be to think about the issues that have occupied investors’ minds this year – and by association the markets – and try to assess whether they are likely to remain so, as we approach 2013. So here are some thoughts.
- ECB’s promise to “do whatever it takes” seen as the turning point for the euro
- EU policymakers continue working towards greater eurozone integration but growth policies still failing
The one piece of knowledge that would have been most useful at the beginning of 2012 was that the euro would be held together by the European Central Bank (ECB). Mario Draghi’s promise to “do whatever it takes” was sufficient to engineer a classic volte face on the part of investors: anyone owning Portuguese ten-year bonds would have made 75%, whilst those also brave enough to pile into European banking stocks would have also made gains of 50–70%. So how much progress has been made in the eurozone towards greater financial stability and growth? As acknowledged by European leaders at the end of their two-day summit last week, the long-promised transformation of the eurozone from a simple currency union into an entity resembling a centralised fiscal and economic block is still work in progress and key issues remain unresolved. Deeper fiscal integration, including banking union, is seen as essential if the region is to survive long term; but EU leaders agreed only to address the issues in six months’ time. “We have achieved some things but just as before, we have a tough time ahead,” concluded Angela Merkel.
Apart from greater integration, most observers would probably put growth as a prerequisite for success and this has, in the face of swingeing austerity cuts, been in retreat, with the region as a whole officially in recession. The situation of Europe’s southern states – the so-called ‘periphery’ – was neatly summed up last week by Italy’s former prime minister Mr Berlusconi, who is threatening to re-enter the political fray. “The situation today is far worse than a year ago when I left government. We have an extra million unemployed, the debt is rising, firms are closing, property is collapsing and the car market is destroyed. We can’t keep going on like this.”
Quite so – and of course, one could substitute Spain or Greece for Italy. Last week there was, though, a flicker of hope following news that the rate at which economic activity is contracting eased last month. An upturn in Germany’s service sector was the main positive factor and indeed the dour mood lifted after the ZEW survey of German investment sentiment showed a sharp rise for this month.
From an investor’s perspective, European stock markets remain, for obvious reasons, fundamentally cheap, trading on low price-to-earnings ratios and offer good opportunities over the medium to long term. Stuart Mitchell, who manages European equities and funds for St. James’s Place, explains his strategy. “There are no signs of emerging market slowdown amongst the companies in the portfolio. Chinese consumer is still very buoyant; the impact of Chinese buying goods overseas is also significant – watch sales in Germany are up 25–30%. Luxury goods companies are still benefiting from emerging world growth, yet valuations remain attractive. Swatch is seeing sales rise at 30% pa, with a third of sales coming from China. Volkswagen has sold 2 million Audis in China and the country is responsible for 47% of VW profits; likewise, Porsche sales are up 30–40%. The key to success for these companies is the manufacture of goods that other companies can’t produce. I also put some European banking stocks in the portfolio a few months ago and these remain relatively cheap despite their sharp rally. So I remain confident that Europe continues to offer some great investment opportunities.”
Slow ship to China
- Chinese policymakers avoid ‘hard landing’ for world’s second-largest economy as growth resumes
Navigating the world’s second-largest economy through economic reform and change was never going to be easy for Chinese policymakers but the current ‘five-year plan’ is aimed at deliberately slowing growth down from a historic 10% to 7.5% per annum by creating a more consumer-driven and thus less investment-dependent economy. Investors have fretted this year that this could lead to a ‘hard landing’, with growth crashing to 3% per annum. The reality has been quite different. In a comprehensive readout on the global economy last month, the Organisation for Economic Co-operation and Development (OECD) said it saw China’s economy growing by 7.5% this year before picking up once more next year to 8.5% in 2013.
Recent economic data from the country has been positive, showing a return to growth as government-led policies to stimulate the economy begin to work their way through without, and this point is crucial, stimulating inflation. Recent data show an improvement in trade, industrial production and retail sales, with the latest ‘flash’ purchasing managers’ index, compiled by HSBC, rising to a 14-month high, suggesting a pick-up in factory activity. Investors’ concerns have been reflected in a moribund stock market but, as mentioned, there is some evidence that the tide may be turning as the likes of insurance companies return to the market. Improving investor sentiment will benefit not just Chinese companies but Asia as a whole, whose economic fortunes are inextricably tied to the continued growth of the region’s behemoth.
Inflation versus Growth
- Central banks look to promote growth with new policies but at the potential risk of higher inflation
- US Federal Reserve chairman targets unemployment and vows to keep interest rates at near zero for the foreseeable future
The last major issue for investors this year has been the outlook for what still remains the world’s largest economy, the United States of America. The country has confounded its critics who have, from the sidelines, advocated more austerity in the face of a huge and growing debt mountain. Policymakers have instead embarked on a programme of quantitative easing on a scale not witnessed before: the US Federal Reserve has spent some $1.4 trillion buying up mortgage and government debt. Its current programme is unlimited and means it is spending some $85 billion a month buying bonds to keep interest rates low to encourage borrowing and spending. The US economy is expected to grow between 1.5 and 1.7% this year but to rise by 2.5% next year, according to official data. Of course, growth could be derailed if the economy plunges over the ‘fiscal cliff’ but this is unlikely, with the consensus view being that the Democrats and Republicans will succeed in cobbling together a deal to allow more time to come up with specific policies to address America’s debt pile.
This brings us back to the US Fed and its chairman Ben Bernanke, the architect of current QE policy. Unlike the Bank of England, his mandate is not just to keep the lid on inflation but also ensure that monetary policy stimulates growth and so keeps unemployment down to levels which are non-inflationary. Historically this has been around 6%. Today, US unemployment, whilst falling, remains elevated at 7.7% and stubbornly so, despite record QE. Mr Bernanke is not alone in finding that QE has not engineered faster economic growth: the same is true of the UK and Japan. Last week, the Fed Chairman went one step further in developing policy to encourage growth by saying the Fed would keep interest rates close to zero until US unemployment falls below 6.5%. The rationale is simple: if you tell people you will keep rates low for a long period (economists believe it could take until 2017 for unemployment to fall this low) it will encourage them to borrow now. He is not alone in starting a potential revolution; the BoE’s governor in waiting, Mark Carney, also suggested last week that central banks should try more radical policies such as targeting GDP. Higher inflation remains the one danger in QE and the skill lies in not misjudging the health of the economy because inflation might well kick in before unemployment falls below target. Central bankers might wish to stimulate growth but they will also want to avoid lighting the inflationary fuse, so the challenge for them next year will be to continue with current policies but without hurting households’ discretionary spending power.
US powers ahead
- Unlocking of huge shale gas reserves becomes the driving force behind America’s new industrial renaissance
- Industry leaders say low-cost energy is benefiting US growth
One of the largest contributors to inflation in recent times has been the increase in energy costs – crude oil continues to trade above $100 per barrel. However, another type of revolution has been taking place in the US: the exploitation of shale gas. Economists are forecasting that the US may well become energy self-sufficient once more within the next decade and this is having huge ramifications for the economy. Manufacturers have announced more than $90 billion worth of investments to take advantage of its new supplies of cheap natural gas, driving an industrial renaissance. Petrochemicals, fuel, fertiliser and steel companies are all committing to multi-billion-dollar investments. Advances in drilling techniques have now made huge gas reserves commercially viable – the price of natural gas has fallen to a 10-year low. Industry executives say low-cost energy and feedstocks are having a noticeable effect on the economy and probably explain why growth surprises are on the upside. The improving outlook for the US economy probably explains why Wall Street has enjoyed a good year and why many US stocks trade at a premium of around 28% over their European rivals.
- Diversification and review remain the watchwords for every investor as we enter 2013
So what does this all mean for investors? Well this year, one successful strategy has been to focus on businesses paying sustainable dividends and there is no reason to think this won’t continue to work: the single largest component of total return from shares has always been the income, followed by dividend growth. Some parts of the equity markets remain relatively cheap so the asset class has some catching up to do; and for those taking a medium to long term view, owning equities continues to make sense if you have the risk appetite. Corporate bonds have done well and by concentrating on income these have a meaningful part to play in any diversified portfolio. Commercial property is regaining favour and historically has been a good income producer; a point we will discuss next week as we begin a more in-depth review of all the asset classes. There is one constant throughout for any investor; irrespective of short-term market movements, there remains the need to diversify one’s investments and, in equal weight, review those investments on a regular basis.
In dulce jubilo
All that remains is for us to wish all our readers a happy Christmas and prosperous New Year.