Private investors become net buyers of UK shares

In this week’s bulletin:

  • Global equity markets turn cautious on the back of weak Chinese and Eurozone economic data
  • Rising oil prices seen as potential threat to economic recovery
  • German and French economic activity slows
  • Spanish government bond yields rise on eurozone worries
  • US recovery gathers pace
  • China’s growth slows raising fears of a ‘hard landing’
  • Doubts over whether the Chancellor’s pledge to help business will work
  • Gold appears to be falling out of favour with investors
  • Private investors become net buyers of UK shares
  • Investors’ hunger for yield boosts corporate bonds
  • More conservative business models seen as a positive for debt holders.

 

Market Eye

  • Global equity markets turn cautious on the back of weak Chinese and eurozone economic data
  • Rising oil prices seen as potential threat to economic recovery

Global equity markets paused for breath last week as investors responded to a more sobering flow of economic data and news on the state of the global economy. Three key areas have been at the centre of attention this year and responsible for driving the direction of investor sentiment: an easing of the eurozone debt crisis, a stronger-than-expected recovery in the US, and concerns over China. Last week was no different but the news-flow was less positive, causing markets to stop and review their outlook for growth and recovery.

Here in the UK, also, news was mixed: manufacturers’ expectations for output growth are at their strongest for a year but, at the same time, companies are also expecting to raise prices significantly; which could undo better news on the inflation front. Last week the Office for National Statistics (ONS) announced that consumer price inflation fell to 3.6% last month; its lowest level in 15 months. Whilst the Bank of England is forecasting that inflation could fall below its official target of 2% by year-end, many economists remain sceptical given the recent remorseless rise of crude oil prices. Sentiment was also upset by news that UK high street stores had a disappointing February as retail sales volumes suffered their largest fall for nine months.

The rising price of oil was put centre stage by the International Energy Agency (IEA) when it said that, if crude prices stay at current levels (Brent was unchanged on the week at $126 per barrel), the cost of oil imports will top $1.5 trillion this year, enough to tip the world into recession. Crude oil prices have risen 15% this year against the backdrop of the stand-off with Iran and despite increased production by Saudi Arabia and Libya’s oil exports rebounding. The International Monetary Fund, whilst more optimistic about global growth prospects compared to six months ago, worries that higher oil prices could choke off growth. So by the end of the week, most equity indices gave ground, with London slipping almost two percent and, overseas, larger price falls were seen in Europe and China. Commodity prices mostly slipped and in the government bond markets yields remained little-changed on the week despite increased investor nervousness.

 

Eurozone Slows

  • German and French economic activity slows
  • Spanish government bond yields rise on eurozone worries

Optimism over a resurgent Germany cooled on news that the composite eurozone Purchasing Managers’ Index (PMI) fell to 48.7 in March – any figure below 50 indicates contraction – which was slightly below expectations. It seems that higher oil prices and softening demand in China are weighing on activity in the European manufacturing sector. Analysts believe business conditions are suffering the aftermath of the sovereign debt crisis, and the associated demand-sapping austerity measures in the region’s southern states. Spain’s borrowing costs rose above 5.5% for the first time since January as investors fretted once more about another escalation of the sovereign debt crisis following the news of economic weakening in the northern eurozone. The markets have been wary about Madrid’s deficit and weak growth prospects for some while and see the country as susceptible to any loss of investor confidence.

Markets have been calmed in recent weeks by the European Central Bank’s (ECB) cheap loans for lenders, the long-term refinancing operation, titled LTRO. The ECB has injected some €1 trillion into the eurozone financial system in order to help banks boost their balance sheets and give them time to undertake repair work to strengthen their free asset ratios. Indeed, the ECB took its first actual steps to tighten the standards on assets that banks can use as collateral when tapping liquidity, indicating confidence that its LTRO scheme is working. The Bank has also been cutting back on its €40 billion asset-purchase programme, launched at the height of the eurozone crisis, in a sign it has begun unwinding emergency support for the region’s financial system.

 

A Tale of Two Cities

  • US recovery gathers pace
  • China’s growth slows, raising fears of a ‘hard landing’

Returning to the other key areas for investors – the US and China – last week witnessed a divergence in fortunes, at least in the short term. In Washington, President Obama has been able to point to evidence of an improving economy; whilst in Beijing, growth of 7.5% has been pencilled in for this year, compared to expectations near last year’s level of 8.9%, leading to concerns of a ‘hard landing’ for the world’s second-largest economy.

The flow of economic data from the US has surprised most investors on the upside in recent months, with better-than-expected news on the employment front as companies hire more workers to cope with increased orders from home and abroad. There was good news too on the housing front last week with revised home sales numbers showing extremely strong growth in January which, coupled with price stability, indicates further signs of recovery. But not everyone is surprised. Based in Hong Kong, Li & Fung is the world’s largest supplier of consumer goods and, as such, a bellwether of global consumer sentiment – crucial to world growth. The firm’s deputy chairman, William Fung, said that new orders showed US demand to be a lot stronger than economic indicators would suggest and that the recovery of its largest market was happening faster than expected.

However, data released by HSBC last week indicated that China’s economy is weaker than hoped for. The HSBC/Markit ‘flash’ purchasing managers’ index for China came in at 48.1 for March, against 49.6 for February. This was the lowest reading since November. Whilst economists continue to debate whether China’s slowdown is merely a blip or something more fundamental, it is clear that the country recognises the need to rebalance the economy which, to date, has relied heavily upon fixed-asset investment as a source of growth. Many economists believe China is coming to an end of what is labelled ‘extensive growth’, driven by rising inputs of labour and capital – and needs to move to ‘intensive growth’, driven by improving skills and technology. The point was recognised by Premier Wen Jiabao when he said China needs to address its “imbalanced, uncoordinated and unsustainable development”. Here and now, though, Li & Fung also scotched the common belief that contract manufacturing in China was ‘dead’, saying sourcing from the country rose 24% by volume last year as Chinese factories were still the top choice for higher-end products. Clearly there is still much life left in Asia’s dragon.

 

A Budget for Business?

  • Doubts over whether the Chancellor’s pledge to help business will work

We have a few thoughts on Mr Osborne’s Budget. Amidst all the ‘Granny Tax’ headlines, the question must be whether the Chancellor’s claim that his Budget would boost business is justified? For some economists the answer was yes but for others, like Martin Wolf, it sadly was not. In his view, little economically important happened. The thrust of his (and others’) argument was that nothing is likely to change from a growth perspective. The Office for Budget Responsibility (OBR) opened its report on the outlook with the comment that “our overall assessment of the outlook and risks for the UK economy is broadly unchanged”. The OBR is forecasting growth of 0.8% for this year, up marginally on its earlier forecast. Cuts in corporation tax whilst useful are unlikely, in Mr Wolf’s eyes, to raise the investment that is crucial to future growth prospects – indeed the OBR has cut its forecasts for business investment this year. The plan to underwrite cheaper loans to smaller businesses is clearly laudable; but with a starting threshold of £25,000, many genuinely small businesses will be unable to take advantage of the scheme. And what was the market’s view? Well, it ended the day much as it began.

 

The ‘In and Out’ Club

  • Gold appears to be falling out of favour with investors
  • Private investors become net buyers of UK shares

As experienced investors know, successful investing is about buying low and selling high (not that it’s always so easy, of course). It seems that gold – the ‘must have’ commodity in recent years – might be about to lose its lustre. Investors appear to be losing their enthusiasm for the precious metal as signs of improvement in the US tempt them away from this traditional safe haven. Interest in gold has seen the price of an ounce rise from $253 in 2001 to almost $2,000 in 2011 but the metal has fallen sharply this year, hitting a low of $1,627 last week.  Senior gold traders believe prices could fall to as low as $1,450. If gold is out then equities might be in, though. Private investors in Britain have, according to Capita Registrars, been buying shares again in recent months to add to the £223 billion worth already owned. Rock-bottom savings rates and attractive dividend yields have encouraged investors to buy more shares. Capita predicts that shareholder payouts will reach a record total of £8.6 billion in 2012, up 6% on last year. Looking at the bigger, long-term picture, it is worth noting that, at 17%, the amount institutional investors have allocated to shares has hit rock-bottom in recent times compared to around 60% back in 1990. From a contrarian perspective, buying an asset which is unloved almost to the point of loathing creates significant long-term opportunities.

 

Corporate Bonds Boosted

  • Investors’ hunger for yield boosts corporate bonds
  • More conservative business models seen as a positive for debt holders

One other asset class that fell out of favour back in 2008 was corporate bonds – IOUs issued by companies that promise to return investors’ capital and pay a fixed income, or coupon, in the interim. In recent times corporate bonds have recovered from their lows as investors seek out more attractive sources of return, with confidence buoyed by a successful Greek debt restructuring and a recovering US economy. We asked the opinions of two corporate bond fund managers about how they currently view the market.

Zak Summerscale of Babson Capital manages a portfolio of primarily US senior-secured debt and gave this view. “The portfolio had a robust start to 2012 on the heels of improved investor sentiment resulting from continued firmness in US economic data and progress regarding European sovereign issues. While concerns on a macro level still exist, corporate fundamentals continue to exhibit strength. We have witnessed another quarter of strong corporate earnings that have helped maintain market momentum through March. Furthermore, this has been supported by strong investor demand for high-yield bonds, providing a solid technical footing to the market. The increase in investors’ risk appetite has led lower-rated bonds to outperform higher-rated bonds during the period. As a result of the improved market conditions, new issuance volume increased during the quarter. Following comments by various management teams during the recent earnings season, we believe that the majority of issuers will continue to report earnings growth over the coming quarters, as corporate fundamentals and improved capital market access supports our view that default rates will remain below historical averages in the short run.”

“Whilst spreads between senior-secured bonds and risk-free assets remain above historical  averages; with a low default rate environment, the high current income coupled with modest capital appreciation offers investors the potential for an attractive return profile.”

 

Paul Read of Invesco Perpetual commented that, “The past three months have seen a significant turnaround in investor risk appetite in the fixed interest markets. Whereas in the autumn investors were averse to taking risk; in the period since December, they have been increasingly optimistic. Where before worries about eurozone sovereign bonds and the stability of the banking system weighed on credit markets, now there is growing hope that steps taken by government and monetary authorities will effectively address these problems.

“Corporate bonds have enjoyed a good period of returns. Sterling investment grade bonds had a total return, according to data from Merrill Lynch, of 6.6% for the three months to the end of February. For the same period European high-yield bonds returned 12.2% (in sterling terms). Within investment grade, subordinated bank capital, the more junior type of bond issued by banks, which is more exposed to any loss by the bank, rallied strongly. Meanwhile, gilts have had a total return of just 0.6%. Notwithstanding the powerful rally in the credit markets, our outlook hasn’t changed fundamentally. We are cautious about the potential for gains in core government bonds from this point. Yields remain very low. We continue to see significant value in subordinated bank capital. We believe that the multi-year rehabilitation that the financial capital sector is undergoing will result in more conservative business models. We think this is positive for debt holders. The strong returns of the last months have made yields less compelling but we think they are still attractive and prices remain below levels of this time last year.”

Please leave a comment - we all like them