Retirement plans risk being thrown off course

In this week’s bulletin:

  • UK emerges tentatively from double-dip recession and US economic recovery continues.
  • Markets switch to ‘risk off’ mode as third-quarter US earnings disappoint.
  • Retirement plans risk being thrown off course by the threat of higher inflation in the future.
  • Savings rates fall as the government’s Funding for Lending scheme comes under scrutiny


Growth up, markets down

  • UK emerges tentatively from double-dip recession and US economic recovery continues
  • Markets switch to ‘risk off’ mode on earnings and growth concerns

Last week was one of ups and downs; economic growth figures from the UK and US were positive, yet markets headed south, reversing some of the previous week’s gains and extending the recent period of fairly directionless ebb and flow. Apart from China, whose numbers cannot always be trusted, no other economy puts out a first GDP estimate as early as the UK, and the wisdom of doing so just 18 working days after the end of the quarter continues to be questioned by those who believe that the inaccurate estimate for contraction in the second quarter itself hit consumer confidence. The Office for National Statistics duly reported on Thursday that the UK economy had emerged from double-dip recession by growing 1.0% in the three months from July to September. The growth figure was better than the increase of 0.6% that most in the City had expected, prompting Graeme Leach, Chief Economist at the Institute of Directors to say that the return to expansion was good news “but not enough to pop the champagne corks”. Olympic ticket sales added 0.2 percentage points to the figures, which were also boosted by surprisingly strong growth of 1.3% in the services sector. The GDP figures were also enhanced by comparison with the previous three months, because the second quarter had an extra public holiday as part of the Diamond Jubilee celebrations, as well as unusually bad weather, which reduced growth. GDP is still 3% below its pre-recession peak and what is clear is that, given the impact of these temporary factors, the recovery is set to remain fragile; the big question is whether the economy can maintain the momentum. With households facing higher energy bills this winter and companies worried the global slowdown is spreading from the eurozone to Asia, the answer lies as much with the world economy as at home. Chancellor George Osborne, whilst being understandably cautious, was quick to seize on the figures as vindication of his Plan A.

In contrast to the UK’s austerity plans, a hefty surge in government spending was largely accountable for stronger-than-expected third-quarter growth in the US. The world’s biggest economy expanded at an annualised rate of 2% in the three months to September, according to the United States Department of Commerce, providing a timely boost to President Obama’s re-election hopes ahead of the public going to the polls on 6 November. The US states its growth in annualised terms, extrapolating its quarterly growth rate as if it was growing at that pace for the whole year. In other words, this equates to growth of around 0.5% for the quarter, compared to 1% for the UK. The figure, which was also driven by a pick-up in consumer spending and a rare contribution from the housing sector, was up from 1.3% in the second quarter and better than the forecast of 1.8%. The US has now been growing for more than three years, since June 2009, although the report also revealed that spending by companies has stalled as businesses become increasingly cautious awaiting greater clarity on tax rates and spending cuts – the so-called ‘fiscal cliff’.

The encouraging US growth figures were supported by additional good news from a University of Michigan survey showing that the mood among US consumers was the brightest for five years. However, analysts looking beyond the headline growth figures took the view that the US economy is still not expanding rapidly enough to bring about a substantial improvement in the labour market that could curtail the Federal Reserve’s open-ended asset purchases. This, together with more lacklustre corporate earnings reports, unnerved investors; the S&P 500 Index was down 1.82% on the week and the FTSE 100 lost 1.5%. It was a similar story in Europe and Asia: the FTSEurofirst 300 slid 1.3%, following a two-month rally where prices have risen 18%; and the FTSE Asia Pacific Index declined 1.6%. Commodity prices also suffered, sinking by the most in six weeks. Gold fell below $1,700 an ounce on Wednesday before later paring losses, while US oil prices dipped 5% – the largest weekly fall since mid-September and a welcome fillip to hard-pressed consumers.


US in the spotlight

  • Disappointing third-quarter earnings add to election uncertainty and the looming ‘fiscal cliff’ but long-term opportunities remain

Last week it was the turn of technology heavyweight Apple to be added to the list of household-name US companies posting disappointing third-quarter earnings, following the likes of Amazon, McDonald’s, General Electric, IBM and Microsoft, and helping the S&P 500 Index down to its lowest level since early September. Analysts expect overall third-quarter earnings to drop 1.2% compared with the same period a year ago, marking the first year-on-year decline in profits since 2009. Such short-term volatility looks set to remain a factor in markets and last week’s falls highlighted the undervalued stock opportunities for longer-term investors. Even with modest revenue growth in the future, companies have a lot of cash and the US market appears fairly valued at 12.8 times next year’s earnings, whilst the UK market is trading at 10.6 times, reflecting the fact that the economic recovery here appears to be on less sure footing. Looking forward, many analysts forecast a ‘relief rally’ after the US presidential election next month. Research by Fidelity, looking at the past 12 elections, shows an average 10% rally in the market if the incumbent president wins, and about half that when a new president takes charge. The election and the ‘fiscal cliff’ have increased investor caution, but these concerns could be allayed in the coming months.

“One of the key worries for the US market, the ‘fiscal cliff’, may in fact be an opportunity. We expect that, ultimately, few of the tax rises or spending cuts will be implemented and thus the impact on the real economy to be mild.”

Dan Morris, J.P. Morgan

Uncertainties remain about the US economy, and in terms of its budget deficit the country is still ‘kicking the can down the road’; but its important housing market has taken the pain, looks more robust than in Britain and is a key driver of consumer confidence and hence the consumer spending which would benefit US GDP.


Erosion by inflation

  • With the prospect of greater life expectancy, retirees need to be mindful of higher inflation levels in the future


“Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.”

Sam Ewing, US writer and humourist

Despite falling to its lowest level since 2009, the longer-term impact of inflation on income and standard of living remains in the spotlight. One potentially unfortunate coincidence is that the September consumer price inflation figure is usually that which is used to determine the annual rise in state pensions, so the low figure of 2.2% could have a knock-on effect to pensioners in the 2013/14 tax year. It is also used to work out the value of an individual’s pension accrual under a defined benefit scheme in the following year, for taxation purposes. The low level of the consumer price index increases the likelihood of individuals being affected by the annual allowance and the more by which they exceed it, the greater could be the tax bill a few years later.

Whilst the rate of inflation will vary in the future, its impact remains a constant threat, even more so as we enjoy greater life expectancy. The flipside of that increased life expectancy is that it comes with a requirement to ensure our retirement income maintains its spending power, thus reducing the danger of us outliving our capital. Some income streams – state pension, final salary schemes, and defined contribution schemes already in payment – provide a predictable price-linked pension. The challenge is to ensure that other assets are invested in such a way to also help counter the impact of inflation. Over a 25-year retirement, an average inflation rate of 3% would reduce the real value of £1 to 47p by the end of the period. The long-term average inflation rate since the 1940s is 5.6% (source: Office for National Statistics), so the calculations do not seem unrealistic.

In this respect, the likely impact of quantitative easing (QE) on future inflation levels continues to be a source of debate. By increasing the amount of money chasing goods in the economy and depressing the value of sterling, which makes imports more expensive, QE is putting upward pressure on inflation. Whilst some argue this is better than the deflationary alternative, retirees’ spending power remains threatened over the longer term, reinforcing the need to find ways to make money work harder.


Down again

  • Savers’ rates fall amid suggestions that the government’s lending scheme is having unintended consequences


Another initiative in the government’s attempts to kick-start the economy, the Funding for Lending Scheme, also came under scrutiny last week, with news that hard-pressed savers are facing another painful chop in interest rates as banks and building societies withdraw their best rates. The £80 billion scheme, launched in August, was designed to encourage banks to lend more to consumers with mortgages and loans by providing the banks with access to cheap funds. The suggested unintended consequence of this scheme is that the cheaper source of money available means that banks no longer need to rely on savers to fund mortgage books and so are less keen to offer higher rates to attract their cash. Anna Bowes, a director of, claimed that “one-year fixed-rate bonds have fallen from a high of 3.65% earlier in the year, to the current level of 3.10%. Four-year deals have fallen from 4.20% down to 3.80%.”

The counter argument from the Bank of England is that, by increasing lending to UK households and firms, the scheme will boost spending in the economy, create jobs and raise incomes and so encourage sustainable economic growth to support savers. Whichever school of thought you subscribe to, it is clear that savers need to be watchful.

As next week’s presidential election looms, the focus of investors is likely to remain on the other side of the pond; a pond currently being roughened up by Hurricane Sandy.

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