UK economy likely to avoid ‘double-dip’ recession

In this week’s bulletin:

  • Equity markets suffer a ‘mid-week wobble’ over Greece
  • Oil continues to rally – Brent crude hits $130 per barrel
  • Greek bondholders suffer a 75% ‘haircut’ on their investments
  • Athens successfully completes the largest-ever sovereign debt restructuring
  • US recovery gains traction on the back of better jobs growth
  • UK economy likely to avoid ‘double-dip’ recession despite weaker manufacturing production
  • World Bank says reforms are necessary to maintain growth
  • Beijing announces it will start loans to emerging economies in local currencies
  • No respite for cash savers – returns remain negative in real terms
  • UK equity income manager Nick Purves of RWC sets out the case for equities
  • Tax-year end planning
  • Time is running out ahead of next week’s Budget when personal pension tax relief could potentially be cut by Chancellor George Osborne

 

Market Eye

  • Equity markets suffer a ‘midweek wobble’ over Greece
  • Oil continues to rally

Financial markets closed the week little-changed as investors digested a stream of news on the economic front. This outcome, though, hid last-minute anxiety about whether Greece’s crucial bond-swap deal would go through – markets suffered a midweek wobble as doubts grew, causing global equity markets to go sharply into reverse. This proved short-lived, however, as better economic data from the US labour market soothed nerves and enabled markets to regain their poise by the end of the week. There was little change, either, in the quality end of the government bond market – gilts, Bunds and US Treasuries continued to trade towards the top end of their 12-month range, giving no hope to savers that interest rates might rise in the foreseeable future. It was a mixed picture for commodities, with gold falling another $20 per ounce, indicating that the markets were less worried about inflationary pressures. This was despite the fact that oil prices advanced yet again. The price of a barrel of Brent crude closed at $130, another record high in sterling terms, which will inevitably cause more consumer pain.

 

Exeunt Left

  • Greek bondholders suffer a 75% ‘haircut’ on their investments
  • Athens successfully completes the largest-ever sovereign debt restructuring

Is Greece’s tragedy finally over? Following last week’s largest-ever sovereign debt restructuring, investors are surely hoping that they have witnessed the closing act on what started as a debacle but quickly became a crisis. True to form, worries persisted right to the end. Those who feared the deal to persuade existing international investors to agree to write-off up to 75% of the value of their existing Greek bonds might fail, decided to head for the safety of the exit. As a consequence, most global equity indices fell 2% with stocks in Germany, Spain and France falling more. To avoid a potentially disastrous outcome, Athens had to persuade creditors holding €206 billion of Greek bonds to swap these (at a capital loss), in a deal that would reduce the country’s outstanding debt by €107 billion. The deal was conditional as part of Greece receiving the €130 billion bailout promised by eurozone leaders in time to meet the €14.5 billion repayments due on 20 March.

Thursday was tense: the Institute of International Finance, the body negotiating on behalf of Greece, put out announcements counting the proportion of those creditors who had signed up, with a 95% take-up needed to secure the deal. This percentage was necessary for the deal to be counted as ‘voluntary’ – failure would require Greece to have resorted to so-called Collective Action Clauses (CAC) to force the deal through. This in turn would constitute a default which in turn would trigger payment of insurance-like instruments for holders of credit default swaps. As it transpired, only 86% of investors accepted the terms, triggering the use of CACs, meaning that billions of dollars will be paid out for holders of credit default swaps. Ordinarily, one might have expected markets to panic but the sums involved totalled a relatively insignificant $3.2 billion and the event was all but ignored. Following such high drama, the final outcome of 96% acceptances meant the deal was struck; Greece gets its next tranche of bailout money and the markets moved on. So by the end of the week it was no surprise that most of the earlier losses were recovered as markets breathed a collective sigh of relief.

 

Obama’s Jobs Boost

  • US recovery gains traction on the back of better jobs growth

 

President Obama’s re-election chances were boosted last week following a third consecutive month of strong jobs growth which appears to indicate the US economic recovery is gaining traction and becoming more robust. Non-farm payrolls for February rose by 227,000, slightly ahead of expectations, according to data released by the Bureau of Labor Statistics. Whilst the overall unemployment rate remained at 8.3%, the data also revised upwards previous job gains by a further 61,000. The news is long overdue for Mr Obama who has struggled in recent months to articulate how his policies have helped put the country back on the road to recovery. The latest numbers put him on the front foot.

“We’re still recovering from the worst economic crisis in our lifetimes.

But here’s the good news: over the past two years our businesses have added

over four million new jobs.”

The numbers indicate for the first time since 2008 that workers previously discouraged by dismal job prospects are finally beginning to re-enter the labour market. Hiring was especially strong in the service sector, with a sharp increase in the healthcare, business services and leisure sectors indicating a broad recovery. Rising consumer confidence has seen retail sales rise in recent months, with a strong recovery in car sales and other big-ticket household items indicating increasing optimism. The markets liked the numbers too, with Wall Street stocks advancing to within touching distance of their post-financial crisis highs as investors took a more optimistic view on the outlook for corporate profitability.

 

UK Outlook Cloudy

  • UK economy likely to avoid ‘double-dip’ recession despite weaker manufacturing production

Here in the UK, the outlook is not perhaps quite so positive despite a better feel to the economy than that experienced in the last quarter of last year. Manufacturing and production output in Britain was weaker than expected in January, according to latest official data from the Office for National Statistics. Meanwhile, an independent survey from the National Institute of Economic and Social Research said growth in the three months to February was just 0.1%, broadly flat but meaning the economy has at least avoided a return to recession. However, a more widely based look at the indicators over the same period by Capital Economics shows a more positive outlook. High street spending has remained resilient and indicators of the housing market have picked up. The CBI’s retail survey rose in February, while its industrial survey held onto gains seen in January. Alongside this, consumer spending rose and net trade made a positive contribution. The one indicator that could threaten recovery is oil prices, which have rallied significantly in recent months and could, potentially, impact negatively on consumer spending patterns along with the outlook for inflation.

 

China’s Growth Pains

  • World Bank says reforms are necessary to maintain growth
  • Beijing announces it will start loans to emerging economies in local currencies

Whilst China has led the charge of emerging market economies – the country’s growth has averaged 10% annually over the last 30 years – it has not come without cost. In a recent report, the World Bank said China must urgently implement economic and political reforms if it is to maintain its growth momentum, saying, “As China’s leaders know, the country’s current growth model is unsustainable”. The report identified key areas of reform if it is to avoid falling into a “middle-income trap”, including government interference in the economy, social inequality, weak rule of law and environmental pollution. Despite its undeniable success – China is the world’s second largest economy and largest exporter of goods – there is apparently evidence that its export-dependent, investment-led growth model is running out of steam. The World Bank estimates that annual growth will fall to 5.9% by 2021 and 5% by 2026.

The report was carried out in conjunction with vice-premier Li Keqiang, who is expected to take over as premier later this year, and so the timing of the report, according to the World Bank, is important because it coincides with a leadership transition.

The report’s proposals include the need for financial reforms that will in turn have huge global impact. The currently prevailing negative real interest rates for savers lead to excessive investment in residential housing thus undermining the goal of restructuring the economy in favour of light industries and services. So the current regime, inter alia, effectively taxes savings, repressing consumption, leading to huge currency interventions and vast accumulations of foreign currency reserves. China’s gross savings are around $3 trillion annually and integration of these is going to have huge global impact, with its banks likely to become the largest in the world in the next decade. So financial reforms are essential; and events last week suggested Beijing is taking the first steps to financial openness by announcing that it will extend renminbi loans to leading emerging nations via the China Development Bank. The CDB currently lends in dollars but will now lend in own-denominated borrower currencies. This could then be the first step towards Beijing deciding to open the dams to a flood of money waiting to wash across the border, with all its global implications.

 

Investing for Income

  • No respite for cash savers – returns remain negative in real terms
  • UK equity income manager Nick Purves of RWC sets out the case for equities

Current negative real returns on cash savings are not peculiar to the Chinese. Here in the UK that has been the case since interest rates crashed almost three years ago to the day, when the Bank of England cut base rates to just 0.5%. As a consequence, investors, understandably, have been engaged in a search for better returns. Last week we discussed the merits of commercial property and this week we re-visit equities as a potential source of return. Nick Purves is a UK equity income manager at RWC and he summed up the case for equity income investing. “It is a fact that, over the longer term, the greatest single component of equity returns is dividends: from 1871 to 2009, dividends and dividend growth accounted for around 80% of total equity return. In an environment of deleveraging and low growth, compounding income could once again be a superior strategy. My criteria for investing are very simple: I am looking for a history of high returns on capital, a low starting valuation, attractive dividends, good cash generation, a strong balance sheet and a stable business.

“You don’t need lots of excitement to generate high returns. Let us take British American Tobacco as a classic example of what I call a ‘cash compounder’. Since 2001 the tobacco industry as a whole has experienced a 1% per annum decline in volumes whilst BAT has achieved 1% per annum growth. Strong cash generation and good use of that cash has enabled the company to improve margins and increase dividend payouts, which has resulted in an extraordinary 17% pa increase in its share price. This is the template I am looking for when I decide whether to invest in a company. The portfolio owns 30 stocks, including the likes of AstraZeneca, GSK, Vodafone and Next, to give some examples, with income yields ranging between 7.8% and 3.3% [net of basic rate tax]. Today, demand for income has never been higher whilst supply has never been lower and I remain focused on the higher-quality cash compounders which remain undervalued.”

 

Tax-year end planning

  • ‘Call to Action’ for investors as tax year-end approaches
  • Time is running out ahead of next week’s Budget when personal pension tax relief could potentially be cut by Chancellor George Osborne

As we approach the end of the tax year there is the inevitable ‘call to action’ for investors; but it is for good reason. The vast majority of tax breaks and allowances cannot be carried forward into another tax year so, if you fail to take advantage of them, they are subject to the ‘use or lose it’ rule. Individual Savings Accounts are a good example: everyone has an annual allowance, currently of £10,680, to use up which can be invested in both cash and stocks & shares. An ISA grows tax-free and is able to produce income free of any further tax too; which is particularly valuable in the current climate where taxes are on the rise.  The favourable tax treatment of ISAs may not be maintained in future and may be subject to changes in legislation.

Personal pensions is another area which currently is subject to fierce debate within the coalition government in the run-up to the Budget on 21 March. There is much speculation that the maximum contribution threshold at which investors are able to claim tax relief at their highest marginal rate (currently 50%) will be cut from the current £50,000 possibly to only £30,000. Irrespective of future changes it is important to remember that, as with an ISA, growth within a pension is tax-free; and with tax relief (at whatever level) the fund receives a welcome boost. Lastly, you can take a 25% tax-free cash lump sum from the accrued sum and an income from the remainder. So whilst we will have to wait until 21 March to hear what George Osborne has in store for us, the benefits of ISAs and other tax shelters are, today, a known quantity.

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