UK government to make ‘massive’ injection of state spending to boost economy

In this week’s bulletin:

  • Markets remain volatile over ‘Grexit’ worries
  • Spain injects €19 billion into Bankia to restore confidence
  • UK government to make ‘massive’ injection of state spending to boost economy
  • China’s economic growth slows to 8.1% in first quarter of 2012
  • Worries over future growth prospects
  • Beijing takes steps to rebalance economy and generate more growth
  • An interview with Nick Osborne of BlackRock gives an insight into ‘absolute return’ investing and why things don’t always go according to plan

 

Market Eye

  • Markets remain volatile over ‘Grexit’ worries
  • Spain injects €19 billion into Bankia to restore confidence
  • UK government to make ‘massive’ injection of state spending to boost economy

“Growth is too slow and unemployment too high. Policies to bolster demand before low growth becomes entrenched are needed.”

 IMF Managing Director Christine Lagarde calls on UK government to boost growth.

Global equity markets endured a choppy week following the previous week’s sharp sell-off caused by worries over a possible Greek exit from the eurozone. The main share indices seesawed as investors weighed up the probability of a ‘Grexit’ with hopes, as ever, of European policymakers coming up with a solution or at least another temporary fix. True to form, the latest informal euro-summit was light on action, merely reiterating leaders’ desires to see Greece stay in the euro but with no concrete plans being announced. There was, however, speculation over the weekend that secret plans are being drawn up in Brussels for a European rescue fund that could seize control of struggling banks across the region, which would halt the steady escalation of the eurozone debt crisis. This followed news from Madrid late on Friday that Spain would make an emergency €19 billion investment in Bankia, the stricken savings bank, in a bold bid to restore confidence in the stability of the country’s financial sector.

There were also high hopes that President of France, M. Hollande, would manage to move the need for growth plans, as opposed to more austerity, further up the agenda. The issue was given added urgency by the release of disappointing economic data in the eurozone, China – which we discuss later – and the UK. The timing of the data coincided with a visit to London by IMF Managing Director, Christine Lagarde, who presented the Fund’s annual report on the UK economy. Announcing that “Growth is too slow and unemployment too high,” she added, “Policies to bolster demand before low growth becomes entrenched are needed.” In tandem with the IMF’s report was a statement from the Deputy Prime Minister, Nick Clegg, that the government is preparing a “massive” increase in state-backed investment in housing and infrastructure to give a boost to the UK economy. Whilst not labelled ‘Plan B’, the change in policy is seen as a way to use the government’s balance sheet to inject credit into the economy in the way it did back in the earlier days of the financial crisis. The timing of the announcement followed news that retail sales fell last month and revised figures from the ONS showing the UK slipping deeper into recession in the first quarter. On the bright side, official data showed that inflation fell back to 3% last month on the back of lower energy prices.

With investors remaining nervous, it was no surprise that the subsequent ‘flight to quality’ meant the havens of German Bunds, UK gilts and US Treasuries benefited most, with ten-year bond yields hitting record lows. Such was the demand for the perceived safety of sovereign debt that it enabled Germany to sell investors two-year, zero-coupon bonds. The weaker data from China also meant that the demand for commodities lessened, leading to lower prices for oil, gold and silver, although copper did manage to rally after hitting a four-month low. Currency movements were muted, with sterling falling slightly against both the US dollar and the euro. However, by the end of the week equities had managed to hold onto earlier gains, with most major Western indices gaining a percent or so. Heading south though was Tokyo, where the Nikkei declined for an eighth successive week, despite better economic data. Investors seem to have become increasingly worried by news that public finances have deteriorated, with government debt projected to hit 239% of GDP by the end of the year; the highest of any developed sovereign state.

 

The Road to Growth

  • China’s economic growth slows to 8.1% in first quarter of 2012
  • Worries over future growth prospects
  • Beijing takes steps to rebalance economy and generate more growth

Three years after the global economy began its recovery from recession, prospects for growth appear, once again, to be stuttering. Last week, in its half-yearly economic outlook, the OECD said the world was “trying to return to growth” with its assessment reflecting a slowdown in Europe and, crucially, signs of weakness in what has been the world’s fastest-growing economy, China. The latest economic data from China last week showed the country’s growth slowing to 8.1% during the first quarter of 2012, down from 9.2% in 2011, raising concerns that the country is heading for a hard landing and that the emerging markets story is over. Given the importance of China to world growth, it is worth taking a closer look at what is actually happening. After growing at an average annualised rate of 10% for the last decade, many analysts see the recent slowdown as more of a natural deceleration. External demand is weakening but, more importantly, this is a lag effect of the government’s effort to slow down the economy as it tries to rebalance to produce ‘better quality’ growth.

Beijing wants its economy to rely less on exports and has been trying to boost domestic spending. So the government has begun to rebalance towards the domestic engine but also recognises that it is still too reliant on investment rather than consumer spending. To counter this, Beijing has been raising the minimum wage across the nation to encourage people to go shopping. However, the handing-over of the growth baton is likely to be a lengthy process and, in contrast to previous statements, Premier Wen Jiabao has called for more pro-growth-orientated strategies. Echoing his comments, the OECD has also called for China to speed up the implementation of key infrastructure projects already planned. Whilst it is very unlikely that the country will roll out a huge stimulus package as it did in 2009, it is likely that small policy changes will be made along the OECD lines to boost infrastructure and consumption.

Over the weekend China announced that it is opening up its banking system to private sector investors – the latest move by Beijing aimed at underpinning economic growth. China said that private investors would have the same rights as state firms when trying to invest in domestic banks. Despite China’s strong economic growth, critics say expansion has been hampered by an inefficient banking sector. China recently opened up other sectors such as energy and telecommunications and the hope is that, by attracting new foreign investment, China can stimulate a fresh and enduring phase of economic development. According to the new rules, private sector investors will be allowed to purchase stakes in Chinese banks through a number of means including stock placements, new share subscriptions, equity transfers, and mergers & acquisitions. The move will effectively break up the monopoly of national banks that have been criticised by Mr Jaibao for not lending enough; one of the areas in which China has seen problems has been the way banks lend to small and medium-sized businesses. The news will be welcomed by Western economies, many of which depend heavily upon China continuing to grow in order to progress themselves and it will also mean that the emerging market story remains intact for the foreseeable future.

 

Striking a Balance

  • An interview with Nick Osborne of BlackRock gives an insight into ‘absolute return’ investing and why things don’t always go according to plan

With financial markets worried about the eurozone and the outlook for global growth, investors have been subjected to significant short-term volatility as traders switch suddenly – quite often from one day to the next – from ‘risk-off’ mode to ‘risk-on’ and vice versa. As we have discussed many times in the past, the key to managing these issues is to have in place a diversified portfolio. One component to consider within such a portfolio is the use of an ‘absolute return’ strategy – in other words a fund with the objective of generating positive returns in all market conditions. Such strategies can be complex and they are not guaranteed to always succeed but they can, over time, help reduce volatility and smooth overall returns for investors. One such fund is the St. James’s Place UK Absolute Return fund, managed by BlackRock; and in an interview last week, fund manager Nick Osborne explained the current strategy and why, last year, the fund failed to meet expectations.

“Undeniably 2011 was a poor year for the portfolio and our strategy. With the benefit of hindsight, we were too optimistic about the economic outlook and consequently seduced by the prevailing low equity valuations which meant that the fund had a net positive equity exposure. We also misjudged the fact that, despite the significant range of financial and economic solutions available for policymakers to use to solve eurozone problems, it was politics that trumped in the end. Our smaller-companies holdings suffered as investors took the view that, should Europe’s banks get into difficulty, it would also impact negatively on these companies’ ability to obtain potential new funding in the future.

Our 2012 theme is back to basics, placing greater emphasis on stock selection, which of course favours our stock-picking skills. We are also giving greater consideration and weight to global macro issues, including the potential impact of politics. Our tools remain owning cash, buying the shares we like, selling the shares of companies we believe to be at risk and a mix of the latter two within the same sector, which is known as ‘pairing’. The shares we own concentrate on businesses with a material competitive advantage, for example Rolls-Royce, which has a technology edge in its field. The ‘short’ [stocks sold] position involves those companies exposed to the EU and the associated risks of austerity and weak consumer demand, including in the UK; for example, the retailer Argos. Our ‘pairs’ currently account for c45% of the portfolio and here we have fewer stocks and larger positions; so for example in the pharmaceutical sector we own Shire but are short AstraZeneca and Glaxo. Overall we have changed the main emphasis of our short-index positions away from FTSE 250 towards the FTSE 100, which has greater liquidity.

So far this year the market is down around 3–4% – depending on which day you take – whilst the fund is up 3–4% and volatility has returned to more historic levels of around a third, when compared to the UK market.

So, in summary, our strategy is quite different from where it was last year, with a greater emphasis on having a short position at present. This is despite the fact that equities look very cheap and corporate balance sheets are very strong and we are positive taking a medium- to long-term view. We are also cautiously optimistic on US growth, where cyclical industries such as house building are improving from a low point, together with the prospects of the US being energy self-sufficient in the next ten years. We are not complacent and, as ever, politics could be the single major risk again in respect of the eurozone but this time we are prepared for every eventuality.”

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