George Osborne, has a potentially tough week ahead with the International Monetary Fund

In this week’s bulletin:

  • Investors experience déjà vu as markets pause for breath after another strong start to the year.
  • Concern over Chinese economic growth affects most asset classes.
  • Media attention focuses on the recent volatility of gold, but there are many factors at work, making it extremely difficult for investors to predict the future.
  • The Chancellor of the Exchequer, George Osborne, has a potentially tough week ahead as the International Monetary Fund and the UK government seem on a collision course.

 

Familiar feelings

  • Markets pause for breath after another strong start to the year
  • Concern over Chinese growth affects most asset classes

Investors would be forgiven for feelings of déjà vu after a week of wobbles in the major equity markets. After strong starts in 2012, the main global indices fell around 13% between April and June; while in 2011, nearly 25% was wiped off the value of stocks between May and October amid concerns over the eurozone, and Greece in particular. Regardless of its wisdom, those who heed the old adage of “Sell in May, and go away” may have felt vindicated in recent times. However, it should be noted that as uncomfortable as last week may have felt, the FTSE 100 only fell around 1.5% – hardly a trigger for panic.

One of the best performers in 2013 has been the S&P 500, rising more than 16% in sterling terms (source: Financial Express), although the recent sell-off has seen the US index fall 2.8% since the record high set at the start of April. Last week’s falls were mainly triggered by weak Chinese economic data, but exacerbated by the International Monetary Fund (IMF) downgrading its forecasts for global growth to 3.3%, down from 3.5%. At the IMF’s spring meeting in Washington, central bankers also struck a cautious tone about the steps they have taken, as several European members made remarks that were far less confident than in recent times. As well as the disappointing economic data, Apple Inc. proved to be a thorn in the side for market bulls amid persistent worries over whether the company can keep up with sales expectations.

Such short-term events emphasise the need for a long-term approach to investment. This year so far, markets have scarcely reacted to the ongoing issues of Cyprus and seem oblivious to Italy’s political stalemate. With bond yields remaining depressed, the long-term case for equities is still an attractive one; and an active fund manager with good access to liquidity will have viewed last week as an opportunity to buy into weakness, a rare chance in recent times.

 

China sends commodities lower

  • Media attention focuses on the recent volatility of gold
  • There are many factors at work, making it extremely difficult for investors to predict the future

Recently, the financial news has been dominated by an extraordinary fall in the price of gold, as well as other commodities such as copper. Disappointing economic data from the US, China and Europe heightened concerns over the global outlook, as well as the aforementioned IMF forecast. The Chinese ‘slowdown’ in growth in the first quarter, down to an annual rate of just 7.7%, was certainly the most unexpected, although it seems to be accepted that the Chinese government is happy to manage a short-term slowdown. The result was for commodity markets to react negatively across the board, and for gold to suffer its largest one-day fall in 30 years, touching a low of $1,321 per ounce. At the time of writing, the metal had recovered to $1,400 once again; but the damage has been done for those who still perceived the asset as a safe haven and bought it in 2011 when prices were more than 20% higher. Elsewhere in the commodity sector, oil fell to below $100 per barrel for the first time since July, while copper hit an 18-month low of $6,800 per tonne.

So why has the gold price fallen so fast? While it is difficult to pinpoint one reason, there has been a huge amount of speculation that the market will soon be flooded with indebted countries such as Italy and Cyprus selling their gold reserves to service debt. According to the Sunday Times, these two countries alone account for 8% of the global central bank reserves and an expectation of such an event may have caused people to react ahead of time. Investors also expect that the US Federal Reserve will cut back on its quantitative easing programme, which has also resulted in less of an appetite to hold gold as a store of value. Many commentators have also suggested that automatic triggers will have been set by larger investors to sell at $1,500, which further exaggerated the drop below that level. However, as with any asset class, this just proves that with so many variables at work in the short term, it is extremely difficult to have confidence in any immediate movement, whether positive or negative.

With gold suffering its largest two-day decline since the 1980s, it is perhaps natural that the media should pay attention to the asset and start the debate (yet again) over the advantages and disadvantages of holding gold over the long term. As ever, our view is that it depends entirely on the objective of your investment and appetite for risk. While recent events dent gold’s reputation as a safe haven, the case for diversification along with other assets such as equities, bonds and property is perfectly valid.

 

Another downgrade

  • The Chancellor of the Exchequer, George Osborne, has a potentially tough week ahead
  • The International Monetary Fund and the UK government seem on a collision course
  • Crucial economic data are due to be released later in the week

George Osborne learned on Friday evening that a second credit ratings agency had stripped the UK of its AAA rating – yet another reminder of the long road ahead economically. The announcement from the Fitch ratings agency came just days after the IMF expressed its own doubts over the validity of the country’s deficit-reduction scheme. David Lipton, from the IMF, told journalists that “the UK economy has turned out to be somewhat weaker than had been foreseen, so our view is that the pace of consolidation ought to be reconsidered”. Mr Osborne responded by commenting, “While of course there are ongoing economic challenges in the UK, I don’t feel a particularly strong political challenge to our economic policy… I don’t see anyone coming up with a credible alternative.” David Lipton is a key figure, according to the Sunday Telegraph, as he is the person due to unveil the latest IMF analysis of the UK and present its policy recommendation next month. In a strong show of support, the paper encouraged the Chancellor to resist temptation to change tack, and wrote “Mr Osborne is right to set his jaw against the IMF dabbling too deeply in UK politics. Sadly he made a mistake by being too cosy when he believed the IMF an ally, as marriages between democratically-elected [sic] politicians and economic bureaucrats are never satisfying. It is now time for Mr Osborne to propose at least a partial separation.”

Fitch blamed weak growth and the lack of impact of current austerity measures when implementing the downgrade. In a statement, it said, “The fiscal space to absorb further adverse economic and financial shocks is no longer consistent with a triple A rating.” However, on a more positive note it should be recognised that the outlook on the new rating was described as “stable”.

Looking to the week ahead, the official growth figures for Britain arrive on Thursday, with economists opining that the country should avoid a triple-dip recession, but only by a small margin. Analysts’ consensus is that the figures will show a rise in GDP of 0.1% in the first quarter. A negative figure would mean that Britain has officially dipped into recession over the winter, the third such recession since 2008. Regardless of the official figure, neither scenario is particularly positive.  Zero, or near zero, growth in the economy will make it harder for the country to repay its debt burden. The problems are certainly mounting for George Osborne, and indeed the incoming Bank of England Governor, Mark Carney. The pressure could increase yet again with the release of the public finances data for the fiscal year 2012/13. Last month, the Office for Budget Responsibility said borrowing would be fractionally lower in these accounts which, in his Budget speech, the Chancellor used as evidence that the deficit was decreasing. Given the emphasis placed on this in his speech, any slippage would be pounced on by critics immediately.

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