In this week’s bulletin:
- A wealth of economic data was released over the past seven days, particularly in the United States.
- Wall Street took all the news in its stride, not wavering in the expectation that tapering will begin later in the year with many analysts stating September as a likely starting point, with interest rates starting to rise sooner rather than later.
- It was a positive week for the FTSE 100, with the rise driven partly by shares in Lloyds Banking Group soaring above the 73.6p price per share paid by the government for its £21 billion stake.
- While the residential property market has been buoyant in London for a long period of time now, house prices around the country are rising at their fastest pace in three years.
The FTSE 100 ended the week on a softer note as mixed jobs data from the US prompted a small amount of profit-taking. The headline UK index closed the week at 6,647, a weekly rise of 1.4%, joining European markets in approaching two-month highs. Elsewhere around the world, Asia was the relative winner, driven by Japan’s gain of 3.3% on Friday alone as yen weakness and Chinese economic data provided a boost. The S&P 500 exceeded the 1,700 level for the first time in history, and the yield on US Treasuries fell marginally to around 2.6% with the expectation that quantitative easing will continue, albeit at a reduced pace.
Not too hot and not too cold
A wealth of economic data was released over the past seven days, particularly in the United States. The main headline was the US manufacturing sector expanding in July at the fastest pace in more than two years, offering comfort to the Federal Reserve with analysts believing that the economy would be able to withstand a slowing of its monetary stimulus. The housing rebound in the US, resulting in double-digit percentage price rises in the last year, has resulted in an increased demand for appliances and furniture, keeping factories busy. Housing construction has been flat after a 2.8% jump in the previous month, but the sector has been a bright spot in the world’s largest economy and is expected to continue strengthening despite mortgage rates starting to rise for house-buyers. Overall, the US economy grew at an annual rate of 1.7% in Quarter 2, outlining how the US is further along its economic cycle than the rest of the Western world.
This positive news shouldn’t necessarily mean we should start immediately dreaming of years of economic prosperity. Earlier in the week, the Fed made a slight downgrade to its economic outlook, changing its view from ‘moderate’ to ‘modest’ but making no mention of a change to its asset purchases later in the year. Following this, despite unemployment continuing to fall, the US payroll data was not as impressive as expected. The country added 162,000 jobs in July, a figure that would normally be well received; but the negative reaction shows how far expectations of US recovery have come. Analysts had predicted 185,000 jobs being added.
Seemingly under the radar, President Barack Obama unveiled an interesting proposal to overhaul the US corporation tax system, eliminating loopholes and reducing the rate of tax to a highly competitive 28%, with the aim to attract companies to the US. His plan is to then reinvest this increased income into infrastructure and employee training. However, the concerning side-note was the Republican reaction to Obama’s plan which suggests the two parties are as far apart as ever, a fact that may be a worry in the coming months. In September, Congress needs to agree the budget for the next US fiscal year while in November, the problem of the US debt ceiling will raise its head again. Either or both of these may prove significant headwinds should they not go as planned.
Amid this myriad of information, Ben Bernanke made it perfectly clear that he would stick to his programme of quantitative easing as he seeks to caress the US economy further on in its cycle. The figure of $85 billion per month in asset purchases will continue, as regardless of the green shoots of recovery, the Fed is still worried about the strength of the economic recovery and persistent unemployment. While the 7.6% unemployment figure looks promising, especially taking into account where it has been since late 2008, it is still well above the 6.5% that the Fed sees as a precursor for any interest rate rises.
Wall Street took all the news in its stride, not wavering in the expectation that tapering will begin later in the year; many analysts are stating September as a likely starting point, with interest rates starting to rise sooner rather than later. In the short term at least, the market is balancing the economic and corporate improvement with likely central bank action, and is coming to the view that things are ‘not too hot and not too cold’.
Taxpayers may get their way
It was a positive week for the FTSE 100, with the rise driven partly by shares in Lloyds Banking Group soaring above the 73.6p per share paid by the government for its £21 billion stake. The clamour has already started for information on when the government will look to sell off these shares. Lloyds swung back into profit in the first half of the year (£2.17 billion), and took steps towards resuming its dividend for the first time since 2009, seeking to overturn the ban from the regulator. António Horta-Osório, chief executive of Lloyds, reiterated his view that taxpayers could make a real profit with the shares but admitted that it was up to the government as to when, and how, it will sell its stake.
The government’s stake in Lloyds is not often mentioned without RBS also being discussed, but RBS is still around 35% below the purchase price of 502p. Announcing his final set of results as chief executive before handing over after five years in charge, Stephen Hester said he regretted not taking the part-nationalised bank back into private ownership. Analysts had originally welcomed the appointment of Ross McEwan, a politically popular choice after a long career in retail banking, but debate soon arose around salary and bonus schemes. Mr McEwan is reportedly to be paid a lower figure than his predecessor, around £1 million per year compared to Mr Hester’s £1.2 million salary, and will waive his bonus for the first 15 months of his appointment. Even when eligible for a bonus, the amount would be linked to the Chancellor’s success in offloading the RBS shares. After his appointment, Mr McEwan is believed to have decided the remuneration package himself to avoid public criticism. He will become the lowest-paid chief executive of all the major UK banks.
When asked about the UK banking situation earlier in the year, Kevin Murphy of Schroder Investment Management responded: “Banks continue to elicit emotion and polarise consensus; both are dangerous in investment. When people become overwhelmingly bearish, a buying opportunity occurs. We believe that with UK banks trading at depressed valuations, this is a good opportunity for recovery investors.
Britain’s favourite subject
Data released by Knight Frank, the London property agent, revealed that 73% of new home sales in inner London during 2012 were to foreign buyers, and more than 50% of overall sales were to buyers from Singapore, Hong Kong, China and Malaysia. Despite stamp duty levels for properties over £2 million rising from 5% to 7%, viewings of such houses are up 15%. Many agents now do not advertise such properties to UK buyers, preferring to focus on the increased demand overseas.
Politically, there is criticism that the domestic market is being distorted and driving up prices for UK buyers with Simon Hughes, the Liberal Democrat MP, even going as far as to state that housing in London should only be bought by UK residents. However, house-builders argue that many housing projects would never break ground were it not for pre-construction contracts with foreign buyers. Without such levels of foreign demand, the banks simply would not finance the projects in the first place.
While the residential property market has been buoyant in London for a long period of time now, it has taken time for the rest of the country to follow suit. Amid government intervention with the likes of the Help to Buy scheme, there are now reports that property values around the UK have risen 2–3%, though there is debate over whether this is a good thing. Several high-profile economists have warned of fuelling another bubble similar to that seen in 2007, though it should be noted that the UK did not suffer anything like the sell-off experienced by homeowners in the US, Ireland or Spain. For the moment, it seems that prices are being kept stable by low interest rates and domestic demand which far exceeds an inadequate supply in many areas, especially for first-time buyers.
House prices and construction activity around the country are rising at their fastest pace in three years. Figures from Nationwide, the UK’s biggest building society, indicated that house prices rose 3.9% in the year to July with the average house price in the UK now standing at £170,825. Robert Gardner, chief economist at Nationwide, said: “Signs of a modest improvement in wider economic conditions and further modest gains in employment are likely to be lifting buyer sentiment. An improvement in the availability and a reduction in the cost of credit are also boosting demand.”
Rising house prices and equity markets have helped to contribute to the largest Inheritance Tax (IHT) takings since 2007, as rising equity prices and house prices contributed to the £3 billion raised up to April 2013 (Source: Office of National Statistics). With the nil-rate band of £325,000 per person frozen until 2019 and brighter horizons for house prices, revenues could be set to rise further. The record IHT level was £3.8 billion in 2007 (Source: Office of National Statistics), showing the link between the 40% tax and house prices. As always, HMRC will take its share of any good news!
In the commercial property sector there are also signs of turning a corner, according to the IPD UK Property Index. Returns over the last quarter rose to their highest level in two years with capital values rising 0.4% during the period, following 18 months of falls. The IPD said that the UK’s return to growth looks to be driving occupier demand and improving market sentiment, while Chris Bartram of Orchard Street Asset Management, manager of the St. James’s Place Property fund, recently reported: “The outlook is for modestly rising capital values, spurred by a hardening of rental values, slower economic growth taking hold and the scarcity value of ‘good’ property increasing. The income yield from the asset class remains strong, especially relative to gilts, and has always been a positive contributor to total returns.”
Equity markets continue their upward trend, buoyed by economic news which is neither ‘too hot’ nor ‘too cold’, enabling investors to believe that monetary policy will remain accommodative for long into the future; the quid pro quo of course being the continued measly rates offered by deposit accounts as the government is seen to favour house-buyers over savers. As outlined in a number of weekend publications, savers continue to pay a heavy price with Leeds Building Society, pioneer of the 0% mortgage, slashing its savings rates by up to 0.35%. This is just one of many cuts in recent weeks and months and, as we’ve oft stated, savers will need to factor in low returns for the foreseeable future.