In this week’s bulletin:
· Conflicting signals from central banks provide markets with food for thought.
· Chancellor “re-doubles” commitment to Plan A as Moody’s downgrade UK debt.
· Over half of the UK working population is not preparing adequately for retirement.
Markets climb a wall of worry
- Conflicting signals from central banks provide markets with food for thought, although the week sees the FTSE 100 Index hit a 5-year high
Last week saw markets climbing a ‘wall of worry’ as insecurity about the provision of central bank assistance and continued reminders about the fragility of the global economy took hold. The main catalyst came in the form of the minutes of the US Federal Reserve’s January Federal Open Market Committee meeting. It highlighted concerns among many officials about the costs and risks of further asset purchases. The comments signalled the worst two-day decline for the S&P 500 Index since November 2012 as investors instigated the first significant sell-off of equity holdings in 2013. The US benchmark index finished the week 0.69% lower, although since the turn of the year US stocks have increased some 5.9%. However, Wall Street’s fear gauge, the VIX Index, saw its biggest single-day jump in more than a year last week as investors sought protection against a potential fall in US equities.
Conversely, the minutes from the latest meeting of the Bank of England showed three members of the nine-strong Monetary Policy Committee, including the Bank’s governor Mervyn King, in favour of further quantitative easing. The value of sterling tumbled against the dollar to its lowest level since July 2010 and touched a 15-month low against the euro, although it clawed back a little in Friday trading. Equity markets carried on, almost regardless, and the FTSE 100 Index recorded a seventh straight weekly gain, eking out an increase of just 0.12%. The index hit a 5-year high on Wednesday, only to suffer its biggest one-day fall since July during Thursday trading.
A 1.2% rally for the FTSEurofirst 300 saw the European index finish marginally ahead over the week, as uncertainty about the Fed’s policy and concerns over Italy’s forthcoming election gave way to some speculative bargain hunting. In Japan, the Nikkei 225 reached a 52-week high during the week but, in line with other markets, gave back the majority of these gains as the week drew to a close.
No longer top of the class
- Chancellor “redoubles” commitment to Plan A as Moody’s downgrades UK debt
The biggest news of the week, albeit in terms of headlines rather than potential impact, was the ratings agency Moody’s decision to strip the UK of its AAA credit rating. Britain’s debt was marked down one notch to AA1. This is the first time since 1978 – when ratings began – that it has lost the AAA rating. Yet this was no bolt from the blue, as the UK has been on a ‘negative outlook’ for several months and the agency’s concerns about the outlook for the UK economy have been well reported. Whilst this does represent a landmark decision, it should be put into perspective – there are 21 rungs on the ratings ladder and Britain has dropped only one.
What does this mean for the UK economy and investors? A weak pound is good for the UK’s exporting companies, making their products cheaper for overseas customers, although those companies sourcing materials from abroad will suffer. However, it is also likely to push up the costs of imports and so put upward pressure on inflation; unwelcome news for families and consumers who are already struggling with rising gas, electricity and petrol prices and therefore potentially bad news for the economic recovery.
Whilst the downgrade saw the value of sterling (against other currencies) fall in early trading, to within a whisker of the symbolically important threshold of 1.5 against the US dollar, it has since steadied and recovered some losses. The year so far has seen sterling lose nearly 7% against the US dollar, while the euro has gained 7.5% against the pound.
Andrew Sentance, former Bank of England Monetary Policy Committee member, cautioned that the cut to the UK’s credit rating would add to the existing downward pressures on sterling. “This of itself won’t increase inflation but it will add to pressure on the pound, which has already fallen a long way in the space of 6 weeks – which is not going to help inflation. In my view, if we get higher inflation, which squeezes consumers, [it] will hurt economic growth in the short term.”
As for the response of equity markets, it would appear that they have shrugged off the downgrade and the FTSE 100 is marginally up at the time of writing.
Opinion on what it means for gilts is more divided; some suggest the likelihood of further quantitative easing from the Bank of England will continue to put a floor under gilt prices, but others suggest sterling weakness could have a knock-on effect on the cost of government borrowing.
The downgrade has led to further calls for the government to alter its austerity-driven strategy, despite Chancellor George Osborne saying on Friday night that Moody’s decision merely “redoubles” the coalition’s commitment to its plan. Whilst supporters will admire Mr Osborne’s resolution to stand by his approach, the opposition has pointed to the absence of a Plan B to generate growth, which would help tackle the debt crisis through higher tax revenues and lower welfare payments. As always, the impact of such moves is never as clear-cut as initial headlines would appear.
Save for tomorrow? No thanks.
- Average UK pension savings pot will last just 7 years into retirement
According to a survey by the Office for National Statistics (ONS), fewer people than ever are saving into their workplace pension scheme. Less than half of all employees, just 46%, were part of their in-house scheme last year – the lowest total since the ONS started collecting data in 1997. The ONS stated that declining membership of defined benefit pension schemes, which pay out a pension dependent on the level of a member’s salary, was the main factor behind the decrease. Defined benefit, or ‘final salary’, pension schemes have struggled over the past decade – particularly in the private sector – as the significant cost of ensuring these schemes are adequately funded has seen many of them close and, in the worst cases, fail to provide the retirement benefits many members were expecting.
However, the good news is that industry experts expect the low figures for this year should improve markedly in the future after intervention from the government in the shape of a landmark scheme to get more people saving for retirement. Private sector workers will now be automatically enrolled into company schemes through a government initiative intended to get more than 10 million more employees paying into a pension over the next five years.
But whilst this will increase the number of people saving, the key to the success of this scheme will be the level of contributions. HSBC last week reported that British workers were the least prepared in the world for retirement. Their international study showed the average retirement in the UK is expected to last for 19 years, but the average pot of retirement savings will last for just seven. According to their data, more than half of the UK working population is not preparing adequately for retirement, with one in five saving nothing at all.
So much for a lost decade
- Ten years on from equity market lows, investors’ patience has been rewarded
The 10-year anniversary of the FTSE 100 Index reaching its modern nadir of 3,287, a week before the invasion of Iraq, will pass at the start of next month. Investors have enjoyed and endured over the period as the index climbed to more than 6,700 in June 2007, before the credit crisis dragged it back down again to 3,500 in March 2009 – not quite touching the lows of 2003. As mentioned previously, it broke the 6,400 threshold as markets cheered the prospect of more quantitative easing by the Bank of England. Of course, these figures ignore the important impact that dividends have in equity returns over the longer term. When these are added to the mix, since hitting rock bottom almost 10 years ago, the FTSE 100 has returned 175% and the broader FTSE All-Share Index has gained 195%.
Source: FE Analytics, data from March 2003 to 22 February 2013.
Past performance is not indicative of future performance.
Against the current economic backdrop of a possible triple-dip recession in the UK, the ongoing crisis in the eurozone and the global economic slowdown, it would be unwise for investors to assume markets will march on relentlessly. However, in the ‘new normal’ environment of low growth, persistent inflation and low interest rates, the case for equities as part of a balanced, diversified portfolio remains as strong as ever.
Navigating the course
- Momentum-driven markets continue to present challenges for investors seeking sustainable, long-term returns
Much has been written about the strong growth in global equity markets of late and, indeed, investors have had plenty to cheer as valuations have soared to ever-higher levels. Yet in a market driven primarily by momentum, rather than fundamentals, identifying opportunities that have the characteristics to provide sustainable, long-term returns becomes ever more difficult. John Wood of J O Hambro Capital Management recently spoke about the challenges for a stock-picker in this environment. “Being a fund manager is currently just like being a surfer: you just have to know how to ride the wave. Amid hopeful talk of a ‘great rotation’ out of bonds into equities, a tide of liquidity engineered by the major central banks is sloshing through the stock market. This has driven share prices up sharply in recent months, despite little evidence of improvement in corporate fundamentals in the still largely overleveraged, growth-starved Western economies.”
Yet despite these difficult conditions, John remains optimistic and went on to explain how their strategy is positioned to deliver against the current economic backdrop. “Our focus continues to be on identifying companies that can generate above-average returns over the long term through compounding growth. These can be companies producing volume growth in a world of negligible GDP growth, or those firms creating value growth in industries where there is no volume growth. Unfashionably, we seek to buy and hold stakes in companies characterised by high-quality franchises that generate plentiful free cash flow and which have solid balance sheets marked by low levels of debt. High-return investments are scarce in the low-return environment now facing us, but we believe we can achieve attractive long-term returns through the patient process of holding stocks that regularly compound their growth over time.”