In this week’s bulletin:
- After the strong start to the year, investors were given a reminder that it is not all plain sailing as Italian and Spanish problems once again came to the fore.
- Signs continue that investors are increasingly willing to accept the higher risk of equity funds.
- Lean times ahead for millions of savers as Cash ISA rates hit record lows.
- With China continuing to release impressive economic data, Hugh Young, of Aberdeen Asset Management, gives his views on how other emerging markets can provide lower risk access to the potential of the country.
After an impressive January, investors’ attention again turns to the eurozone
Relative strength of key currencies come under the spotlight
After the strong start to the year, investors were given a reminder that it is not all plain sailing as Italian and Spanish problems once again came to the fore, while the relative strength of the euro also raised concerns. The FTSE 100 recorded its first weekly decline of 2013 despite a rally on Friday on the back of encouraging Chinese and US economic data. In the US, the S&P 500 suffered its biggest one-day drop of the year while in Europe, German stocks dipped below the level at which they ended 2012. In bond markets, Spanish and Italian yields rose sharply higher after Mariano Rajoy, Spain’s prime minister, faced calls to resign after allegations that he had received secret payments from his party. In Italy, concerns mounted that the forthcoming general election could result in a parliamentary impasse as opinion polls showed Silvio Berlusconi narrowing the gap on his rivals. Spain’s 10-year yield rose to 5.37% while Italy reached 4.56%: though it should be noted this is still far below the stress levels of 7% seen previously. In contrast to the continuing turbulence around Spain and Italy, Irish sovereign yields fell to levels not seen since the start of the financial crisis in 2007, after Dublin was given the green light to restructure €28 billion issued to fund its banking sector bailout.
Meanwhile, the risks to eurozone growth from the recent appreciation of the euro came under scrutiny after François Hollande, the French president, called on the region to manage its exchange rate. The single currency recently hit a 15-month high against the US dollar and a multi-year peak against the yen; a position seriously hindering the competitiveness of the region’s exporters. Although Mr Hollande’s remarks were largely ignored, they helped to heighten expectations that Mario Draghi would try to talk down the euro after the European Central Bank (ECB) held its scheduled policy meeting. The ECB president adopted a serious tone as he warned of downside risks to the eurozone economy, saying the bank would monitor the level of the euro. Immediately after the speech, the euro sank to its lowest level in two weeks before falling further on Friday. A weaker euro is essential to a region struggling to re-establish itself on the global scene; so keeping its key exporters competitive is a must. Another country battling with its currency, though it has been for years, is Japan. After the Japanese finance minister, Taro Aso, said that its currency had weakened further than intended, the yen strengthened immediately against other major currencies. The recent pace of the yen sell-off is expected to be a topic for debate at the upcoming G20 meeting in Moscow.
The Great Rotation
Signs continue that investors are increasingly willing to accept the higher risk of equity funds
Diversification is still crucial – it is impossible to predict short-term movements consistently
A phrase that seems to be slowly creeping into the public consciousness is ‘The Great Rotation’, which is a rather grandiose name Merrill Lynch has coined for a theory suggesting that investors are moving en masse from fixed-interest investments to equities. Speculation persists over the bond market, with some areas offering zero or negative returns after inflation is taken into account.
Research from the Investment Management Association (IMA) shows that equity funds were the most popular investment for the last four months, drastically shifting from corporate bond funds. At first glance, it seems the choice is to take little risk and accept a zero real return, or accept greater volatility and at least attempt to outpace inflation. Experts can point to a 30-year bull run for bonds which has resulted in the kind of yields being seen now, while equities have suffered a 13-year bear market since the bursting of the dot.com bubble in 1999 – a market level that has not since been revisited. However, the last time this same ‘rotation’ happened was September 2007, one month before the financial crisis started. As the Daily Telegraph pointed out: while equity dividend yields look relatively attractive, it is against the backdrop of depressed bond yields due to quantitative easing. It should also be noted that while equity fund investment has overtaken that of fixed-interest fund investment, the data released by the IMA suggests that bond funds are still seeing net inflows. This would suggest it isn’t a wholesale switch from bonds to equities but more a slight increase in risk appetite from investors.
Our view is that it is impossible to predict short-term market movements, and trying to time the market by moving wholly from one asset class to another significantly increases risk. Diversification across asset classes remains one of the most important factors in producing long-term returns with lower volatility. With so much uncertainty in the world, a diversified portfolio that suits your own particular risk profile remains the most appropriate strategy.
Savers continue to suffer
Lean times ahead for millions of savers
In the run-up to the end of the tax year, it is clear that very few will be offering a worthwhile rate of return. According to research by The Times, in February 2012 there were 385 Cash ISAs available, offering an average of 2.55%. Today, there are only 309 accounts available, with an increasing trend for banks and building societies to put restrictions on ISA transfers, making it harder for savers to shop around for a better rate. While it is still possible to find an instant-access cash account paying 2.5%, the average instant access account now pays only 0.87%; compared to an average of 3.67% in February 2007 before the financial crisis. The average bonus-rate Cash ISA now offers just 1.74% compared to 4.99% pre-crisis, with little prospect of rates rising soon.
This news came in a week where a renewed surge in oil prices (hitting $119 per barrel on Friday) threatened to push inflation further above the much-discussed official 2% target. The Bank of England is set to concede that it has little chance of hitting that target for the next two years. The Bank’s Monetary Policy Committee is expected to acknowledge that food and energy prices will keep inflation higher throughout 2013, probably above 3% by mid-year. With Mark Carney, the new Bank of England governor, believed to be concentrating on broader economic stability, the mythical 2% inflation target will most likely become a secondary objective. In addition, growth forecasts are expected to be reduced slightly and the Committee is believed to be keeping the door open for further quantitative easing.
How is best to take advantage of China?
China recovers from its slowdown, releasing impressive data for January
Other emerging market countries can provide access to the growth potential of China but with lower risk
China’s first official data of the year showed signs of economic recovery, as exports, imports and new lending soared. Exports in January were up by 25% compared to a year earlier, while imports surged by over 28%. There was also good news from China’s banking sector, as new lending more than doubled, compared with December, to 1.07 trillion yuan (£67.7 billion). The news came as Chinese inflation slowed to 2% in January – down from a peak of 2.5% in December. The Chinese government is seeking to boost growth after the country expanded at its slowest rate for 13 years in 2012.
So while China, and many emerging markets, is releasing economic data that Western countries could only dream of, how best can investors take advantage of such growth while managing the obvious risk? Hugh Young of Aberdeen Asset Management recently gave his views.
“China has been a remarkable growth story and over the long term is expected to maintain its momentum. However, buying Chinese stocks is no guarantee of impressive returns. The key to making good returns in China is to do your homework at a company level – after all, we are investing in real businesses. We look for businesses with strong competitive positions, robust balance sheets and attractive growth prospects. Unfortunately, Chinese firms fare poorly in this regard as most are state-owned, and not necessarily managed in favour of shareholders. The national interest comes first, especially in energy companies, while the vast majority of companies lack transparency.
This is why I prefer to tap into Chinese growth via Hong Kong-listed companies. Typically, such companies can derive 40% of their profits from China but have higher standards of corporate governance as well as far greater regard for shareholders. Furthermore, their managements have been through challenging conditions and know how to manage their businesses.
If China dominates the West’s interest in the East, but is not necessarily rewarding as a market, the corollary for investors over here [Hugh Young is based in Asia] is that economies that seem less important often provide good opportunities. One example is Singapore, which is home to many financially sound companies. The majority have long outgrown their domestic markets, expanding across Asia and even further afield.”