Tentative signs emerge that investors’ appetite for risk is increasing

In this week’s bulletin :

  • New year market rally is tempered by realisation that US politicians have merely deferred the most difficult decisions.
  • Whilst the US economy is proving resilient, contraction in the UK’s services sector prompts fear of a triple-dip.
  • Despite the global economic challenges, tentative signs emerge that investors’ appetite for risk is increasing.
  • Savers and investors should consider maximising their tax exemptions and allowances among their new year resolutions.


Relief rally

  • Markets make positive start to 2013 but rally stalls as US politicians again kick the proverbial can down the road
  • US jobs data and rising confidence in services sector suggest economy has some momentum

The shortened week did little to curb the enthusiastic response of the markets to news that the immediate dangers of the US fiscal cliff had been avoided. However, after the initial rally, realisation that the most difficult decisions on spending cuts have merely been deferred for two months did prompt markets to retreat slightly. The politicians in charge of managing the world’s largest economy have come in for heavy criticism over their game of brinkmanship – the fate of the global economy represents pretty high stakes. US political uncertainty will continue to concern markets; the end of February will see more wrangling over spending, with Republicans in the House of Representatives again threatening to force the US to default.

“The 11th-hour deal was a stop-gap not a solution. It will likely translate into increased volatility for financial markets.”

Russ Koesterich, Chief Investment Strategist, BlackRock

The brakes were further applied on news of an apparent split within the Federal Reserve’s Federal Open Market Committee over whether to maintain its quantitative easing programme until the end of this year. The minutes of its December meeting confirmed that “several” of the 12 voting members were concerned about financial stability or the state of the Fed’s balance sheet.

Encouraging jobs figures did, though, suggest that the US economy is growing steadily enough to withstand the squeeze from the fiscal cliff deal and continue its recovery in 2013. Non-farm payrolls increased by 155,000 last month, very much in line with expectations, while the unemployment rate held steady at 7.8%. There was also some positive news on the US services sector, as the Institute for Supply Management’s December non-manufacturing index hit a 10-month high. Markets were also boosted by news that Chinese manufacturing picked up sharply in December, suggesting that its economy has bounced back from the export-induced soft patch in the second half of 2012.

So, whilst the looming cliff had denied investors the fairly traditional year-end market rally, the end of the first week of 2013 provided some welcome relief. Wednesday provided the best day for US equities in more than a year and the S&P 500 Index ended the week up 4.4%, within touching distance of a post-financial crisis high. The FTSEurofirst 300 Index finished up 3.2%, at a 22-month high. In the UK, the FTSE 100 gained 2.8% to end the week above 6,000 and at its highest level for nearly two years. Asian markets saw similar gains.


Worries about the three Rs

  • UK services sector contraction prompts triple-dip fears
  • Better news on mortgages but Funding for Lending Scheme continues to penalise savers

In contrast to signs of rising confidence from its US counterpart, confirmation that the UK’s dominant services sector had suffered its first contraction in two years increased fears that the economy is heading for an unprecedented triple-dip recession. Activity in the sector, which makes up three-quarters of the economy, dropped to 48.9 in December, from 50.2 the previous month, according to the Markit/CIPS Purchasing Managers’ Index. The 50 mark separates growth from contraction; the last time the index fell below that level was in December 2010, when heavy snowfall brought the nation to a standstill. When added to the week’s figures from the manufacturing and construction sectors, the data point to the economy shrinking by about 0.2% in the fourth quarter of 2012. The worse-than-expected drop was largely down to companies’ continued reluctance to invest, in the light of the uncertain backdrop, and signs that jobs were being cut in the face of weak demand. In response, the pound fell to its lowest level in a month and Britain’s cost of borrowing rose above that of France for the first time since April 2011, as gilt yields rose to 2.12%.

More positive news came from the Bank of England’s latest figures showing mortgage approvals at their highest level in ten months. Approvals rose from 53,000 to 54,000, the fifth monthly increase in a row, raising hopes that the government’s Funding for Lending Scheme is feeding through into an actual pick-up in lending.

However, there is another side to the story. UK savers outnumber borrowers by seven to one and the Funding for Lending Scheme continues to push down savings rates to an unprecedented degree, making it increasingly difficult to achieve a real return after tax and inflation is taken into account. With the Bank of England expected to keep interest rates on hold for at least another two years, the outlook looks miserable for those wanting to keep their money in a low-risk environment. That said, cash remains a vital part of a balanced investment strategy because it is accessible at any time and avoids the potential need to sell long-term assets when markets take a turn for the worse.

Savers need to remain vigilant; those who were attracted by easy access and deposit accounts offering bonus rates need to check the date when that rate runs out, as many accounts offer poor rates thereafter. To underline the challenge faced by savers, currently only 17 Cash ISAs on the market beat inflation compared to 138 just two months ago.


Gilts losing their shine?

  • Despite challenges for the global economy, there may be signs that risk aversion in on the wane

The rise in the 10-year gilt yield heralded the first time since last May that it has crept above 2%; and is seen by some as a tentative sign that the flight from equities seen in the last few years might be going into reverse, as investors draw encouragement from recent events. Aversion to risk since 2008 has seen money ploughed into ‘safe havens’, with the result that shares have become cheap relative to bonds, property and just about anything else.

“Most markets remain rather cheap based on conservative valuation criteria, so any good news results in money coming into equities.”

Jim O’Neill, Chairman, Goldman Sachs Asset Management

Of course, rising share prices is not a fail-safe sign that the economy is in good shape or even on a firm road to recovery, and that is certainly true of the UK. In the western world there is still much to resolve, not least the need for politicians to thrash out a new structure for the eurozone. But given the tens of billions currently invested in perceived ‘safe haven’ assets, any signs that the world’s money managers are concluding that equities are the least-worst asset to own could trigger a significant rally in share prices.

The crystal ball-gazers forecast that the FTSE 100 will finish 2013 anywhere between 6,500 and 7,000. We do not subscribe to an investment strategy based on such speculation, but continue to believe in the key principles of diversification and placing our clients’ money in the hands of investment managers who can identify value opportunities across asset classes and in all market conditions.


New year, new broom

  • Savers and investors should consider maximising use of exemptions and allowances in run-up to tax year-end

Making the most of your annual ISA allowance and keeping an eye on the interest rates you are getting on your cash are just two of the new year resolutions that savers and investors should consider in the period leading up to the end of the tax year in April. Using annual tax exemptions and reliefs can reduce the taxable estate for those concerned about Inheritance Tax liabilities. The annual gifting allowance is £3,000 per tax year for each individual, and if last year’s exemption wasn’t used it can be carried forward for one year. This means a married couple could potentially give away £12,000 before the end of the tax year, perhaps to help provide investment funds for grandchildren’s future. The small gift exemption and the gift allowance in consideration of marriage should also not be overlooked.

The annual Capital Gains Tax (CGT) allowance of £10,600 allows you to minimise the tax paid on assets or investments sold before the end of the tax year. It might also be worth considering transferring assets between spouses to make the most of both reliefs. Putting money into a pension for a non-taxpaying spouse is one of the most tax-efficient ways to save. At the other end of the scale, those with incomes over £150,000 should be aware that the 50% tax relief on pension contributions will disappear at the end of this tax year.

From a wider perspective, we would recommend that investors regularly review their portfolios to understand what impact market movements have had on their asset allocation, to ensure that it still fits their risk profile and objectives. The new year presents just such an opportunity.

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