The Royal Mail float has grabbed market attention

In this week’s bulletin:

  • Uncertainty surrounding the US shutdown puts pressure on equity markets.
  • The longer-term outlook remains upbeat for markets and the global economy.
  • Boardrooms are showing renewed confidence through acquisitions and public offerings.
  • The Royal Mail float has grabbed market attention as a large-scale investment opportunity.

 

At the pier’s brink

Britain’s political party conference season drew to a rain-swept close last week offering a steady patter of policy ideas for austere conditions, notably the government’s accelerated sequel to the mortgage guarantee Help to Buy scheme and Labour’s proposal to freeze energy bills. There were distractions from the deluge, including a punch-up between a spin doctor’s publisher and a protestor on the Brighton seafront and a wronged son and party leader defending the name of his father against a tabloid newspaper’s accusation of nation loathing. Amid the pledges, diversions and talk of the rising tide of economic recovery, British politics looked unable to lift itself beyond its preoccupation with the distribution of wealth rather than address the far more pressing need of how to ensure its creation.

Political concerns in Britain seem parochial, however, compared with the stand-off on the other side of the Atlantic over wealth distribution and public spending. The US government last week began its first partial shutdown in 17 years as Republicans and Democrats failed to agree over whether to link changes to a new healthcare reform package with a short-term extension of government funding. The Republican-dominated House of Representatives has passed a bill funding the government, but stripping the Obamacare health reform of funding, which is unacceptable to the Democrat-controlled Senate. The US is now heading towards reaching its $16.7 trillion statutory debt limit by the middle of the month.

Last week around 800,000 non-essential American public sector workers were sent home, while another 1.3 million are not being paid. Parts of American life will remain at a standstill until Republicans and Democrats reach a deal. A Bloomberg survey of leading economists has estimated that 0.1% will be lost from the fourth-quarter growth rate for each week the government is closed. If the two parties cannot strike a deal by 17 October and raise the US debt ceiling, Congress will have steered the American and the world economy into unchartered and extremely perilous waters.

After all the twitching over Federal Reserve policy and quantitative easing (QE) this year, however, markets have remained composed in recent weeks despite the threat of a fiscal crisis on Capitol Hill. The prevailing wisdom on Wall Street and other world financial centres has been that the shutdown will be temporary and brief, but, as the US approaches its second week of government semi-paralysis, this earlier confidence in the ability of Republicans and Democrats to agree a way through its impasse is beginning to look strained. Concerns are mounting that the two parties will not be able to agree to fund the government before the US Treasury runs out of cash. However, the consensus remains that the brinkmanship will take America to the edge, but a last-minute compromise will be reached in time for the 17 October debt-ceiling deadline.

In New York, the lack of progress on the government shutdown and the US debt-ceiling deadline put pressure on the S&P 500 index, with companies that rely on government contracts particularly hit by the stand-off in Washington. Defence contractor Lockheed Martin’s share price lost 5.6% of its value after it announced thousands of its workers would have to be sent home if the shutdown continues this week. Other US defence-sector suppliers affected included Raytheon (-5.4%), United Technologies (-4.8%) and Northrop Grumman   (-3.2%).

Although the S&P 500 rallied 0.7% on Friday to 1,691 from a 0.9% fall on Thursday that was close to its four-week low, the US equity index was down just 0.1% over the week. The dollar on Thursday dropped to an eight-month low, before rallying the following day by 0.4%. The US government bond market also looked confident despite the gridlock on Capitol Hill with the ten-year Treasury yield rising only 2 basis points to 2.65% on Friday, although it is down from the levels reached in early September prior to the Fed’s decision not to taper its QE programme. With the ten-year Treasury note holding its course, the signal from the US bond market is that a government default is not expected.

The US budget crisis also heightened investor risk in Tokyo with the Nikkei 225 Stock Average index taking its first weekly loss since August, declining 4.98% over the five-day period to settle at 14,024 at close on Friday. In London, the FTSE 100 index continued to lose some of the strong gains it made earlier in the year and was down for a second week, losing 0.9% over the five-day period to close at 6,454, in part, from the ripple effect of the concerns from across the Atlantic. However, the FTSE is 11% up from the start of the year, with retailers such as Dixons and Home Retail Group rallying on signs of increased UK consumer confidence.

European equities also slid over the five-day period, with the FTSEurofirst 300 index sustaining a weekly decline of 0.9% to close at 1,244 on Friday. However, European concerns over the US debt debacle were offset by political developments in Rome last week, which held out some much-needed stability for the eurozone’s third-largest economy. Italian Prime Minister Enrico Letta won a vote of confidence and defeated Silvio Berlusconi’s attempt to bring down his government, while Italy’s Senate voted to recommend expelling Berlusconi from the upper house following his tax fraud conviction. Meanwhile, the European Central Bank left its main interest rate unchanged at 0.5% and said that it was ready to provide cheap loans to banks, through further longer-term refinancing operations.

 

Casualty of jaw?

One of the casualties of the shutdown will be the publication of some of the US government’s economic data that is vital for politicians, markets and central bankers to assess the strength of the US recovery. Last month’s non-farm employment figures were not released as scheduled on Friday, although private sector surveys on manufacturing and service activity indicated relatively encouraging levels of expansion. Moreover, an erosion of economic confidence and growth stemming from the shutdown could also further delay the start of the US Fed’s end to the $85 billion-a-month QE programme.

The continued uncertainty over the debt ceiling, the Fed’s intention for QE and the strength of the economic recovery are likely to weigh on US equities markets. Back in July and August 2011, the debt-ceiling crisis brought a fall in equity prices, which did not recover until towards the end of that year. However, the US benchmark index is up by a strong 15.68% this year and this course should not be dented in the event of an anticipated last-minute compromise. But an inability to strike an agreement by mid-October will bring a very different set of conditions. As specialist European fund manager Stuart Mitchell of S. W. Mitchell Capital observed, the repercussions of a failure on Capitol Hill to reach a compromise is beyond the pale for a world economy finding its feet. “The consequences would be terrible,” said Mitchell.

However if, as markets hope, the brinkmanship does not lead to a US debt crisis, then the economic recovery in the US and elsewhere can continue, at least, with this potential peril circumvented. And the US economy is beginning to go at a clip, expanding much faster than expected in the second quarter at an annualised growth rate of 2.5% that was more than double the pace in the first quarter. Although the shutdown could slow US economic output, evidence is accumulating that the recovery is picking up momentum. US investment bank Goldman Sachs believes that US growth will be at 3% in 2015, ahead of every other advanced economy.

As has been suggested consistently this year, the growth of corporate earnings and the world economy into 2014, together with the support of low interest rates, should provide strong support for equities. And confident businesses will be looking to use their cash stockpiles built up over the lean years, either through dividends or share buy-backs, or merger and acquisition (M&A) activity – as good as any measure of corporate confidence.

 

Animal spirits’

From Wall Street to the City of London, there is a renewed sense of vigour in boardrooms and financial markets whether for M&A, global corporate bond issues or initial public offerings (IPO). Dealogic analysis has identified $865 billion of acquisitions in the US in the first nine months of 2013, which is the highest level since 2008. The third quarter brought M&A activity amounting to $351 billion, including Vodafone’s $130 billion sale of its 45% stake in Verizon Wireless. Dealogic also reports that global corporate bond issues so far this year are at $1.6 trillion, which is the highest since 1995.

IPO activity is on the increase on both sides of the Atlantic with equity markets enjoying strong runs this year. From the point of view of the boardroom, clearly it is a good time now to raise capital. Global IPO activity so far this year is just over $100 billion, according to Dealogic. The level of public offering activity is a fair indicator of the reinvigorated animal spirits for the broad economy and, although this level of activity is behind 2010 and 2011, it reflects confidence of the equity markets and investors. IPOs allow boardrooms to tap into this optimism and generate funds for further business growth.

In Britain, there is an added political dimension this autumn with the government flotation of the Royal Mail, which will value the company for as much as £3.3 billion. In the US, last year’s controversial $16 billion Facebook float has been followed by social media group Twitter looking to raise $1 billion through its flotation in New York over the coming months. And in Europe, Thomson Reuters counted 77 IPOs so far this year of almost $18 billion, amid renewed M&A activity in Europe – most notably US technology leviathan Microsoft swallowing the Finnish telecoms group Nokia for €5.3 billion.

Private equity, after finding its feet again five years on from the financial crisis, has also figured in a number of high-profile listings this year on the London Stock Exchange. These have included estate agent Foxtons’ £390 million launch, private healthcare provider Al Noor Hospital (£221 million), life insurer Partnership Assurance (£558 million), estate agent Countrywide (£224 million) and insurer eSure (£695 million). As business enters the fourth quarter, there is a sense in the City that 2013 will draw in with an upsurge of activity surrounding public offerings – not least from the boost the Royal Mail sale will give to the London Stock Exchange.

 

Returned to senders

The Royal Mail float has unsurprisingly grabbed market attention as a large-scale investment opportunity. Although extra publicity for the float has come in the shape of threatened strike action, there has not been the level of fanfare that accompanied the privatizations of the 1980s, such as the British Gas ‘Ask Sid’ advertising campaign. City analysts expect the shares will be priced at the top end of the 260p to 330p indicative range which would value the company at around £3.3 billion – and there is anticipation that the price could close at 380p when it is announced at the end of the week. Shares will start trading on the London Stock Exchange on 15 October. Panmure Gordon said that the underlying value could be in the region of £4.5 billion.

There are hopes in the City that the largest government flotation for two decades will attract US interest too. However, there are misgivings that the flotation has been rushed at the expense of taxpayers, with this week’s 8 October deadline for retail and institutional applications for the offer considered by many as too soon. The government in the run-up to a general election in 2015 might hope to be able to look back on the privatization and court comparisons with the heady days of the late 1980s. A year is a long time in politics, but, perhaps, next year’s party conference season will brim with talk of an economy that has stepped further away from the brink – and with ideas on how to create wealth for Britain rather than manage its cost of living.

Meanwhile, as long as the polarization of politics continues on the other side of the Atlantic, there is an unwelcome threat to the US and the wider global economic recovery – and investors can expect equity markets to remain volatile. However, with US bond yields holding steady and no signs yet of a sell-off, financial markets remain optimistic that the brinkmanship on Capitol Hill will conclude in time for the mid-October deadline. If and when Washington lawmakers find a way through their impasse later this month, the longer-term outlook remains positive for global financial markets and the world economy.

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