In this week’s bulletin:
- The developed economies and equity markets are showing renewed optimism
- The Vodafone and Microsoft deals are a boost for global M&A and equity markets
- Mark Carney’s forward guidance policy on interest rates does not convince markets
- The breeze is fair for the UK economy but it has not yet stirred for Britain’s cash savers.
Leap of faith
When BBC Radio 4’s religious slot, Thought for the Day, leads on a reflection on the latest signs of economic recovery in the UK, there is reason to conclude that the great British turnaround has become an article of faith – even if it has at times looked like it has come in on a wing and a prayer. Five years on from the collapse of Lehman Brothers in September 2008, having passed through financial crises, bailouts, credit crunches and the worst global recession since the late 1920s, the world’s developed economies are regrouping. Global equity markets, too, are reflecting renewed optimism, even if uncertainty over Washington’s timing of an intervention in Syria and a withdrawal from loose monetary policy threaten short-term squalls.
Global economic recovery is not a question of belief but, as we have consistently pointed out through the year, an observable phenomenon shown in a steady, if slow, procession of statistical evidence from America and Britain, as well as Europe and Japan. That was also the outline of Britain’s progress delivered by George Osborne during a speech in London on Monday ahead of the political conference season. The developed economies’ gradual pullback from recession has come, however, with a stronger-than-expected jolt of emerging markets into an uncomfortable financial and economic zone. But the economic turnaround, if tentative, is good for all financial markets and investors, for global wealth creation and prosperity.
Certainly, there are many who still contend that this is the wrong sort of recovery or not a good thing for investors. Some will not even concede the fact that it is underway at all. But, in the meantime, August brought further flows of investors back into the developed markets as the world waited for Washington to start to end its $85 billion-a-month bond-purchase scheme. And a steady stream of sometimes mixed but overall positive economic data points to a return to more normal monetary policy that will allow financial markets and investors to get on with the task of creating wealth.
There are trials along the way, with some of last week’s data – in particular the slower-than-forecast growth of US jobs – not strong enough for markets that have priced in an announcement later this month by the US Federal Reserve of a tapering of quantitative easing. The major stock markets in August lost some of the gains made earlier in 2013. The emerging market sell-off continues to cause problems for those who sought higher-yield alternatives in the era of easy money since 2008; and for developing nations that have become reliant on cheap dollars. And the prospect of a Western strike on Syria raises the risk of bringing further short-term volatility to stock markets and world oil prices.
On the world’s leading stock exchanges, however, overall optimism for the global economy and markets outweighed pessimism surrounding the anticipated US move in the Middle East and other factors. Moreover, the disappointing US employment figures for August eased concerns among many over the impact the Fed’s tapering of monetary policy will have on valuations. Equities in all of the major financial centres strengthened over the five-day period, while benchmark borrowing costs slipped from two-year highs amid the reduced expectation of this shift in US monetary policy this month – and the return of major merger and acquisition (M&A) activity in the global telecoms sector.
In the US, the S&P 500 index closed on Friday at 1,655 points, gaining 1.63% over the week, redressing losses the previous week on uncertainty surrounding US foreign and monetary policy. Homebuilder, automotive and technology stocks recorded strong gains over the week’s trading on Wall Street. In the City of London, the FTSE 100 index ended the week at 6,547 points, a 0.23% gain during Friday trading and a 2.10% rise over the week, which was marked by Vodafone’s $130 billion (£84 billion) deal with Verizon. European equities also performed well with the FTSEurofirst 300 index up 2.92% over the week to 1,230 points, backed by stronger-than-expected industrial data for car manufacturers and Nokia’s €5.4 billion sale of its handset business to US giant Microsoft. In Asia, the Nikkei 225 Stock Average fell 1.5% on Friday to 13,861 as investors awaited the final decision on a tax rise that some fear could halt the recovery of Japan’s moribund economy.
The Vodafone and Microsoft deals have both been keenly anticipated and are a welcome break in a slump in global M&A activity this year as cash-rich companies sit tight amid global financial and economic uncertainties. Vodafone’s move to offload its 45% stake in its US mobile phone business is one of the largest in corporate history, although it does not surpass its €166.6 billion purchase of German group Mannesmann in 1999. The Nokia sale follows some difficult recent years for the Finnish group, whose market capitalisation has shrunk from €200 billion to €15 billion in a decade. Both deals are a boost for markets and investors, if not for the UK Exchequer which will not receive any tax on the profit. (The US Treasury, however, will net $5 billion.)
Richard Peirson of AXA Framlington holds Vodafone across his portfolios and believes that the Vodafone price and the lower tax bill looked good for shareholders. The deal was expected for some time and was a large part of the investment case supporting AXA’s shareholding. “There will be regulatory hurdles to clear but they should not be insurmountable,” adds Peirson. “The amount of cash that finally flows back into UK equities will also provide a useful support for the UK equity market.”
Netherlands-incorporated Verizon has paid through a combination of shares, £38 billion in cash, £2.3 billion from its 23% stake in Vodafone Italy, £3.2 billion of loan notes and £1.6 billion in liabilities associated with Vodafone’s US group. Verizon this week launched a potentially record $20 billion corporate debt sale to help fund the acquisition. Ian Lance of RWC Partners also holds Vodafone stock across his portfolios and says the deal reflects the growth and profitability of the US mobile market. “Time will tell whether Vodafone is exiting close to the peak of the market,” says Lance. “But, for the moment, it has realised the value in the stock that many were looking for.”
Vodafone is also a significant component of many equity funds, and around half a million UK investors are expected to benefit from Vodafone chief executive Vittorio Colao’s decision. Vodafone will return £54 billion to shareholders, of which £22 billion is destined for UK investors. The deal is equivalent to 112p per share. The payout to UK shareholders is expected in March 2014, following a shareholder update in December.
Vodafone said it plans to use the profit, in part, to invest in in its high-speed mobile phone networks. A £6 billion investment plan will accelerate the introduction of 4G networks and investment in laying fibre-optic cables. The UK group plans its five main European markets to have almost complete 4G coverage by 2017.
The deal will also leave Vodafone with the balance sheet power potentially to acquire other assets, says the investment team at Majedie Asset Management. “European operators are trading at very depressed valuations,” Majedie notes. “We view this as a good result for Vodafone, and continue to find many attractive stocks among the European telecoms sector.”
Vodafone may even become an acquisition target with Majedie and AXA noting that US rival AT&T has made no secret of its interest in Europe. Peirson believes that the rump of the Vodafone business remains at a value that could attract further M&A interest from AT&T. “This is unlikely in the short term, at least until the Verizon offer has completed, but will support the Vodafone price in the meantime,” adds Peirson.
Carney: Be calm
Mark Carney’s forward guidance policy on interest rates will come under scrutiny again this week when the Office for National Statistics publishes its latest labour market statistics. As we have highlighted over the last month, the Bank of England governor has turned official unemployment data into the tiller for the shared path of the UK economy and financial markets. Carney last month pledged not to raise interest rates until the number of Britain’s out of work falls below 7%, which the Bank does not expect until mid-2016.
Markets continue to disagree with this guidance and are pricing for a rise in the Bank’s base rate as early as the end of 2014. Some analysts think the UK’s 7.8% unemployment rate is inching nearer to the Bank’s guidance threshold. A fall in Britain’s 2.51 million unemployment level could stir further hopes of an early interest rate rise. Carney has pledged more monetary stimulus if interest rates continue to rise and threaten the recovery.
While the Bank and the City differ, Britain’s recovery is ahead of the other G7 economies with the OECD expecting the UK to expand by an annualised 3.5% in the second half of the year. Recent official statistics are also identifying improvement for long-suffering areas such as manufacturing, with output up 0.2% in July, which is adding to the sense that there is balance to the recovery as it gathers pace. The National Institute of Economic and Social Research also reported that Britain’s economy is growing at its fastest rate since the summer of 2010, although it noted slow demand from the eurozone area and emerging markets.
Business surveys are identifying, however, that companies have not expanded staff and that growth is coming from higher productivity. Opinion is divided over when growth will create more jobs, a crucial indicator now for UK investors. But the development addresses lingering problems over UK productivity which is a good indicator of the confidence that has gripped the UK economy as it has its financial markets. (Last week, for example, after the Bank’s monthly policy meeting held to its course, ten-year gilts rose briefly above 3% for the first time since July 2011.) The winds of change are gathering even if not all agree on the speed of the clip.
The breeze may be fair for the British economy and capital markets, but it has not yet stirred for Britain’s cash savers. Carney’s stance that interest rates will stay low at least until 2016 – caveats and market hopes not withstanding – means deposits could face another three years of standstill and gradual erosion by inflation.
The stark reality for savers is that interest rates have remained at 0.5% since 2009, while inflation is at 2.8%. However, for a basic rate taxpayer a savings account needs to offer a 3.5% return to outstrip inflation. And, for higher rate taxpayers, the threshold rises to 4.66%. Furthermore, out of more than 800 accounts in the marketplace only two provide a positive return after tax and inflation, according to Moneyfacts.
With cash under sustained pressure, there are no risk-free options for investors. Government bond returns have been lower than inflation. Asset classes such as equities or property, however, offer potential growth alongside risk to combat inflation. Diversification of investments across and within asset classes is one approach to help offset risk – and possibly turn inflation into a potential investment opportunity.