In this week’s bulletin:
- US and UK stock markets register their best start to the year for two decades, shrugging off news of a fourth quarter contraction in US GDP.
- Investors and policymakers need to avoid complacency despite the positive start to the year.
- With the end of the tax year in sight, ‘simply does it’ is the key for tax planning.
‘R’ for recession or recovery?
- US and UK stock markets register their best start to the year for two decades
- Fourth-quarter contraction in US GDP fails to dampen the mood
The upbeat tone of markets continued into February as a rosier picture of the global economy outweighed lingering concerns about corporate earnings, the US debt ceiling and the outlook for the eurozone. The FTSE 100 Index gained 6.4% in January, adding £95 billion to the value of the UK’s top companies, and finished off the week with its biggest daily gain of the month on the back of encouraging global economic data. The index recorded its first close above 6,300 for four and a half years and its best start to the year since 1989. It was a similar story on Wall Street, where the Dow Jones Industrial Average rose above the 14,000 mark for the first time since October 2007 and closed the week up 1.1% at a five-year high, capping its strongest start since 1994.
Markets were buoyed by official data showing that the US economy had added 127,000 more jobs in the final three months of 2012 than had been expected, although the jobless rate inched up to 7.9% from 7.8%. Strange though it may seem, investors took heart from the rise in unemployment, as it reduced fears of an early withdrawal of quantitative easing by the Federal Reserve, given its target of reducing the jobless rate to 6.5%.
The positive mood was such that markets shrugged off news of an unexpected contraction in the US economy in the fourth quarter and dismissed fears that it might be the start of a new recession. US GDP fell 0.1% in the final quarter but the underlying detail was much less downbeat than the headline figure suggested. A massive slump of 22% in defence spending subtracted 1.3% from overall GDP growth and a reduction in inventories had a similarly negative effect. But despite the looming ‘fiscal cliff’ at the end of the year and Superstorm Sandy, consumption growth and business investment both rose. That said, some economists highlighted the risks to growth posed by the debt ceiling and spending cut battles on Capitol Hill and the recent tax increases. Policymakers in the world’s largest economy were also quick to point out that the easing of Europe’s debt crisis and signs of speeding up in Chinese economic expansion were just as important to the broader global recovery.
“At the moment… you see a general financial trend of measured optimism… This is not necessarily matched in the real economic numbers.”
Christine Lagarde, Managing Director, International Monetary Fund
Elsewhere in the world, the sleeping giant that is the Japanese stock market also appears to be getting in on the act. The Nikkei 225 Stock Average rose for a 12th successive week, its best run since 1959, registering a gain of 2.4% to hit a 33-month high. The peripheral European markets have also been flying in recent months, with investors moving back into both equities and debt. Net inflows of private funds into the region were €93 billion in the final four months of 2012, following outflows of €406 billion in the previous eight months. Notwithstanding this improved sentiment towards the eurozone, Spanish stocks slipped at the end of the week after the market regulator lifted a six-month ban on short-selling. The FTSEurofirst 300 Index was marginally down 0.57% on the week, although it did hit a two-year high in the process.
The ‘January effect’
- Investors and policymakers need to avoid complacency despite positive start to the year
- Impact of QE comes under scrutiny
With the US stock market recording its best January performance for nearly two decades and the FTSE 100 Index having its best start to the year since 1989, the statisticians were inevitably prompted to delve into the history books to predict what it might mean for the rest of the year. Variously called the ‘January barometer’ or ‘January effect’, the theory is that as the first month of the year goes, so goes the rest of the year. If history is any guide, and it certainly isn’t always, evidence over the past half century shows that when the US market has risen by more than 5% in January, the whole year has shown double-digit returns in 10 out of 11 occasions. Only the crash of 1987 upset the trend. Similar analysis of the FTSE 100 Index since it started in 1984 shows that the UK market has risen in the first month of the year in 18 out of 30 years. In 80% of those previous occasions the market has continued to rise for the rest of the year. Such prophesies are all very interesting and encouraging but definitely not something on which investors should place all their faith. As Nick Purves of RWC Partners, manager of the St. James’s Place Equity Income fund, recently commented: “We are certainly not off to the races yet.”
Swings in sentiment triggered by ‘crisis looming’ concerns and ‘crisis avoided’ relief dominated market movements last year. Such risk on/risk off amplification has proved a challenge for active investment managers seeking to add value through stock selection, as correlation between stocks remained high and the macroeconomic picture drove market performance. Whilst the correlation has yet to return to its pre-financial crisis level, it has been falling steadily for the last 12 months, presenting a much better sense of target prices and fair value and giving more scope for active managers to outperform.
The view of Robert Farago, head of asset allocation at Schroders, was that last year’s rally was driven by “worries disappearing rather than positive news”, but that “This year, risks are more balanced”. However, it seems obvious that the world economy needs a better catalyst than the absence of imminent danger to propel it into a solid recovery.
Whether or not the positive start to the year is maintained, the more buoyant mood has prompted investment of $16 billion into equity mutual funds in the US in the last three weeks, the most in any three-week period since 2001. In the UK, the Investment Management Association revealed that investment into equities through unit trusts and other vehicles outstripped fixed-income sales for each of the last four months, reversing a trend which has seen fixed-income funds outsell equity funds for the last five years. This in turn has fanned the flames of the debate over whether the ‘great rotation’ from safe-haven assets such as bonds into riskier equities has begun.
So what are the prospects for the rest of the year? The comfort blanket of quantitative easing (QE) has been with us for four years and has become the ‘new normal’, distorting risk and leading recently to a collapse in market volatility. It is this lack of nasty surprises that has encouraged investors back into the market; but the problems of the US debt ceiling and the eurozone have not gone away and investors need to remain alive to the potential for a pull-back or increased volatility if doubts re-emerge. Indeed, increased volatility would be welcomed by those investors who recognise the buying opportunity that it provides. “Buy stocks on weakness, don’t chase strength,” was the advice of Tobias Levkovich at Citigroup.
“We are not forecasting large equity returns, but large enough to justify the volatility risks we see in 2013.”
Richard Lacaille, Chief Investment Officer, State Street Global Advisors
The charge sheet against QE also extends to it being inflationary and storing up problems for the future, as well as having forced down savings rates. In that respect, the Bank of England has admitted that savers forfeited £70 billion of interest between September 2008 and August 2012, while borrowers gained £100 billion. However, low base rates and initiatives such as the Funding for Lending Scheme are also factors at work.
Central bankers have been downgrading the ‘war on inflation’, focusing instead on economic growth and employment. The danger is that they take their eye off the inflation ball just at a time that confidence is starting to seep back into the financial system. The combination of companies, consumers and banks starting to unbatten the hatches and monetary policy being left too loose for too long could put upward pressure on inflation.
The message for investors is to be mindful of the risk of greater volatility and higher inflation ahead and ensure that their portfolios are sufficiently diversified across assets capable of countering the ups and downs of markets and delivering inflation-proofing returns.
Simply does it
- Don’t overlook annual ‘use it or lose it’ tax allowances
- Average pension savings of £36,800 at retirement illustrates missed opportunities
With the end of the tax year in sight, it seems that HM Revenue & Customs’ purge on tax avoidance schemes is having an effect, as accountants report on increased focus by more wealthy individuals on simple tax-planning measures. We have always subscribed to the view that making the most of annual tax allowances and building a balanced portfolio which spreads your money across a range of asset classes are the cornerstones to an effective investment strategy. Maximising use of tax-efficient shelters such as the annual ISA allowance of £11,280 is one obvious way, but it is a ‘use it or lose it’ opportunity, as is the chance for parents and grandparents to contribute up to £3,600 a year into a Junior ISA for under-18s. However, savers’ aversion to risk in recent years resulted in Cash ISAs accounting for 80% of all ISAs opened in the last tax year, compared to 49% when they were first introduced in 1999 (source: HMRC, September 2012). With the best-buy Cash ISA rate recently falling below 3% for the first time since 1999 and currently only two Cash ISA accounts delivering inflation-proofing returns (source: MoneyFacts, January 2013), it seems that many may be wasting this valuable tax-saving opportunity.
Pension contributions remain one of the most tax-efficient investments for most individuals, despite repeated tinkering with the rules by successive governments. The annual allowance for pension savings was £215,000 in April 2006 but is now just £50,000 and will be further reduced to £40,000 next year. For those pre-retirement, the message is a clear one: putting off saving, whether via a pension or an ISA, will ensure that you have a smaller retirement fund. Worryingly, research by NEST, the state-provided default pension scheme, reveals that 7 in 10 private sector workers do not currently pay into a retirement scheme. The average pension pot at retirement is currently just £36,800 (source: Office for National Statistics, February 2013). It is reasonable to assume that most people would prefer to retire on rather more than the income such a fund could provide.
You should however remember that the levels and bases of taxation and reliefs from taxation can change at any time and that the value of any tax relief generally depends on individual circumstances.