A Brighter Outlook

Posted on: 04 June 2008 by Gareth Hargreaves

This week's finance news including house prices and interest rates, with Graham Kerner.

In the midst of a weak housing market, declining consumer demand and the well-documented banking crisis, figures released last week shows that the US economy performed better in the first few months of 2008 than initially thought.

The Commerce Department confirmed that the economy grew at an annual rate of 0.9% between January and March, up from a previous estimate of 0.6% growth.

The upward revision in GDP growth was driven by a fall in demand for imports and by healthy construction spending on commercial property.

In contrast, consumer spending, which accounts for two-thirds of overall output, is now at its lowest level in seven years.

Although some commentators argue that the US economy is already in recession, this latest boost followed recent figures showing orders of durable goods to be healthier than expected.

New orders for manufactured goods fell by 0.5% last month, but this represented half the 1% decline that had been expected.

Economists said they were encouraged by signs that growth was more balanced than first thought, with exports up 2.8% over the period.

The National Association of Business Economics is forecasting annualised growth of just 0.4% in the second quarter, although it expects growth to pick up to 2.2% in the third quarter.

This reflects the likelihood that the aggressive interest rate policy adopted by the US Federal Reserve and the tax rebates of billions of dollars given to families by the Bush administration is unlikely to impact on consumers’ willingness to spend until later in the year.

On the other side of the globe, the Indian economy was also looking up as it grew by a faster than expected 8.8% from January to March compared with a year earlier.

The growth was driven by a strong performance from the service and construction sectors.

Growth is expected to continue to slow this year, but will remain higher than most other economies in the world.

House Price Slowdown Confirmed

The Financial Times carried the news that the continuing slowdown of house prices in England and Wales has been confirmed by figures from the Land Registry.

It said property prices fell by 0.2% during April, taking the average house price to £183,626.

That drop meant that the annual rate of house price inflation fell again, from 3.6% to 2.7%.

It was the eighth month in a row during which annual property inflation has fallen, though the decline has not been as fast as suggested by other surveys.

"This latest movement continues to point towards a weakening housing market," said the Land Registry.

Many other reports, from lenders such as the Halifax and Nationwide, and also from surveyors, have claimed that prices have fallen so fast that they are now lower than they were a year ago.

On Thursday, Nationwide said prices were now 4.4% down on May last year and had dropped at a record rate.

However, the Land Registry survey, which covers all completed property sales and not just those of particular lenders, suggests that point has not yet been reached in England and Wales.

The mortgage market continues to be volatile, as lenders launch and then withdraw their latest deals at a rapid rate, often within two weeks of their being launched.

From next Monday the UK's biggest lender, the Halifax, is shaving an average of 0.3% from its various fixed rate mortgage offers.

By contrast, earlier this week the Abbey raised some of its rates, reversing cuts announced only two weeks ago.

What does seem certain is that after many years of consistent increases, homeowners will have to get used to the prospect of falling values, as Ian Cowie commented in The Daily Telegraph: “My home is my pension”.

But that always begged the question: "So where will you live when you retire, then?”

Rates To Remain The Same

The Independent on Sunday highlighted City economists’ predictions that the Bank of England (BoE) will keep interest rates on hold at 5% when its Monetary Policy Committee meets on Thursday.

As inflation continues to rise, home-owners are likely to get little respite from high borrowing costs.

Expectations are that inflation will rise above 3% in the next month, compelling the Governor, Mervyn King, to write a letter of explanation to the Chancellor.

The Mail on Sunday described the current situation facing the BoE as a “really horrible mixture” - reducing rates would help stave off a full-blown recession while increasing them would ease the inflation picture.

The City is encouraging the BoE to take a long-term view, in the belief that cutting rates now will lead to a much worse inflation problem in the next few years.

Indeed, there were calls last week for rates to be raised – the chief executive of HSBC bank saying that: “Inflation is a long-term problem because there is no long-term will to solve it.”

Turning Bad News Into Good

In recent days the press has made much of the opportunities offered to investors by the current market turbulence and economic outlook.

The Financial Times observed that some UK fund managers are adapting their portfolios to take advantage of rising gas prices.

With energy bills set to rise still further, the potential investment gains from energy stocks could offer a way for private investors to hedge against inflation.

British Energy was cited as a case in point, a stock much favoured by Neil Woodford of Invesco Perpetual, who manages funds for St. James’s Place.

Centrica was also highlighted – the value of these stocks currently reflects a focus on the short-term impact of rising wholesale gas prices, but over the longer term these costs will be passed onto the consumer, leaving these companies in a very strong position to benefit from high fuel prices.

The Sunday Telegraph focused on the opportunities for income investors and the logic for maintaining a diversified portfolio that contains cash, fixed-interest securities and income-producing equities and property.

The doom and gloom in the markets has meant that entire asset classes have been savagely marked down over the last few months, often by 50% or more.

As a result, income levels from these assets have risen sharply.

Whilst recognising the downside risk of both further capital losses and a reduction in income if the economy suffers further, the article highlighted commercial property, small company shares and financial sector corporate bonds as offering attractive income levels and scope for capital growth when the economy recovers.

In contrast to the long-term view, The Sunday Telegraph reported that City traders are targeting high street store chains as they are confident that there is more bad news to come.

Short sellers have staked nearly £6 billion on the share prices of 21 retailers in the FTSE 350 being pushed down by disappointing news.

These include Marks and Spencer, Tesco andNext. This means that short sellers now hold 8% of all shares in the retail sector.

But the article went on to suggest that some analysts believe the shorting bonanza in the retail sector could be about to come to an end.

Morgan Stanley believes that retailers are approaching a “trough” and that shares could soon start to rise and recover.

The sector is at a 30-year low against reported earnings and offers an average dividend of 5.3%, the highest since 1981.

After several years of lagging the rest of the developed world, Japanese equities rose by 3.5% in May – the second successive monthly advance, to close at its highest level since 10th January.

The market has been lifted by a more positive earning outlook from Japanese companies and by the weaker tone of the yen against the dollar, supporting those managers who view Japan as an attractive investment opportunity.

Contrarian Approach

In a feature on fund managers who don’t follow the pack, The Sunday Times highlighted some of those with a “contrarian” approach to investing – in essence, identifying unloved stocks and having the courage to stick with them.

The article went on to say that some of the most well- known fund managers, including Neil Woodford of Invesco Perpetual, have a contrarian style at the core of their investment process.

The article also highlighted that some of these managers believe that now is the time to move into financial companies such as banks and insurance companies, which have been the main sufferers from the credit crisis, and away from commodities which have seen five years of strong returns.

In a similar vein, The Mail on Sunday reminded readers that even the country’s most renowned fund managers have suffered periods of underperformance before atoning with a spell of sustained market outperformance.

That is where monitoring of managers, coupled with a long-term view is so important. Again, Neil Woodford was mentioned as probably the one star manager to have kept his reputation intact throughout the credit crunch, largely due to his early decision to steer clear of most financial stocks.

3rd June 2008

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