Midsummer money moodsPosted on: 30 June 2009 by Gareth Hargreaves
After the solstice comes midsummer and amidst the heat, markets meandered last week, with little real direction for either equities or indeed, other parts of the financial markets.
In the last few weeks most of the major indices have drifted backwards a little as investors wait for more green shoots to support the view that the worst of the global slowdown is now over and that the eagerly awaited recovery is underway.
Indeed, policymakers appear increasingly confident that this is so – last week President Obama ruled out the need for a third fiscal package to revive the American economy even though he believes unemployment will rise above 10%.
Coinciding with news that the US housing market showed a rise in existing home sales for a second month in a row, he said it was “important to see how the economy evolves and how effective” the $787bn stimulus package, passed in February, was. And on the monetary policy front, the US Federal Reserve sought to dampen expectations of an early rise in US interest rates, saying it was in no hurry to tighten its current policy bias towards easing.
The move helped bond prices rise causing yields to fall back from recent highs as investors’ fears were allayed. With the Fed also leaving its quantitative easing policy unchanged, all eyes turned to the eurozone where the European Central Bank (ECB) pumped hundreds of billions of Euros into the region’s weakened banking system, making record amounts of emergency finance available in a bid to unlock credit markets and revive the eurozone’s economies.
In a dramatic step, dubbed ‘stimulus by stealth’ in the financial markets, the ECB lent €442bn for twelve months to more than 1,100 banks at its current benchmark interest rate of 1%. The Bank’s action could boost recovery prospects by lowering market interest rates and creating more scope for banks to lend to the private sector. The Financial Times commented that the central banks’ combined actions had sent a message not only that systemic risks had not yet disappeared or that recovery was guaranteed, but also that further financial stabilisation and recovery efforts were needed.
This last point was highlighted in the Bank of England’s half-yearly Financial Stability Report which alluded to the continued fragile state of Britain’s banks, saying “Banks inevitably remain vulnerable . . . and will remain sensitive to further shocks for some time. If recovery were to stall as a result of weak bank lending, losses on assets could rise, further affecting confidence in the banking sector.”
Whilst the OECD said that the recession will end this year and that the economy may well endure a bout of stagnation by failing to grow at all next year, the outlook for property suddenly appears a lot brighter it seems.
According to The Times, the view in the City is that the housing market slump is close to ending, with prices set to bottom out later this year and begin rising again thereafter, albeit very slowly. With the average house price having fallen around a fifth, a growing majority of economists polled by Reuters are calling the end of the housing crash.
“We will get a few more month-on-month negatives, but it is pretty flat from here” was the view of BNP Paribas. Both the Nationwide and Halifax price indices reported rises in April and May, although their early indications are that prices fell marginally this month as rising mortgage rates made it difficult for cash-strapped first-time buyers to secure home loans, according to property specialist Rightmove.
Official figures from the UK Land Registry did support the view though that prices are stabilising – despite falling 0.2% overall in May, house prices rose in half the regions in England and Wales, and the fall was the smallest since the previous February.
Alongside this, fewer homeowners are expected to face repossession this year than had been feared because there is less pressure on people struggling with mortgage payments, according to a forecast from the Council of Mortgage Lenders.
Whilst the CML has revised down its estimates for defaults, The Times pointed out that even the rich are at risk, citing what is likely to be the UK’s most expensive repossession – a £20m mansion in Mayfair which is due to be sold by sealed bid in July. Over in the commercial property sector there are signs emerging that the sector is also over the worst and there is value to be found.
According to The Financial Times, fund managers are gradually more confident that prices are now close to the bottom and some are starting to pick up opportunities where they can.
Whilst the developed economies of the West are still struggling, the dynamism of the world’s largest emerging economy, China, continues apace. Of course, global growth is not exclusive to China – the other BRIC economies of Brazil, Russia and India will all grow strongly this year, but China will lead the way with GDP expanding by 8% this year after stalling at the beginning of the year.
But its regional neighbour India is also trailblazing, as The Financial Times pointed out, with the country’s corporate sector hailed as one of the most dynamic of the emerging market world. Of course, high growth also means an increased appetite for raw materials and energy, so requiring new lines of supply.
Last week, China’s rush to secure Middle-eastern and African energy supplies intensified as Sinopec, its state controlled oil refiner, sealed a £4.4bn takeover of the British-listed Addax Petroleum. The deal will give the Chinese group access to oilfields in northern Iraq, Nigeria and Gabon.
And the extraordinary opportunities in the world’s fastest expanding economy have not been lost on investors who continue to drive up not only the Shanghai Composite index, but also other markets in the region. Whilst most major indices fell back last week, shares in Shanghai hit their highest level for a year, with the market up some 80% from its March lows.
Capturing growth from the world’s emerging markets can be achieved in a number of ways. Firstly, by investing directly in a country’s shares – this can be very difficult in the case of China and India for example, where restrictions on foreign buyers exist and also where corporate governance is not as robust as in Western markets, meaning more risk.
The other way is for investors to buy into international companies who derive a meaningful part of their revenue from the developing economies – this approach is popular with professional investors such as Bernie Horne of Polaris, based in the US. “In general my investment philosophy adheres to a bottom-up stock picking discipline whereby opportunities are identified amongst companies where their share price offers best value.
So if emerging markets are good value, my process will identify these and in all likelihood, the portfolio would be invested there. Also, to the extent that the companies I’ve identified as best value are not in emerging markets but whose cash flow and value benefits from emerging market growth, the portfolio will gain exposure this way.
Currently the portfolio is invested in both types of emerging market exposure but in fact; investment results last year were less than optimal. Emerging market exposure and the reduction in growth among our material and industrial investments affected performance as general economic growth declined, including those in emerging markets. But currently I own a number of companies within the portfolio which are direct emerging market participants. In South Korea I own Samsung Electronics, which is a vertically integrated business involved in microprocessors to consumer electronics, and SK Telecommunications.
Sasol Ltd. is a South African based coal to liquids manufacturer and Thai Oil is the largest oil refiner in Thailand. Our exposure to the material sector benefits from the increasing appetite for raw materials in these markets and the portfolio includes Methanex Corporation, a methanol producer; copper producer Metorex and Australian miner BHP Billiton.
Our exposure to the shipping industry benefits from increased global trade as these markets slowly integrate with the rest of the world, so here I own Nippon YKK and Iino Kaiun Kashai of Japan and Eitzen & Co from Norway. Many of the industrial names have emerging markets as a key focus and have been significantly increasing their sales in that region and include the likes of Trevi Finanziaria Spa which is involved in foundation engineering. Andritz AG of Austria makes machines to produce pulp, hydroelectric power, steel, aluminium and waste treatment machines. So whilst you might immediately look at the portfolio and think it is not orientated towards emerging markets, the reality is quite different.”
This year investors have endured significant volatility in financial markets and, whilst the recent strong rally that started in March has repaired some of the damage, investors need to continue to focus on the longer term – a point discussed by TheSunday Times.
The paper took the opportunity to remind its readers that investing in equities is a long term strategy and despite what’s happened in recent years, shares historically have done better than cash. The Barclays Equity Gilt Study, which collates returns going back to 1899, shows shares returning 4.9% a year compared to 1.2% and 1% for gilts and cash respectively. Obviously, people invest for shorter periods and over rolling 10-year periods since 1908 shares have outperformed 70% of the time. So are the recent falls in global equities meaningful?
"The equity markets reacted strongly to the recent emergence of green shoots in the global economy. They are now taking a reality check. Long-term investors in equities should hold their nerve since this is a temporary adjustment in a longer-term rally. Equities will continue to rise, but there needs to be stronger evidence – both in company earnings and economic data - that the green shoots are going to blossom into a sustained recovery” was the view of Rupert Robinson, CEO of Schroders Private Bank.
The paper also reminded investors that it makes sense to spread your portfolio across other assets too, such as corporate bonds and commercial property, which tend to perform well at different stages of the economic recovery.
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