Ray Of Sunshine

Posted on: 02 September 2008 by Gareth Hargreaves

Graham Kerner takes stock of the week in finance, including whether property or equities are a better pension bet.

The British summer has not been the only thing hit by heavy clouds; financial markets have been occluded too as we know, but last week there was at least one ray of sunshine to cheer investors.

As The Financial Times explained, fresh signs of the resilience of the US economy offered support to global equity markets and the US dollar, offsetting renewed upward pressure on oil prices.

Behind the optimism lay news that US second-quarter GDP growth was revised sharply upwards, thanks in large to strong export growth. The world's largest economy is thought to have enjoyed a boom-style annualised rate of growth of 3.3 per cent, up from previous estimates of 1.9 per cent and much stronger than analysts had expected.

The news was well received and acted as a catalyst for a rally in share prices which propelled markets higher across the globe, with Japan leading the way - Tokyo ended the week almost 3 per cent higher, breaking its recent poor run.

European bourses enjoyed a fillip too, notwithstanding comments by the ECB governing council suggesting cuts in interest rates were far from being considered, despite the abrupt slowdown in eurozone growth and indications of inflation easing in Germany.

In London the leading blue-chip index maintained its gains, advancing over 2 per cent as investors' risk appetite returned despite the fact that UK economic data was pretty dismal. The Independent reported that retailers delivered their worst performance for nearly a quarter of a century in July, according to data from the CBI, as consumers continued their retrenchment. There was some good news which helped offset this, and downbeat comments from the deputy governor of the Bank of England, Charles Bean, who reckoned the downturn will drag on for some while yet.

The continued drip, drip of poor economic data emanating from Britain has put sterling under pressure and The Financial Times pointed out that the pound has suffered its worst month against the dollar since 1992 - it traded at $1.82 last week, with some analysts predicting it could fall to $1.50 in the coming years.

Whilst recession fears may be growing, there has been one clear benefit for the UK from a weaker currency - exporters are doing well and also maintaining prices, although the latter is one aspect which few businesses are talking about. While import prices are growing so too are export prices, but at a faster rate, as companies earn more in sterling terms from foreign sales where, for example, suppliers who bill customers in euros see little reason to offer a price cut.

Helping Hand?

One of the most obvious casualties of the credit crunch is of course the property market and particularly residential which is close to consumers' hearts, having been seen as a cash machine by many in recent years.

The home of the credit crunch was the US housing market which boomed on the back of cheap lending to all and sundry, but came to an abrupt halt some 18 months ago. However, according to recent data there could be signs that the market may be close to hitting bottom. The Daily Telegraph reported that data from the respected Standard & Poor's/Case-Shiller index showed the fall in house prices slowing to 0.5 per cent between May and June - down from a monthly decline of 2 per cent at the beginning of the year. Although the survey showed a record annual price decline of 15.9 per cent in June, some commentators suggested that the slowdown in the rate of decline could signal that the worst is over for America's ravaged housing market.

Here at home there is little evidence of any let-up, with the Nationwide suggesting that house prices fell 1.2 per cent last month with new mortgage approvals still languishing as lenders continue to apply stricter criteria, effectively shutting out first-time buyers by insisting on a 10 per cent deposit.

Against this difficult backdrop, Britain's lenders have been lobbying the government for months, asking for help to kick-start the mortgage market. The Sunday Times reported that the clamour for assistance is likely to be snubbed by the Treasury though, when a package of measures is announced this week. Intended to stabilise the housing market, it is unlikely to meet key demands from the banks and building societies. The Council of Mortgage Lenders has said that without government intervention in the market for mortgage-backed securities, the lending famine will continue.

Not only are homebuyers and builders suffering but so too are estate agents, according to property website Rightmove, which warned that casualties amongst agents continues to increase. The company added that many sellers are busy reducing prices which should help, although hopes of changes to stamp duty mean many buyers are playing the waiting game.

The only part of the housing market which remains blissfully unaffected, according to The Daily Telegraph, is at the top end, where sales of luxury homes worth more than £10 million have become completely detached, it seems, from the slowdown in the broad market.

Plan Wisely

Staying on the same subject, The Sunday Times discussed whether property can be a pension saviour and concluded that as prices fall investors shouldn't bank on their homes or buy-to-lets to provide a retirement income. Apparently some 5 million people - 10 per cent of British adults - think their home is the only investment they will ever need following a poll commissioned by the paper, with the figure rising to half of all buy-to-let landlords, according to Bradford & Bingley.

Recent price falls, about 11 per cent over the last year, may now disabuse people of the myth that house prices are unlikely to fall, although buy-to-let lending is only down 18 per cent compared to 65 per cent for the whole market - and the IMF expects house prices to drop by at least another 15 per cent in the next two years.

So what's the alternative? Well, the paper pointed out that increasing exposure to equities is a good idea because historical data suggests they are a better long-term investment than property. House prices have grown by 507 per cent over the past 25 years while the UK equity-income sector has returned 1,914 per cent - nearly four times more. The average home in 1983 was worth around £30,000 compared to around £180,000 today, but if the same amount had been invested in equities it would be worth £604,000, providing an annuity of £42,400 per year compared to £12,600 for the property investor.

Income Counts

The performance of income funds was also highlighted by The Daily Telegraph which said that in times of crisis, lower share prices can yield big rewards and UK equity income funds had a track record of holding their own in difficult conditions. Even though share prices may fall, dividends historically have grown at a faster rate than inflation and therefore maintained their real value for investor.

The top performing fund manager in this sector is Neil Woodford of Invesco Perpetual, who manages funds for St. James's Place and he is currently very positive on the outlook for UK equities. The question of dividends was also discussed in The Times and the fact that in difficult economic times some companies might have to cut dividends, so the best strategy was to stick with bigger companies, a view held by the likes of Neil Woodford.

The papers also reminded their readers that the best investment profits often come to those who are brave enough to turn against the herd, even though it feels unnatural to, and buy when others are selling. Another sensible tip was to reduce timing risks - being over-optimistic and possibly buying too soon - by phasing or drip-feeding money into your chosen investments over a period of time.

Patience Is A Virtue

Cato Stonex has been through many bear markets and despite the poor economic environment, is currently taking a sanguine view of events.

"When financial markets are volatile it clouds investors' outlook and judgement, but at the end of the day, one needs to remain focused on the one simple fact of investing: that it's all about economic activity - the global economy. Over recent years the potential market size has grown from 1.2 billion to 4 billion people - in other words developing markets have opened up huge opportunities by creating a bigger cake for commerce."

"This had led to increased economic activity coupled with major changes in technology, but in capital terms investors have made little progress in developed equities over the last ten years. In other words, the huge increase in corporate earnings is not reflected in current valuations where prices have been hurt by huge problems in the credit markets. But I take the view that equities are not the cause of current problems so why should investors be scared? Equities offer very good value at current levels and ultimately this will be recognised, leading to sharply higher prices."

"Of course there are problems - in the West the consumer is over-stretched and it will take time for credit issues to be resolved, but it will happen. The last credit crisis took around eighteen months before confidence was restored to financial markets and on that basis we're over half way through."

"There are some indications that things are improving - the rate of house price falls in the US has steadied and there is increased turnover in housing stocks. Employment has enjoyed a fifteen year growth trend and I don't see huge a increase in unemployment."

"Along with the US, Europe is doing better, although there are exceptions like Spain, but generally economies are coming through the crisis."

"There is no quick fix to the current situation and in the interim we are being handsomely rewarded by dividends - equity yields are historically high at present and the portfolio yields c3.5 per cent which is a good return whilst we wait for markets to pick up."

"Within the portfolio we hedged around 40 per cent of the European portfolio against the pound to lock in some of our profits and we might do more. We continue to build our holding in Financials which account for about 20 per cent of the portfolio where we believe there is huge value and after falling so significantly are likely to rally sharply when investors' appetite for risk returns. Commodities have come off, along with the Chinese stock market which itself has fallen 65 per cent this year, reflecting the likelihood of slightly slower growth in the economy."

"So where we are today is that we remain very positive about the markets for several reasons, not just valuations but also the pent up demand from the commodity-rich countries who have huge reserves which have to be invested somewhere. The danger for any investor is that they wait until it becomes obvious that recovery is underway - if you do that then you'll have missed the main opportunity because markets will have long since moved ahead."

Cato Stonex is a principal of THS Partners, who manage funds for St. James's Place.

1st September 2008

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