Renewed optimism in the economyPosted on: 16 June 2009 by Gareth Hargreaves
Graham Kerner digests a broadly optimistic week in the press, with mixed contributions from politicians, economists and investors about whether the economy had reached a nadir and was indeed exhibiting more durable signals of recovery.
Unemployment in the US rose to 9.4% in May, but the cut of 345,000 jobs in non-farm payroll employees was the smallest reduction in over eight months and significantly lower than expected. In Europe the last few weeks have provided further evidence that the economy is improving, with the UK and Italy increasing industrial output for the first time in over a year.
The Financial Times led with the strengthening of Sterling. The pound has surged to its highest level this year against the world’s major currencies, propelled by renewed investor confidence and stands around 14 per cent higher year to date.
Despite this, the US & UK markets ended the week on a rather downbeat note. The US market was down marginally on Friday as investors spent most of the trading week nervously observing developments in the Treasury market as bond yields rose sharply. The yield on the 10-year Treasury bond exceeded 4% for a period, driving mortgage rates higher as investors revealed their concern over the huge amount of issuance required to fund the US budget deficit. Concerns over inflation contributed to the FTSE 100 index closing down marginally on the week below the psychological 4,500 barrier at 4441.95.
Weaker commodity prices were a factor as a 3% fall in the price of copper impacted on mining stocks which made up around half of the top fallers on the week. Vedanta Resources suffered from a negative reaction to its bond issuance as part of its plan to finance possible acquisitions and to increase its stakes in subsidiaries. Rio Tinto and BHP Billiton also suffered falls towards the end of the week.
Asian markets displayed greater strength with the Japanese Nikkei 225 rallying and was up three and one quarter percent on the week, closing above 10,000 for the first time since October. Across the region, markets rose for a fourth successive week.
European bourses also faired slightly better on the back of a strong week for the pharmaceutical sector, favoured for their defensive qualities and both GlaxoSmithKline and AstraZeneca experienced improved demand with the shares closing up on the week.
A Run On The Banks
A number of major US financial firms began repaying debt to the US Treasury last week signalling that the health of the sector was improving to a degree. The Economist reported that it was a significant milestone when the US Treasury allowed ten financial companies to repay a combined total of $68 billion in loans they had received under the Troubled Asset Relief Programme (TARP). They included JP Morgan Chase, Goldman Sachs, Morgan Stanley and American Express.
The US Treasury Secretary, Timothy Geithner, viewed the repayments as an encouraging signal but warned that the crisis in the banking industry was not over yet. In the UK, Lloyds Banking Group repaid £2.3bn of the money it had received from the Government after raising funds through an open offer of shares. Lloyds also featured in the press over the closure of its Cheltenham & Gloucester branded bank branches which resulted in over 1,600 job losses.
The closures form part of its continued restructuring process. Lloyds posted a marginal gain on the week and The Financial Times reported that the improved outlook is causing private investors to flock back to banking stocks, creating a new meaning to the phrase ‘run on the banks’. Investors enticed by the near 100% rise in the shares of Lloyds Banking Group over the last three months believe that the bank has past the worst and could benefit if the housing market continues to improve given its market share in the mortgage market. The sector is not without risk, as a number of managers have highlighted recently. Neil Woodford of Invesco Perpetual still sees a lack of visibility in the sector, but others such as George Luckraft of AXA Framlington and Nick Purves of Schroders feel there are opportunities in the banking sector.
Economic Growth - Is The Recession Over?
Larry Fink, founder and chief executive of Blackrock told The Financial Times last week ‘Armageddon is behind us’ following the deal to buy BGI, making the US firm the largest money manager in the world. His optimistic perspective is not in the minority with more and more anecdotal evidence signalling economic recovery. Finance ministers at a recent G8 meeting were urging the world to address loose fiscal and monetary policies. The UK has seen carmakers restarting production lines and hiring staff while Germany’s engineering conglomerate, Siemens, has ended a mandatory four day week at its plant in Congleton. There is still an air of caution in relation to bank lending capacity and Chancellor of the Exchequer,
Alistair Darling recently told his counterparts in Europe that efforts need to be redoubled to ensure that the banking crisis is fully resolved. Some manufacturers also argue that the upturn is a reflection of new orders and that further evidence is required to support a sustained recovery.
Ian McVeigh of Jupiter Asset Management, lead manager for the St. James’s Place Cautious portfolios recently stated “Cash piles are very high, while the return on low-risk assets, whether cash or government bonds, is extremely low. We are already seeing evidence that investors are prepared to embrace a bit more risk as they look for higher returns. We therefore believe the UK equity market will continue to make progress for the rest of 2009.
Whilst the widespread global plunge in credit availability and economic activity continues to weigh on global trade we remain focused on identifying world beating companies which have strong business models with differentiated products and services that have a reasonable expectation of structural demand growth. Eastern European markets have performed well in recent months but we believe that there is room for this to continue as valuations are still extremely attractive given the opportunities for companies to grow earnings in the medium term. The global outlook has become healthier, and while growth may remain weak in the short term, some leading indicators suggest that the sharpest stage of the slowdown may be behind us.”
Renewed confidence is also apparent in the beleaguered property market with The Sunday Times quoting a number of experts arguing that house price falls could be ending. Capital Economics improved its forecast for the UK housing market for 2009 and 2010, citing falls of around 15% over the next year or so from previous predictions of around 30%. Lloyds Banking group were even more optimistic and mortgage broker John Charcol believes that prices could be rising as early as the end of this year.
The Financial Times highlighted the tangible improvements in the prime market of Central London with clients paying prices of up to £3,000 per square foot for properties in Chelsea and Knightsbridge, only a shade lower than prices being paid at the top of the market in 2007. The Financial Times House Prices index also showed clear signs that the pace at which prices are falling in England and Wales is slowing significantly, around a third of the pace of decline seen at the height of the credit crunch last November. In the broader market however, the concern lies in the first time buyer market where the availability of loans to those without a large deposit has slumped by 97% over the last couple of years.
The Guardian reported that around two thirds of first time buyers are likely to see loan applications rejected as a result of more stringent lending criteria. Despite the Council of Mortgage Lenders showing a rise in new borrowers in April, the numbers remain historically low and the experts argue that the market cannot recover fully until first time buyers can find loans.
The Financial Times reported that the prospects for property investors are brightening following sharp price falls and a more recent stabilisation of rents following months of sharp decreases. The paper warns, however, of the hidden costs in managing a property portfolio which erode the real income streams. While yields ranging from 5-7% are enticing for investors seeking a more attractive income than bank deposit rates, they need to be alert to the costs involved such as agent fees, maintenance costs, insurance and income tax liabilities. Specialist agents confirm that letting costs often shave between 1-1.5% off the gross yield assuming the property is fully let. Void periods can have a disastrous effect.
Mortgage Rates & Corporate Bonds
The Sunday Times led with the impact of an economic recovery on the mortgage market. The paper opined that banks and other lenders are aiming to boost margins by keeping deposit rates low and increasing fixed rate deals as the economic outlook improves. The cost of funding has anticipated base rate increases in 2010 and the paper highlighted the impact that rising rates could have on investors who have sought more attractive income streams in the Corporate Bond market place.
Paul Read of Invesco Perpetual manages the St. James’s Place Corporate Bond funds with colleague Paul Causer. In a recent report he highlighted the activity undertaken across the portfolios to reduce these risks by reducing exposure to Government debt and focussing those areas where the yield spread is still wide and the potential for capital appreciation is strong in the face of rising interest rates.
Keeping An Eye On Your Affairs
In other news The Sunday Times touched on recent action by HMRC to catch out individuals looking to change their residence status to avoid the new 50% top rate of income tax. Individuals can claim to be non-resident if they spend fewer than 90 days of the year in Britain leading to income tax and capital gains tax savings on foreign income and gains after a period of time. HMRC plan to charge full UK tax to individuals who are deemed to have strong associations with Britain, such as a club membership. The Sunday Telegraph led with a wake up call for sleepy savers encouraging depositors to shop around for the best rates as banks and building societies continue to offer paltry returns on savings. Investors Chronicle recently highlighted the difficulty of selecting skilled investment managers when basing decisions using past performance alone – citing the chance of selecting the right manager at less than 1%.
The Sunday Telegraph reminded investors about the penalty free exit window available on many With Profit vehicles. The article reported that around 300,000 policyholders may be able to use a ‘spot’ guarantee to cancel their policy without being penalised by a market value adjustment/reduction which can be as high as 20% of the fund value. All of these articles highlight the need to deal with an experienced financial adviser who can keep a close eye on your financial affairs.
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