Slight Returns?Posted on: 08 July 2008 by Gareth Hargreaves
This week financial expert Graham Kerner turns the spotlight onto property prices and with-profits investment.
The FTSE 100 Index closed the week at its lowest level since 2005 at 5412.8, as it threatened to join Asia, the US, and Europe in bear market territory.
The UK benchmark of 100 largest companies has fallen 19.6 per cent since October and experienced seven straight negative weeks, leaving it slightly short of the 20 per cent drop that would define it as a bear market.
The Dow Jones Industrial Average became the latest global benchmark to fall into a bear market this week, following the FTSE Eurofirst 300, Japan’s Nikkei 225 and the MSCI Emerging Markets index.
The Financial Times described it as a torrid week for global markets, stating that the credit crunch may be entering a new phase, with inflation continuing to rise and corporate earnings under pressure.
Where global inflation is concerned, most analysts expect it to continue to rise, with analysts at Morgan Stanley pointing out that one in four global economies are now experiencing inflation of higher than 10 per cent, all of which are Emerging Markets.
Discussing this issue further, The Times blamed the falls on escalating fears that losses in the leading equity markets could mount rapidly amid a growing barrage of profit warnings, as well as recent grim economic data.
They pointed out that as well as US markets sinking into bear market territory, it was quickly followed on the same day by Japan’s stockmarket, whose run of losses is its longest since 1954.
This gloom rapidly infected European markets, with steep losses in Paris and Frankfurt, with their 12 month losses now totalling 30 per cent and 21 per cent respectively. Where Europe is concerned, pessimism was compounded by a warning from Goldman Sachs, that Europe’s banks may try to raise between €60-90 billion if losses continue.
Yet again, the oil price dominated the commodity markets, with a surge of more than 3 per cent this week, ending at $144.25 per barrel, after announcements of a fall in US stockpiles, and increasing tension between Israel and Iran.
In currency markets, the Euro was massively affected by the European Central Bank being the first of the large central banks to raise interest rates since the credit crunch began, although the Bank president Jean-Claude Trichet stressed that he currently had no bias towards interest rates going forward. The Dollar also strengthened this week after US employment data was released highlighting that this area was not as gloomy as previously thought.
Positivity Amongst The Gloom
UK housebuilders have had some well-publicised problems over the last year, with Taylor Wimpey, Barratt Developments and Persimmon occupying significant space in the financial press for the wrong reasons. As reported in The Independent on Sunday, the UK housebuilding “big three” have all lost around 80 per cent of their value in the last 12 months.
This week, it was Taylor Wimpey’s turn for the limelight as it emerged that, unless they raise significant capital or house prices rise dramatically, they will find themselves in breach of at least one of its banking covenants from the 2007 merger of Taylor Woodrow and Wimpey.
Amid the negativity that is rife about property, The Financial Times argued that the dwindling stock prices amongst UK housebuilders could result in an increase in property prices within the next two years.
Residential property in England and Wales has fallen in value by around 6 per cent since last year, but estate agents say that prices could start to rise again within 12 months if housebuilders continue to shelve plans for new developments. If there are insufficient numbers of houses around, then property will become more valuable.
This is markedly different to the last property crisis in the early 1990s when there was an over-supply and insufficient demand.
However, it is worth noting that the recovery in house prices is contingent on mortgage providers recovering their appetite for lending. They continue to report that estate agents believe banks and building societies could start freeing up lending options for customers within the next few months, and when this occurs, the pent-up demand from buyers will mop up the remaining supply of new builds and existing empty property. It is at this point the lack of supply will result in house price inflation.
In the short-term, The Mail on Sunday produced a small survey of the experts in the property market, and asked how bad it will get this year. The general consensus was that prices will fall between 5-10 per cent by the end of 2008, though there was no agreement as to what will happen in 2009 and beyond.
With-Profits - Just Without The Profit
The Personal Finance editor in the Mail on Sunday, Jeff Prestridge, highlighted the With-Profits area. He pointed out that the latest figures for these endowment policies make for desperate reading, highlighting the poor value of some of these investments.
Firstly, several 10 year policies are currently paying out less than the capital that has been invested, meaning that any claim that these policies are supposed to be a halfway house between cash and equities just doesn’t add up.
Secondly, the average payout for a 25 year With-Profits endowment plan is less than half of the amounts received for the same type of policies 10 years ago, and a third less than the amounts paid out 5 years ago.
With-Profits plans were designed to smooth returns for investors through good times and bad, but returns are in freefall and there seems no way back for this type of investment.
Long-Term Investment Is The Key
Many people are understandably concerned about where their portfolios should be positioned currently, and this was discussed widely in the weekend press.
The Mail on Sunday suggested that while the weariness of equity markets is understandable, experts are urging investors not to panic. The comment was made that, "If the long-term decision was to invest in equities, then unless your circumstances have changed, stick with it."
It was claimed that market sentiment is the driver, and while fear is the over-riding sentiment, share prices will be driven down. The stockmarket is currently factoring in all the anxiety over possible recession into share prices, as often the market is one step ahead of the economy.
It is impossible to time the market, as has been proven many times over the years. Markets fall fast, but recovery is often just as quick.
As was pointed out in The Sunday Telegraph, short-term repositioning of portfolios can be very dangerous, because if it is proven wrong, a portfolio could miss out on a significant portion of positive performance.
The more you buy at today’s prices, and at the potentially lower prices of tomorrow, the more you will benefit if and when shares recover.
For existing investors, the advice was widely given that unless you need money immediately, don’t sell existing equity investments. For investors making regular equity investments, the argument was made that the coming period could be a very good one in order to meet long-term goals.
Every expert interviewed discussed the benefits of a fully diversified portfolio, making it clear that it was crucial to have a number of different asset classes including equities, fixed interest, commercial property, cash and alternative assets.
Amongst the short-term pessimism, The Sunday Times sounded a more positive message. While the long-term message was consistent with other media, they provided opinions that the short-term view may not be so bad either.
The optimists point out that the FTSE 250, often seen as more representative of the UK economy than the international FTSE 100, is already well into bear market territory and so the time to buy may well be close.
One expert suggested that, "If you take resources stocks out of the equation, the market has fallen 30 per cent since its peak in 2007, which means we are some way through the bear market cycle."
The Opportunities Are Out There
With the recent volatility around the world, and steep declines in certain stocks and sectors so far in 2008, active fund managers have been presented with some very attractive long-term opportunities. This has created an opportunity to position the portfolios with one eye on protecting capital through this tough time, but also with one eye on the long-term potential of cheap stocks.
The funds managed for St. James’s Place are no different, and their fund managers have illustrated this point recently.
George Luckraft, one of the UK’s most highly regarded fund managers, and manager of the St. James’s Place Diversified Income funds, comments, "Although the credit crunch has undoubtedly led to a marked increase in volatility, these moves are presenting opportunities to pick up good stocks with sound fundamentals at attractive valuations."
"I try and take advantage of the benefits that the volatility provides, and despite the negative sentiment in terms of top-down economics, the bottom-up perspective is more positive."
"At a sector level the Financials, which are impossible to avoid for yield purposes, are still in the process of absorbing the full impact of developments, but while I remain cautious, the sector is beginning to settle."
Neil Woodford of Invesco Perpetual, manager of several St. James’s Place funds, recently said, "The UK Equity market appears attractively valued in our view, as the market is already discounting weaker earnings growth in 2008 and a slowing UK economy. Furthermore, it is possible to construct a portfolio with minimal exposure to economic problems."
"As such, selective stock-picking will continue to be the order of the day. For us, companies which are able to display growing profits, strong cashflows, and reliable dividend payments in a difficult environment, should provide resilience and stability even if markets remain volatile."
"Consequently, for the remainder of the year and particularly for the long-term, we are confident of the prospects for the funds.”
For the more cautious investor who is weary of equities at present, there are opportunities in the Fixed Interest asset class, according to Paul Read and Paul Causer of Invesco Perpetual, managers of the St. James’s Place Corporate Bond funds.
They state, "Looking ahead it seems inevitable that economic conditions will remain challenging for some time, which will provide a headwind for credit markets in the coming months. Although we expect defaults to increase in the short-term, we believe the market is already pricing in an overly pessimistic outlook."
"While the risks involved in investing in credit markets have clearly increased over the past year, for those investors that are prepared to look beyond the current problems, there is compelling value both on a relative basis against government bonds, and increasingly on an absolute basis."
7th July 2008
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