For more fund manager comments and information on ISAs see www.sjpp.co.uk/stephenwalker
WALKER FINANCIAL MANAGEMENT
This weekly Briefing Note aims to pick out some of the key financial and economic issues touched on in the press over recent days and from time to time includes the views of some of our independent fund managers.
Fed Discount Hike
The financial world was taken by surprise late on Thursday, as the US Federal Reserve took a big step towards unwinding its massive economic stimulus programme. As reported in The Financial Times, the move by the Fed to raise the discount rate, the level at which commercial banks borrow from the central bank, was expected but the timing was still a surprise. In what is being described as a sign of the Federal Reserve’s increased confidence in sustained economic recovery, the discount rate was raised by a quarter of a percentage point to 0.75%, and the immediate impact was for the US dollar to leap to a 9 month high against both the euro and sterling. The Fed tried to dampen expectations by saying this would not necessarily be the start of a continual rate-rise, but the general consensus was that this decision will still affect markets, as the message it gives out is that the US Federal Reserve is the only major central bank that can even contemplate a rate hike in the foreseeable future.
As well as the immediate rally of the dollar, there was also knee-jerk selling of stocks, US Treasuries and commodities, amid speculation that it heralded a further tightening of US monetary policy. Subsequently, this was all reversed on Friday as investors digested the move, and took the view that this was merely the first move of many for the Fed going forward, and it was best to focus on the positives. Overall, the US equity market seemed to focus more on continuing positive economic data and corporate earnings, as well as benign inflation figures. In European markets, the Eurofirst 300 Index enjoyed its biggest weekly gain since July, with Financials leading the charge upwards, while Asian markets gave back the week’s gains in tough Friday trading. In the UK , the FTSE 100 index rose during every trading session, closing the week up 4.19% at 5358.17, taking optimism from positive corporate news and economic signals from the US .
Focus on the UK
Britain’s anaemic economic recovery could be slightly stronger than initial figures suggested, as official data is expected to show growth of 0.2% in the final quarter of 2009 rather than the anticipated 0.1% first announced. The Sunday Telegraph reported that an upwards revision of this sort shows improvement, but is still a fragile scenario nonetheless. The key will be the breakdown of expenditure and output data for the fourth quarter, which will provide a signal as to whether consumer spending is holding up and whether trade is providing the support to the economy that the government is hoping for.
Despite these reports that the UK may have limped out of recession slightly faster than originally thought, there are increasing concerns which continue to hit the value of the pound. This was also covered by The Financial Times, which looked at the increasing vulnerability of sterling while the world focuses on the problems of the euro. January is usually a month which swells the government coffers due to increased tax revenues, but this year saw a net borrowing of £4.3 billion, with analysts now suggesting that 2010 borrowing will be higher than the £178 billion that Alistair Darling has forecast. Such a deficit would be greater than the shortfall in Greece . This, combined with a contraction of UK lending to businesses and the potential for a hung parliament in May, results in there being few sterling bulls in the world. All in all, reported the paper, “the absence of any positive adjustment to the UK fiscal position runs the real risk of a run on the pound”.
Greek Fiscal Woes
The woes of the euro continued this week, as there were persistent concerns over the problems of peripheral Eurozone countries. However, the ongoing worries over the potential bail-out of Greece eased slightly as it emerged that there would be emergency funding if necessary. As if to highlight the high-risk premium attached to Greek Government debt at present, the 10 year yield jumped 27 basis points to 6.44%. Reports in The Financial Times on Saturday suggested that Greece was preparing to raise between 3 and 5 billion euros through a bond issue. This is seen as a crucial test of Greece ’s credibility in the eyes of the world, and the success of the issue will determine whether an emergency bail-out is necessary.
The Independent on Sunday had a slightly different angle to most, with the emphasis being much more on the fact that Greece actually holds a strong hand in negotiations. While most see Greece as having to go cap-in-hand to the EU, the paper commented that the EU simply has to lend to Greece at the same rates as other countries, and that increasing interest rates for Greece would potentially push the costs of borrowing up for the likes of Spain and Portugal, and makes Eurozone problems much worse than currently.
Still on the Critical List?
With Royal Bank of Scotland scheduled to announce results later this week, the press discussed the possibility of the two state-owned banks showing £12 billion in losses, yet paying out in excess of £1.5 billion in bonuses to its investment bankers. The Sunday Times reported that the RBS Chief Executive, Stephen Hester, had not yet decided whether to accept the reported £1.6 million pay-out, despite the bonus being written into his contract when he was appointed, and was under increased pressure after two of Barclays senior board members recently rejected their bonus awards, despite being taxpayer funds-free and reporting a £11.6 billion record profit. The Sunday Telegraph reported that with RBS and Lloyds unlikely to show any profit before 2011, announcements of bonuses while making extreme losses would be “political dynamite”. According to the paper, neither lender will be able to escape the fact that the general public will not understand how a state-owned bank can award performance bonuses when declaring an overall loss.
Today’s Financial Times confirms that Mr. Hester is indeed to forgo his bonus for 2009 – a gesture seen as part of an effort to “depoliticise” RBS’s bonus issue and to help pave the way for the UK government to sign off the bank’s plans to pay a “commercial rate” of bonuses to its investment banking staff. The move will pile pressure on Eric Daniels, Mr. Hester’s opposite number at Lloyds, who has yet to make any declaration about his bonus plans.
Longer-term prospects
Much of the weekend press reported on the current cash ISA rates that are available, especially in light of the recent announcement of the Retail Price Index hike to 3.7%, meaning it is now increasingly difficult to get a real return when invested in cash. The Independent on Sunday reported that with cash rates reducing in real terms, many people are not going to be using their full ISA allowances in the near future despite the rise in allowance and the obvious benefits to taxpayers, whether they be basic or higher rate taxpayers.
With cash returns at their lowest levels in recent memory, what are the prospects for certain other asset classes? Paul Read and Paul Causer, managers of the St. James’s Place Corporate Bond funds, recently reported “Although we do not expect a repeat of the recent strong gains, underlying conditions remain supportive of credit markets. Core inflation in the UK should remain subdued and interest rates are widely expected to remain near their current low level for a considerable time. Spreads on sections of the market remain generous by historical standards and high-yield bond markets offer a good opportunity even after the strong rally of recent months. In terms of strategy, we believe that some of the more attractive investment opportunities are to be found amongst higher yielding investment-grade names and better quality high-yield issuers. During January, additions included investment grade positions in Catlin Insurance 7.249%, General Electric 5.5% and Northern Rock 5.625%.”
The Sunday Telegraph highlighted Commercial Property as an option, where rental yields remain attractive following the falls in capital value of office space and factories during the recession. Nick Montgomery, manager of the St. James’s Place Property funds, commented, “When property values fell, it was indiscriminate and this is continuing as values start to rise. With values now on the up, the fall in rent should not continue as pressure builds up for rental income to increase. Broadly speaking, normal service is starting to be resumed, with Property once again starting to be recognised as an asset class that is income-driven”.
Where equities are concerned, The Financial Times took the side of the stockmarket by highlighting the Barclays Equity Gilt Study which shows that the longer an investor holds shares, the higher the likelihood of outperforming cash. The paper showed that shares outperformed cash 66% of the time over a 2 year period, but this rises to 91% over 10 years. This is the type of longer-term view held by Nick Purves of Schroders, manager of the St. James’s Place Equity Income funds. He recently commented, “We see value in particular equities, regardless of the current economic outlook. This is because the difficulties facing companies over the next couple of years should not have a significant impact on their fundamental value and their ability to generate dividend and profits growth over the long term. This leaves the possibility of a sharp rebound in profits as and when sales pick up, and, therefore, further strong returns given the relatively low expectations still reflected in these companies’ valuations. I am very happy with the current portfolio, and I would anticipate turnover within it to be very low and very few new stocks to be added. Certainly, within the Financials sector, it could take 2-3 years for the real value of stocks to come through”.