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.
Final Act
The deeply troubled Greek economy gave a last gasp mid-week as nervous investors finally gave up on the country and offloaded government bonds. As a consequence Greece ’s borrowing costs rose to their highest level in more than a decade amid fears its debt crisis would deteriorate further, increasing stress on the government to agree a financial rescue deal. By the end of the week, bowed by overwhelming pressure from financial markets, Greece ’s Premier George Papandreou, appealed for emergency eurozone loans in what will be the first rescue of a euro region country since the inception of European monetary union in 1999. Athens is expected to set out its needs in a letter to the European Central Bank who will assess if the request is valid. However, the timing might, according to The Financial Times, cause problems because there are elections due shortly in Germany – which has taken the most hawkish line to date - and as a consequence, politicians are ultra sensitive to any backlash from angry voters opposed to the bailout. The most likely outcome it seems, is that the European Commission, ECB and International Monetary Fund (IMF) will provide a team to negotiate terms with Greece and the view is that the IMF will demand tougher austerity measures than Mr Papandreou adopted in his 2010 Budget.
Of course it is not just Greece ’s woes that are causing concern in financial markets – investors have been keeping a wary eye on other eurozone members in recent months with much speculation about the outlook for Portugal , Spain and Ireland . But undeniably the issue of sovereign debt is a problem – a point made by the IMF in its regular assessment of the global economy, released in Washington last week. The organisation warned that high levels of government debt are reducing policymakers’ freedom to manoeuvre and are threatening to short-circuit the global economic recovery. “The global recovery has evolved better than expected but in many economies the strength of the rebound has been moderate given the severity of the recession” the IMF said, adding that while capital was
flowing back to emerging markets, sovereign debt would continue to restrain fiscal stimulus.
Mixed Fortunes
Financial markets were caught in a two-way pull last week as worries over Greece vied with mounting evidence of US corporate strength. Initial weakness in European markets dissipated leaving the main indices largely unchanged on the week – London slipped slightly after a choppy 5 days. In the Far East there was similar volatility with share on Shanghai ’s index enjoying a strong rally mid-week only to go into reverse by Friday, taking the Hang Seng Index with it: both markets retreated around 5% on the week. Likewise, Tokyo ’s strong rally petered out to leave it down some 200 points. However investors on Wall Street were far more positive as they gave the thumbs-up to what have been, so far, better-than-expected first quarter corporate earnings. Sparkling figures from Apple and encouraging results from Morgan Stanley and Boeing, offered more reasons for optimism about the global recovery. US stocks received a further boost on Friday when official economic data showed that new home sales surged 27% in March and that durable goods machinery orders, along with inventories, were ahead of expectations. The latter two numbers are both catalysts for GDP growth so by the close of business on Friday, the Dow Jones Industrial index had advanced almost 2% on the week.
UK Flagging
Here at home data from the Office for National Statistics (ONS) showed that Britain ’s recovery almost ground to a halt in the first quarter of the year with unexpectedly slow growth of 0.2%. “A disappointing first quarter GDP outcome, capping a week of disappointing UK data” said Ross Walker, economist at Royal Bank of Scotland , in the wake of a record high deficit, higher inflation, a rise in unemployment and sluggish retail sales. However the ONS figures are a preliminary estimate and notoriously subject to revision – the fourth quarter GDP figures for last year were subsequently doubled in the ensuing weeks. But undeniably, last week’s numbers were disappointing. On the jobless front, figures released showed a rise in unemployment to 2.5m – its highest level for nearly 16 years – as another 43,000 people became unemployed in the three months to February. The Financial Times pointed out that the number of people classed as economically ‘inactive’ rose to 8.16m; the highest since records began in 1971. A jump in the cost of petrol and air fares managed to push inflation higher than expected last month with the Bank of England’s target measure of CPI jumping from 3% to 3.4% - significantly above its 2% target. One good piece of news though was that gross UK mortgage lending jumped 24% in March compared to a month earlier as the property market continues its recovery.
Red or Blue?
With the election drawing ever closer speculation on the outcome continues to intensify, no less so than in the City. Last week the Shadow Business Secretary, Kenneth Clarke, warned that a hung parliament carried the risk of an immediate credit downgrade and an IMF bailout. However, as The Sunday Times pointed out, City traders responded to Mr Clarke’s comments with complete indifference and the paper observed that, as expectations of an inconclusive election outcome have grown in recent weeks, calm has descended. At least one of the rating agencies has made it clear that there might be positive aspects to a hung parliament which could preserve Britain ’s AAA rating. “We do not think a hung parliament will have a direct impact on the UK credit rating. If you had a fiscal plan agreed by a coalition that could actually be quite positive, because it would imply broad popular support” was the view of analysts at Moody’s.
One other view was expressed by Capital Economics, who observed that “If such an outcome [a hung parliament] is now largely priced in to the markets, there might be scope for a considerable ‘relief rally’ in sterling assets if the election throws up a decisive result”. Should there be a decisive outcome the next question is of course, which colour government would investors prefer? The Financial Times carried out a survey of ten leading investment funds who collectively manage some $7,000bn of assets to find out their preferences for the next government. Apparently 9 out of 10 of the funds surveyed said they were equally happy to see a new Labour or Conservative government provided it had a clear majority.
Ian McVeigh of Jupiter, who manages UK equities, takes the following view. “If there is one thing markets don’t like, it is uncertainty. So a hung parliament, for example, could shake investor confidence if there is no clear leadership and another election is called. This could lead to a further period in which borrowing continues to mount and bond market investors are not given details of how the deficit is to be reduced. This in turn could drive up gilt yields, making borrowing more expensive. Once a government is chosen, it will need to demonstrate to debt holders that it has the political will to execute measures which inevitably involve a degree of pain for the public sector and taxpayers. The market is likely to take account of this election more than most. That said, we live in a global economy and global factors will remain a significant influence on investor sentiment. Moreover, many of the UK ’s largest blue-chip companies generate most of their earnings overseas and so are little affected by domestic politics”.
Taking a Global View
Whilst the IMF warned about the dangers of too much sovereign debt it also set out its growth forecasts for the world’s major trading regions and unsurprisingly, takes the view that emerging markets will grow more quickly than their developed counterparts. Emerging markets account for around half of global GDP and it is usually the likes of China , Brazil , Russia and India that steal the limelight but in reality, there are 44 countries that in aggregate, make up the emerging market sector. Jonathan Asante, a fund manager with First State Investments, is well known as an experienced and successful global emerging market investor and he explains why he prefers to look outside the BRIC countries for investment opportunities. “Like any other investor I don’t want to pay top price for a company and good quality companies in Brazil , China and India continue to trade at significant valuation premiums to those in the rest of the global emerging market universe. This is reflected in our underweight positions in these markets versus the benchmark index. For example, within the portfolio, China accounts for just under 2%, India 3.5%, Russia around 3% and Brazil 10%.
Many of the top companies’ shares in these economies have price-earnings ratios in their high twenties which means there is little upside left for an investor – I want to buy a quality business which is trading on a p/e of around 11. My strategy is to buy into businesses that I can trust, who if they are profitable, will treat minority shareholders fairly. This doesn’t happen with some of the very large companies that operate in these markets – many are answerable to state bureaucrats and so one has to understand not only the economics but also the politics. So my approach is to own between 25-50 stocks – companies that I have extensively researched and where I trust the management teams and in many cases, the families that are major shareholders. Currently markets are nervous over the removal of economic stimulus packages which hints at the high level of risk for equity investors currently. My portfolio has significant holdings in companies with exposure to clean energy and energy efficiency. It is clear that many developing countries will be unable to follow the traditional development path pursued by industrialised nations in the past and we expect significant investment opportunities to result.”
Ian McVeigh and Jonathan Asante both manage funds for St. James’s Place.