For more fund manager comment call Stephen Walker or look at 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.
‘Risk-On’
Global equity markets performed a spectacular volte-face last week as investors switched from ‘risk-off’ to ‘risk-on’ mode, sweeping aside concerns from the previous week that the global economy might be slowing and that some developed economies were heading for a so-called double-dip recession. Sentiment was bolstered by news that the International Monetary Fund (IMF) had raised its estimate of global growth this year from 4.2% to 4.6%. But the forecast hides significant regional differences, with the IMF downgrading its forecast for Britain to just 2.1% - far less than the 2.6% recently forecast by the Office for Budget Responsibility – and just 1% for the eurozone. The institution points to the risk of a liquidity crunch in the banking sector caused by increasing worries about sovereign risk and soaring funding costs for weak eurozone governments. At the same time, weak consumer and business demand could be made worse as governments take the axe to spending in the public sector as a result of recently announced austerity budgets.
On the brighter side, the IMF raised its expectations for economic expansion in the US and in Asia’s emerging markets but particularly the BRIC countries of Brazil , Russia , India and China , where activity is positively frantic. In aggregate, the organisation expects growth of 6.5% from emerging markets compared to just 2.5% in developed economies next year. The IMF did include a small, cautionary caveat though, saying that whilst Asia ’s workshop economies have few financial links to the eurozone, a stall in the region’s recovery could spill over and affect them. The IMF’s report coincided with news that China ’s exports grew faster than expected last month, reassuring investors on the strength of the recovery in the world’s fastest growing economy following the previous week’s concerns. But the data did show that manufacturing growth slowed for a second month in June, with orders in the oil and metal-processing industries falling.
As a corollary though, the 49.3% increase in exports left the country with a $20bn trade surplus for the month and puts more pressure on China to let the value of its currency climb. Critics have accused the country of keeping the value of the yuan artificially low in order to
make its exports cheaper and so gaining an unfair advantage over rival exporting nations. China ’s effective pegging of its currency to the US dollar has been a source of irritation to the Obama administration and the country scrapped the two-year peg to the dollar in June, allowing its currency to rise 0.8% in the last three weeks. Notwithstanding this, last week the US Treasury said the yuan “remains undervalued” and needs to rise. This is thought unlikely - as its own economy slows a little, some economists believe this will mean the Chinese government will be reluctant to allow the yuan to appreciate at the rate other countries would like. In engineering slightly slower growth, China ’s government is endeavouring to cool soaring house prices which are considered a threat to social stability as ordinary workers cannot afford to buy.
Recovery Hopes Fade
The IMF’s view that the British economy will struggle to gain traction unfortunately seems to have hit the mark. Our own trade deficit reached its widest level in May since the collapse of global trade in September 2008, with the UK importing £3.8bn more in goods and services than it exported. For the year to date, exports have grown by just 2.4% whilst imports have risen by almost 6%, which doesn’t augur well for the government and Bank of England’s hopes that a weak pound will boost British competitiveness and support growth over the coming years. Recovery worries were heightened too by the release of data which showed that activity in the UK ’s service sector rose at the slowest pace for almost a year last month. The Purchasing Managers Index (PMI) accounts for nearly 75% of GDP, including service companies from restaurants to accountants and is a crucial measure of activity. In June the index fell from 55.4 to 54.4, although it remained above the key level of 50 which indicates expansion.
Business confidence fell too as companies reacted to the government’s planned austerity measures which, although welcomed by finance chiefs, have raised fears over the country going back into recession, according to a Deloitte survey. PMI compiler Markit confirmed the findings, saying “The less positive outlook appears to be already affecting decision-making, with some clients reportedly reluctant to commit to new business”. With official data on the economy delayed because of errors, economists are anxiously watching other data sources and there was further confirmation of overall slowdown from the respected think-tank, the National Institute for Economic and Social Research (NIESR). Its data showed that, whilst the UK economy continues to grow, the rate of quarter-on-quarter change fell from 0.9% to 0.7%, with output actually falling last month. Against this backdrop, the BoE held interest rates steady at 0.5% for the 16th successive month, with economists expecting rates to stay at rock-bottom levels for much longer. Sterling remained steady on the news, closing the week virtually unchanged at $1.51.
Fresh Wave of Confidence
Despite a bag of mixed economic news, investors took the view that recent concerns about a double-dip recession in the US had been exaggerated – even though US service sector growth slowed in June, according to the Institute for Supply Management’s index, falling to 53.8 from 55.4 in May. “Recent market pricing appeared to discount a stagnation of global growth and earnings. Pessimism was overdone, setting the stage for some consolidation, which now appears to be underway” commented UBS economist Larry Hatheway. As global equity and commodity prices staged a strong rebound, broadly positive news on the health of the global banking sector underpinned the more bullish mood. Investors reacted very positively to an upbeat assessment of operating conditions from State Street , the US bank, whose second quarter earnings beat expectations. This week sees a raft of companies reporting similar second-quarter earnings figures to the markets, so State Street ’s figures have boosted expectations.
There was also increased optimism about the outcome of “stress tests” on European banks which are due to be released shortly, even though there are some doubts about their credibility, according to The Financial Times. So by the end of the week, stock markets had reversed the previous week’s losses, with London leading the way, ending up some 6% on the week, closely followed by Wall Street where the heavyweight Dow Jones Industrial index advanced around 5%. Commodity prices rose too with oil up similarly, making the cost of a barrel of crude almost $76, but apart from the yen appreciating against the US $, currency markets were little changed on the week.
Last week’s rebound in share prices inevitably drew comments from City figures with some, such as Jonathan Jackson of Killik Capital, arguing that the recent decline in equity markets provides a buying opportunity whilst others, including Investment Manager David Kaunders, hold opposing views. Regardless, the increased volatility in the markets has caused some private investors to review the level of risk they are carrying within their portfolios. The Financial Times sensibly pointed out that, for those investors who are bullish on the economic outlook, they should weight their investments towards equities – perhaps as high as 70% with the balance in cash, property and quality bonds. For those investors who are more cautious on the outlook and wanting to reduce risk then less should be held in equities with a higher exposure to cash, property, quality bonds and funds focused on delivering absolute returns.
Going for Growth
One fund manager who puts himself firmly in the more bullish camp is Cato Stonex, a principal of THS Partners and last week he explained why. “Big picture, I believe investors are being presented with an opportunity that has not been witnessed for a very long time – in my view equities are cheaper now than they were back in 2003 with one significant exception: there is no corporate leverage this time. All the components for growth are in place – a positive outlook for corporate earnings, strong balance sheets and a growing global economy. The IMF have recently upgraded their forecast for world growth to 4.6% - even allowing for austerity cuts in Europe - which would represent one of the strongest periods for many years, excluding 2007. Of course, within that some economies will do better than others, most notably the emerging markets such as China . Some people are worried that growth is slowing – this is not surprising given the breakneck speed of recent months but even at 10% it is sustainable. You have to remember that the Chinese economy is starting from a low base – average GDP is around $5,000 per head compared to say $70,000 for somewhere like Norway, which leaves enormous scope for future growth.
There are of course potential setbacks that could hold equities back and markets may remain volatile for a while yet. Investors’ worries have moved from excessive private indebtedness to sovereign or government debt, particularly in southern Europe , as we have seen. It’s true that the Japanese and the US governments - and I include municipal bonds in this - are deeply indebted but there is no reason to believe that the same problems will beset them. Despite the unprecedented volume of bonds issues by governments, prices remain historically high with correspondingly low yields. This reflects a lack of investor risk appetite rather than a worry that equities are too expensive. Shares are good value at current levels and European shares are the cheapest on a global compare and contrast basis, added to which dividend yields for UK , European and Japanese equities are all above their respective government bond yields.
It therefore makes sense to continue to invest in global growth companies based in the developed world where they are both safer and cheaper than direct emerging market alternatives plus they offer a good mix of developing market revenue exposure. Nestle, for example, derives some 34% of its revenue from Asia and emerging markets and for the portfolio as a whole, the figure is 31%. So we continue with our thematic approach, increasing exposure to agriculture, telecoms (to capture smart phone growth) and demographics & healthcare. Having been negative on pharmaceutical stocks for 15 years we now own Roche and Pfizer, which trade on lowly p/e’s of 11 and we’ve also bought a little BP which we think is very cheap. Liquidity in the portfolio of 5% is at one of the lowest levels for almost 20 years and is a statement of intent as to how we feel about markets and future growth prospects”.
THS Partners manage the St. James’s Place International and THSP Managed Funds.