Is optimism returning to global markets?
The world economy is expected to grow by 4% this year - implying growth is going to be above the long-term trend for two years in a row. This is a positive background for equities. And the mood is perceptively more optimistic among our panel of five asset allocators as a result.
Fears of a double-dip recession have receded. Michael Turner of Aberdeen Asset Management thinks that as 2011 progresses, "markets will become convinced that we are no longer threatened by those double-dip worries. That will encourage equity investors".
Turner has stuck his neck out to predict the FTSE 100 might reach 6500 before the summer, with a similar 8% rise expected by the US S&P 500 index.
Indeed, equities - UK in particular - have emerged as the asset class most favoured by our panel of five experts. Their average score for UK shares is now seven (from a possible nine) and all five panelists, apart from Kemp and Turner himself, have raised their scores in this category.
Equities favoured over bonds
This does not mean they are all wildly bullish. Far from it. It is much more a case of believing that holding stakes in well-financed companies around the globe is probably the least dangerous strategy to adopt.
By contrast, all show less interest in government bonds, whereas in the case of UK gilts four out of our five panelists have reduced their scores.
"There are significant problems that have not been fully dealt with," Robert Talbut, chief investment officer at Royal London Asset Management, admits.
"But I think 2011 will be another year of reasonable growth and the authorities are going to stay fully engaged with the monetary taps at full tilt. Animal spirits are rising - to use a Keynesian phrase - and companies themselves are starting to feel more confident about the future."
In Britain, Talbut believes retailers will do everything they can to absorb the VAT increase to 20% and he doesn"t see this having a major effect on consumers.
New panelist Rob Burdett, joint head of multi-manager funds at Thames River Capital (now part of the F&C Group), agrees: "Surveys of business confidence are up. Companies have cut costs heavily. Margins are high and growth is resuming."
Volatility still in store
However, he warns against envisaging too rosy a picture. The shock of 2008 has left the business community wary. "If you ask them how far out they feel confident it is a much shorter prediction than it used to be."
Indeed, Aberdeen"s Turner is convinced this will be "a year of two halves", with prospects much less certain after the summer. "I think it will be a bumpy ride in the second half," he says.
"Tax rises will start to kick in and concern will increase about growth, unemployment and the coming to the end of the US quantitative easing programme. On top of that, the rumblings about the future of the euro will continue to plague the markets."
Despite all that, the panelists are all positive on shares.
Keith Wade, chief economist at Schroder Asset Management, says higher-rate tax cuts forced on the Obama administration by the Republicans in Congress is "a positive surprise for the US markets that should help growth in America - although it is not so good for the US bond market".
Schroders is now "rotating out of credit markets where we were previously very positive and more into equities," says Wade. He scores for three out of four of the equities categories a seven but has reduced an "overweight position" in emerging markets where the score goes down from seven to five.
"Last summer, 'double dip' became the topic of conversation when the economic indicators started to show a slow down," Wade says. "But since then things have picked up and there are now clear signs that the US consumer is not dead."
Dan Kemp of Saltus Fund Management has barely changed his opinions on equities from three months ago. His views belie a much more jaundiced view of stock market valuations.
"The early autumn was a particularly murky time for trying to work out what was going on," he argues.
"The financial world has now become more polarised - partly reflecting the fact that risk assets such as equities, credit markets and commodities have done very well. However, bond prices have not done so well and have probably lost you money."
He believes this polarisation is partly "an unintended consequence" of quantitative easing. "The Bank of England did not bother with QE2 in November but the US Federal Reserve certainly did," he says.
"In an environment where central banks are printing money, asset prices reflect the relative value of the asset to the currency it is measured in."
Kemp believes it has begun to dawn on investors at large that they should be looking at the price of assets, such as shares, in these currency contexts. He thinks if share prices and commodity prices are going up, it is as much to do with the value of currencies falling as with an economic recovery in train.
"The movement in asset prices has come to reflect a view of where the mainstream currencies, such as the dollar, the euro and sterling, are heading rather than a view of the global recovery."
In fact, Kemp is disturbed by the risk of another major financial crisis: a re-run of what happened in the final three months of 2008.
"If we think about the credit crisis of 2007, mortgage bonds got hit first because they were the weakest part of the system," he says. "But it did not stop with mortgage bonds but spread out so much that by the fourth quarter of 2008 it almost brought the real economy to a standstill."
He is not predicting that will recur but thinks it is "an important risk". And when Kemp looks at the problems in the eurozone he sees "the first fruits of a deeper endemic problem in the global market for government debt".
Royal London"s Talbut agrees: "There is still far too much government debt. There will be times when the markets become very concerned about the sustainability of that debt."
From Kemp, however, the warnings appear couched in much more stark terms. "We are tip-toeing into a government bond crisis rather than being in the middle of one," he says.
"What we have seen in Ireland and Greece is a warning bell rather than a finale. As always, the markets are picking off the weakest members of the herd one by one."
He is deeply disenchanted with the bond market and UK gilts. "As the strong countries increasingly bail out the weak ones there is a real risk that instead of strengthening the weak, it will weaken the strong," he reasons.
Other panelists hold a less extreme view on government bonds but none shows any enthusiasm despite the recent decline in values, which has seen yields on 10-year gilts rise from 2.83% at the end of August to 3.5% now.
"They are more attractive than they were but not sufficiently attractive compared with equities", says Aberdeen's Turner. He does, however, still enthuse about some emerging market bonds.
Burdett stresses he is not expecting sharp rises in interest rates from the central banks. He simply asks: "Why sit in government bonds to earn 3.5 to 4% when you can double that in a year from the return on an equity?"
If there is precious little enthusiasm for the government bond markets, there is even less interest in holding cash. In the past, panelists such as Kemp and Talbut held cash as they awaited opportunities to find value elsewhere.
The case for holding cash might have lessened but Talbut and Burdett, in particular, think equities around the globe will continue to experience high levels of volatility. But they obviously feel confident enough about the long term to keep cash levels low.
Talbut puts it this way: "Up to the credit crisis we had a period of consistently high growth and consistently low inflation - the best of all possible worlds. Now we live in a world of great volatility, so there will be inflation scares at times and also worries about growth not being strong enough."
He feels in this climate investors need to be either "incredibly nimble or should simply take a long-term view."
He says it is time for investors to acknowledge they cannot try to trade every movement up and down the rollercoaster.
"Instead they should be saying: 'There is decent value here and we will all come out the other side of whatever crisis occurs. Therefore let us concentrate on good-quality asset allocation and company selection and believe that over the medium term that will do us very well'."
Burdett has a very similar approach: "We favour equities over all other asset classes, but having said that, we face the problem of volatility being elevated. So the risk of our outcomes being incorrect is higher than usual."
Like Talbut, he talks about being more nimble but also about "providing a little extra insurance and in our case that comes through investing in companies with stronger balance sheets and attractive dividend yields".
He emphasises how important dividends are in shoring up the market. "On the one hand, BP's dropping of the dividend was a hammer blow for UK equity income funds - it was the UK market's biggest company and the yield was above average.
"On the other hand, we expect BP to reinstate a dividend this year and generally we are also well beyond the bottom of the dividend-cutting cycle."
Because global credit (corporate bonds) as a sector has had such a strong performance in the past couple of years, enthusiasm is beginning to wane among the panelists.
Commodities still popular
When it comes to the commodities sector, Turner and Wade emerge as generally the most bullish. "I think we are in a very long-term bull market for commodities," Turner says, "and nowadays investment in commodities by institutions has become much more strategic than cyclical in nature as it was in the past.
"We are certainly not in the camp that says there is a horrendous bubble that is about to burst in commodity markets."
A major factor in this view is the emergence of China, where "a quite modest rise in domestic demand from such a large population has a much greater impact on the global demand/supply equation".
Talbut remains keen on soft commodities and holds gold to provide "insurance".
If there seems to be a fairly broad consensus emerging from our panel of asset allocations in favour of equities and other risk assets, such as commodities and global credit, Burdett does not find this to be the case among the general herd of fund managers. His role in multi-manager funds means he talks to 250 fund managers all over the world in the space of a year.
"Normally there is a distribution of views clustering around a consensus," he says. "But at the moment you have nothing of the sort. Instead there are the bears collecting at one extreme, the bulls at the other and not much in the middle."
He explains this in terms of the current political and financial climate over such issues as the future of the euro and quantitative easing.
"Normally politics and the actions of governments and central banks only dominate in the short term and have a lesser impact on long-term sentiment," Burdett says.
"But now we are living in the middle of an experiment and the sheer magnitude of the issues we face makes politics and the role of the central banks more relevant than at any other time in my working life."
Burdett"s solution to the problem? "To concentrate on those fund managers who are stockpickers rather than those macroeconomic managers who try to second-guess the politics."
This article was originally published in Money Observer - Moneywise's sister publication - in February 2011.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
Investment funds that invest in other investment funds from a wide range of asset managers and are often referred to as funds of funds. Some multi-manager funds only invest in the funds of the investment house providing the fund of funds and these are known as “fettered”. An “unfettered” multi-manager fund is free to invest in what the fund manager believes are the top performing funds from across different markets and industries. Investing in multi-manager funds means your risks are spread across geographical regions and industry sectors but it also adds another layer of charges and some multi-managers also levy an out-performance fee.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
Invented by a Frenchman in 1954 and ironically introduced in the UK on 1 April 1973, VAT is an indirect tax levied on the value added in the production of goods and services, from primary production to final consumption and is paid by the buyer. Its levying is complex, with a number of exemptions and exclusions. For example, in the UK, VAT is payable on chocolate-covered biscuits, but not on chocolate-covered cakes and the non-VAT status of McVitie’s Jaffa Cakes was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit. The judge ruled that the Jaffa Cake is a cake, McVitie’s won the case and VAT is not paid on Jaffa Cakes in the UK.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
A bull market describes a market where the prevailing trend is upward moving or “bullish”. This is a prolonged period in which investment prices rise faster than their historical average. Bull markets are characterised by optimism, investor confidence and expectations that strong results will continue. Bull markets can happen as a result of an economic recovery, an economic boom, or investor irrationality. It is the opposite of a bear market.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.