Interest Rate Decisions and Further QE

It has been a busy day today as central banks around the world announced interest rates and quantitative easing for this month .  Japan led the way as the new Bank of Japan governor Haruhiko Kuroda hit the ground running after his first meeting as they announced further bond purchases of 7 trillion Yen ($75bn) a month over the next two years easily beating market estimates of 4 trillion Yen.

This commitment is what the market wanted and they certainly have delivered, the Yen fell 3.4% against the USD following the announcement and Japanese equity markets rebounded from earlier losses.  I expect many foreign investors will be eager to increase their exposure to the 3rd largest economy as other equity markets have hit a recent stand still.  This was certainly evident after the Japanese market closed up 2.20% the futures market rallied a further 2%. 

Back to Europe...Many were eager to here from Mario Draghi following issues with Cyprus and the worsening state of the Eurozone's economy.  Rates were kept the same as expected however, Draghi hinted at lower rates down the line if the economic situation did not improve.  His comments lacked the commitment many were hoping for as previous statements have been bold and provided direction.  The Euro weakened further as the hint of lower rates caught traders ears, however recovered slightly as the day went on.  A weaker Euro will help ease the blow for exporters, and Draghi mentioned an economic recovery should begin during the later part of 2013 (fingers crossed).

Mervyn King may have failed to convince the monetary policy committee once again that further quantitative easing(QE) should be implemented as interest rates and QE were kept level.  The UK's economy has been relatively flat since last month and data has failed to inspire either on the up or downside. 

An interesting time for equity markets, it highlights the importance of sector allocation, some markets this year I expect will massively outperform others so pick wisely.

What next for the High Street?

The decline of the UK High Street is there for everyone to see. Walk round your local town centre and I'm sure you will notice many more vacant units than 5 or 10 years ago. Prime retail zones like Oxford Street in London buck this trend but in many other regions in the UK it is apparent. 

The High Street has faced two main headwinds. One has been the Credit Crunch; in a nutshell reducing consumer's ability to spend. Second has been the Internet; online shopping from sites such as amazon has boomed in recent years making the High Street redundant. Without expensive property and staff costs these online businesses can drive down price, stealing market share. Recently we have seen Comet and Peacocks close down, highlighting the structural shift occurring in this sector. 

So what does this mean to investors? Well one thing to consider is property investments. Retail property may not be the best investment currently as empty rates are likely to be at highs historically and there could be a lack of rental growth as demand falls. Retail stocks with businesses in structural decline should also be avoided; they may look cheap but they are likely to be 'value traps' and keep getting cheaper! 

Opportunities could arise from retail businesses with a strong online presence. Amazon is a prime example of this type of successful online business model. 

It is not all doom and gloom for the UK High Street and this was highlighted by John Lewis who recently announced strong profit growth as well as staff bonuses of 17% across the whole business. This company has integrated successfully into the online market whilst also benefiting from the success of Waitrose. Strong management has seen this business adapt and change and this dynamic approach has seen it succeed and grow market share when many peers have struggled.

For now let's make the most of the UK High Streets, in 10years time the landscape could look a lot different.

The importance of income

For many investors assets that produce a natural income are often highly desirable. Typically people automatically gravitate towards bonds and property for this income, however given the potential headwinds facing these asset classes equity income may become more desirable.

Since the credit crunch UK Equity Income funds have been very popular. I think this is for two main reasons. Firstly in a low growth environment income becomes a bigger part of total return and helps underpin portfolio growth and does help offset any erosion in capital. The second reason is down to the nature of business that pays dividends. These businesses are usually seen as 'defensives' with stable and predictable cash flows, allowing them to return cash to investors on a regular basis. Since the credit crunch many investors have favoured these more defensive businesses that are more resilient during economic downturns. 

There are many funds available to investors wishing to have exposure to UK Equity Income stocks. Probably the most famous is Neil Woodford's Invesco Perpetual Income and High Income funds. These funds hold stocks like AstraZeneca (c.6% yield), British American Tobacco (c. 4% yield) and Rolls Royce (c. 3.5% yield). I would argue however that this fund is now too large and that some of the smaller, more nimble funds are likely to perform better and also contain less stock specific risk. Neil Woodford has large allocations to a handful of companies which could add a layer of risk. Unicorn UK Income has been the stand out performer over recent years, and other funds such as Royal London UK Equity Income also have excellent track records. 

So when looking for income from investments, equities should be considered. Many businesses are available on attractive yields, and often grow these dividends as well as having the potential for capital growth, something bonds don't offer. Many corporates are also flush with cash on their balance sheets so we may see special dividends, with even more cash returned to investors!

Asset Managers - a leveraged way to play a rising market

Over the past 12 months the number of available asset classes which have produced competent returns has been diminishing and as a result many have moved into equities.  This increased flow of money into equities has proved great news for asset managers as they make up significant proportion of equity investments.

The asset managers came under pressure after the credit crisis as many ran to cash to protect themselves from heavy losses. Unsurprisingly share prices collapsed along with the market. Since then assets have been slowly building back up gathering pace over the past year. A number of companies have reported increased profits as a result.

Increasing demand for equity funds has rolled through from institutional, retail investors and Wealth Managers.   As the asset managers have experienced gains at the end of the line, further towards the front, Wealth Managers have experienced a similar trend.  Since the introduction of the Retail Distribution Review (RDR) at the start of 2013 this separated the good from the bad and a number of wealth managers have taken this in their stride increasing assets under management.

Namely Brooks MacDonald, announcing an increase of 44% in discretionary assets over the year and raising their dividend is a prime example. Also St James’ Place and Hargreaves Lansdown have also benefited all be it from slightly different avenues.

With banks still having a number of structural issues, many investors are wary of jumping back in. These other alternatives to the financial sector have great growth potential, especially as these mid cap stocks have room to grow and increase their dividends going forward.

This rotation into equities may have only just begun which is great news for both asset and wealth managers a like.  Without going out and buying a number of these stocks directly, I would suggest purchasing Guinness' Global Money Manager Fund that invests solely in asset managers and has performed very well over the past year, returning 34%!

Mergers and Acquisitions – A Pathway to Growth

Since the credit crisis M&A activity has been fairly low as companies aimed to strengthen their balance sheets and reduce debt levels.  Over the past five years, this global restructuring has meant these companies are in some respects the strongest they have ever been.

The start of this year has seen a rapid increase in M&A activity as companies utilize high levels of cash to expand.  Such companies as Dell and private equity firm Silver Lake Partners agreeing a leveraged buyout to take the company private.  Virgin Media, also agreed a takeover by Liberty Global for $23.3bn, and Warren Buffet’s Berkshire Capital acquired Heinz for $23bn to take it private.  

Larger companies have historically had no problem in achieving good year on year growth, however markets have now changed and in many countries growth is anaemic.  The changing demographics weigh on government spending and will inadvertently reduce expansion and demand for many businesses for years to come.  A possible area for companies to expand are to takeover business which are in the growth phase, allowing larger companies to capitalise on growth elsewhere without having to expand existing operations.  

So why now, what has caused this activity to pick so much since last year? Markets have calmed significantly and volatility has been gradually decreasing.  There is a slight correlation between M&A and volatility and this is inherent in the great start we have had this year.

There are a number of factors which are helping company mergers and acquisitions.  Interest rates are at historic lows, and yields on even the highest yielding debt are the lowest it has ever been.  For M&A particularly this is a good thing, companies can borrow large sums of money for a leveraged buy out. 

As the larger companies try not to stagnate, we may see a lot of their small competitors prime for the taking and a number of funds could benefit from this.  Mainly funds in the mid cap space will be best placed to see takeover bids as they have a more consistent growth rate.  Funds such as Schroder U.S Mid Cap and Royal London UK Equity Income could do well from this over the next few years.

Contrarian Investing - Buying on the Dips

One of the hardest things to try and achieve in investing is market timing; I know it is something I have never managed to perfect, and many other more talented investors have also admitted defeat! 

However, what I do find interesting is how people approach investing. If a stock falls 10% then there is an argument that that stock is less risky than one that has risen 10% as the likelihood is the bad news has already been priced in to some degree and you are investing at a lower base.  However, time and time again people buy in on the "way up" and sell on the "way down".

I thought this article would be poignant today given Standard Chartered's announcements of a 10th consecutive year of income and profit growth as well as an increase in full year dividend of 10.5%. Over the summer Standard Chartered were hit by the Iran money laundering scandal which saw around 19% shed from their share price in 24 hours. Many investors I am sure panicked fearing almighty fines on the bank and sold their positions. If as an investor however, you had bought into the stock immediately following this scandal you would be sitting on a profit of around 46% (not factoring in any dividends!). Standard Chartered were fined around $700m for the scandal, but that has failed to dent profits significantly and the Emerging Market focused bank continues to perform strongly. 

Source: Google Finance

Of course there are examples where a stock has fallen sharply on the back of bad news and continued to fall, so investors need to keep an eye out for this. I think the key is to ask yourself, what has caused the stock to fall, what is the consensus view and have the fundamentals changed. If you believe the market has overpriced the bad news, and that in fact the company can recover then it could be a good buying opportunity. 

For investors who don't have the time or expertise for such type of investing there are contrarian funds available. Probably the most famous is M&G Recovery which has a brilliant track record, and a particular favourite of mine is Investec UK Special Situations.

Contrarian investing often means going against consensus and is a bold move, but if it is good enough for Warren Buffett then it is good enough for me!

The UK Economy, an Uphill Struggle

The UK has suffered its fair share of problems since the credit crisis.  In 2010, the Conservative Party was elected as they vowed to sort out the huge financial deficit which built up from years of frivolous spending.  

Huge cuts were promised as people grimaced at the notion of heavy austerity for years to come.  However, after just under three years in power, only 30% of the original cuts have come to fruition.  This has caused deficit levels to miss forecasts weakening the economic growth outlook for the next few years.

Recently, Moody’s, one of the three major rating agencies downgraded the UK from AAA to AA1 and for many this was no surprise.  The UK has one of the highest budget deficits as a percentage of GDP in the whole of the Eurozone.  Furthermore, Public Debt to GDP is at 88.7% and historically this has been below 40% for a AAA rating.  As demographics start to change, the world’s baby boomers weigh on public sector spending.  There may be no way back for many developed nations to the prized AAA rating, only two major countries retain this now; Australia and Canada. 

One way the UK can reduce the piling debt levels is through inflation.  With slow growth forecasted for the coming years it may be the only option.  As the world restructures and deleverages it is important for investors to select the correct asset classes and economies to invest in.  Certainly, the UK Economy is not high on my list, however this does not mean equities listed on the London Stock Exchange are ruled out. 

Of the FTSE100 companies, around 80% of the revenue is obtained from overseas and with some of the largest and most profitable companies listed in the UK, I always maintain exposure to this key market.

A few examples of top UK Equity funds are Liontrust’s Special Situations (for the more aggressive investors) or Royal London’s UK Equity Income which have a great history of selecting  the top UK listed companies.

No more QE....for now

As predicted by 29/39 economists surveyed on Bloomberg the BoE rejected the opportunity to hit the printing press once more. I imagine the debate raged on during the meeting and it was a very close call, and I do believe that over the next few months we will see at least another round of £25bn sanctioned. 

With anaemic growth and the threat of a triple-dip the BoE seems hell bent on trying to stimulate the economy in order to aid growth. There is much debate about QE, in relation to both the intended and unintended threats. It seems to me that there will be no real answers on the merit of QE for many years. My concern over all this printing, on a global scale is inflation. At some point it has to feed through the system, at which time we could experience high levels of inflation. If this inflation hits before we are well on the road to recovery it could be very painful. The typical response to inflation is to raise interest rates, however this is detrimental to growth. Higher rates hurt commercial and residential property markets, which therefore effects banks - and we all know the consequences of this by now! So if the recovery is struggling, governments will not be able to raise rates, which means for a time we will have to live with inflation. 

Inflation hedging can be tricky in portfolios. Index-linked Gilts are very expensive. Real assets such as gold are popular inflation hedges, as is property. A more liquid alternative to property are equities, particularly companies whose revenues are linked to RPI. Utilities and infrastructure stocks revenues are often linked to RPI and so these holdings should provide relatively cheap inflation hedges, and many offer an attractive yield, unlike gold and some prime commercial property. 

It could be a way off yet, but inflation in the long run is something I worry about, more so than deflation, as I often read in the press. It will be one to watch closely, and I fear once we have it, it may be something that takes a while to contain!