Bad News Fails to Spook Investors

Equity markets edged higher today continuing a three day rally following on from a turbulent week.  There has been a substantial change in market behaviour since the start of 2013 as fear and volatility are becoming much more digestable. 

Equities have been the asset class of choice this year, as investors sought to take advantage of improving economic conditions mainly from the US.  After reaching record highs and rising almost 10% in the first three months, many investors have become cautious as this rise in equties has occurred very quickly given the level of corporate earnings and economic outlook.

We can expect equity markets to calm down somewhat as Q1 results begin to flow through, however what gives me cause for concern is the way news, especially bad news has been interpretted by markets. This year has already thrown a few curve balls at us.  Starting with Italy, their elections ended undecided leaving questions being asked about whether a governement can be formed to continue along the path agreed with the ECB and maintain their involvement with the Eurozone.  Whilst volatility spiked during this period, markets were remarkably unaffected.  There was an initial sell off on the Tuesday the results were annouced, however by the end of the week markets had closed higher.  Secondly, more Eurozone worries flowed through, this time from Cyprus as peripheral countries and their people were reminded how vulnerable they were as bank depositers faced haircuts.  This spooked the market again, having a slightly more significant effect than Italy, however yet again, over the following weeks, markets rallied back being pushed along by optimistic data out of the US.

More recent news surrounding North Korea, has been fairly localised.  South Korea has seen its markets and currency fall as a result, however global markets have been fairly reserved.

So why is bad news being taken so lightly?  This could be down to a number of reasons however it is evident that the psycological impact of bad news has been numbed over the past 5 years.  Since the credit crisis in 2008, we have seen consistent flow of bad news from Europe, then the Arab Spring, China's possible hard landing, US fiscal issues, the list goes on.  Investors have become used to this  and as a result markets can recover fairly quickly from the intial shock.  If the issues with Cyprus occured back in 2011, markets would have almost certainly reacted extremely to this. 

Another possible cause for markets to be bought back so quickly is the rotation into equity markets.  Many investors would have had a large exposure to fixed interest over the past 3 years, and now as bond yields reach record lows, there has been a rotation into equity markets (Great Rotation and the Hunt for Yield). This has certainly occured with the large amount of money sitting on the sidelines in cash.  As a result many investors see market pull backs as an opportunity to increase thier positions.  There is still a significant amount of money still on the fence, and this could continue to act as a support to markets throughout 2013.

A word of caution, when investors become complacent bad things tend to happen, so be wary of asset bubbles. 

In the meantime enjoy the ride, and if you are one of those investors still on the side line, climb aboard there is still plenty of opportunities out there.

Trouble in Egypt

A country that has fallen off many peoples radar is Egypt.  This used to be a top holiday destination and attractive investment area before Hosni Mubarak, the President for over 25 years was ousted by a public uprising.  Since then this country has slipped into the Abyss, continuing uncertainty and lack of structure within the country has led to many holiday makers and investors to stay away.

The two biggest income streams for Egypt are tourism and foreign investment, the land is rich with natural resources, hot weather and beautiful seas.  The political uncertainty has acted as a deterrent and with many business contracts that were put in place during Mubarak's reign under dispute it is making it less desirable for the overseas investor.  Subsequently Moody’s downgraded Egypt to Caa1, on par with the likes of Pakistan.   This on the face of it seems unruly, however if you delve a little further into the state of the economy you may understand why.

For years the people of Egypt have received significant subsidies for things such as oil and food, but as global costs rise this pressure has been passed onto the government.  Economic growth prior to 2011 was around 6%, an attractive level, however this has fallen off significantly as demand for Egypt has dissipated.  This economic weakness has been amplified by the weakening local currency.  This year alone the Egyptian Pound has fallen off 7% making those sought after imports such as fuel and food more expensive.  As such petrol shortages are now common throughout Egypt.  Price rises have been so severe many distributors are not buying the allowed quota as they fear the wrath of their customers when they see prices have risen so much.   Rolling blackouts throughout Cairo are not uncommon as during the midst of summer weather energy demand is in full throttle as people use air-conditioning. 

With many structural and political issues still to overcome there have been talks with the IMF about an emergency loan of around $5bn to keep things ticking.  The key importance is to make the country more stable and attractive for foreigners and generate demand again.  Political issues over business contracts certainly are not the way forward however, we may see heavy royalties inflicted on those already situated as a method for government income generation.

A number of companies operating in this area, such as Centamin (gold miner) are currently very cheap, however like many their mining contract is under dispute.  There are certainly  opportunities, however investors will most likely keep a close eye on over the coming months before jumping in.

The market is waiting for that bold statement, “We are ready for business”.

Mid Week Market Update

We're half way through the week and global equity markets have been broadly flat over this period. 

There was initial optimism following the announcement a bailout agreement had been reached. However, as markets digested the exact agreements of the terms this optimism faded and markets dipped lower as a result. The problems with Cyprus have not simply been resolved with this bailout and it is clear there could be years of pain ahead for the small Euro nation. Consumers may have experienced a hit to their savings and will now be faced with increased taxes and austerity, which will not be supportive of consumer spending. We may also see unemployment increase as businesses could face liquidity issues due to the closure of Popular bank and the banking sector shrinks.

So onto the good news! Well, not for the first time U.S. data surprised on the upside with Tuesday's Durable Goods Orders data increasing to 5.7% (consensus was 3.9%). This helped raise the S&P 500 to near all time highs, although it did fall slightly from this peak. 

Wednesday so far has disappointed in the UK, with the FTSE 100 initially rising but gains have since disappeared. UK GDP data for Q4 showed it had increased by 0.2% year on year, which was slightly below market expectations and may have caused the market to reevaluate their views on the UK recovery. 

French GDP data for Q4 showed the country had contracted by 0.3% year on year, a worrying trend for the Eurozone's 2nd largest economy. 

Our regular feature The Week Ahead should hopefully provide a 'heads-up' of some of the global data being released that week. 

Eurozone - the uncertainty is back

Europe continued to be the main focus around global markets today as the ECB gave a March 25^th deadline for Cyprus to come up with a plan to raise a further €5.8bn.

The mood was further dampened by poor manufacturing data out of Germany and France, the bears gained momentum as similarities to last year show.

Whilst last year did not have the momentum of money moving into equity markets, and an improvement in the U.S, we did see equity markets rise at the start of the year over optimism that the worse was over for the Eurozone.  Then... equity markets fell off a cliff as worries Greece would vote in an anti-austerity government causing the possible break-up of the Eurozone.  This did not happen, however with its neighbour Cyprus banging on the door, we could see a similar situation.

Many have a fairly heavy weighting to equities within their portfolios, and this would have turned out nicely over the past 6 months.  But questions may be rolling through the minds of many investors as doubts whether the Eurozone can keep funding bailouts spread.  With Germany’s elections coming up in December, Merkel is somewhat on the back foot about using tax payer’s money to bailout countries which have been reckless with their economic policy.  Anti-austerity political parties in many countries are gathering momentum as seen in the most recent election in Italy and it is a concern this may happen in Germany, resulting in a Eurozone without a leading economy.  A lot can happen until then, but it will play a fundamental role in the future of the Eurozone.

This year will certainly be a bumpy ride for the Eurozone, and with Cyprus issues to be resolved, uncertainty over an Italian government and economic issues in France (read more on this soon) let’s hope the end result is positive.

I still maintain a positive outlook for equity markets over 2013, and as long as these issues are resolved quickly, it will draw focus away from the negatives and look forward to the possibilities the future holds!

Check out our Top 10 Funds of the Month to see which funds we rate highly.

The Budget and Bubbles...

The UK budget was announced yesterday and really it was a bit of a let down. There were no bold policies to tackle unemployment, no venturing from the austerity path and really it seems that the UK is going to attempt to muddle through the current problems and that growth, at best, is going to be very slow, if not declining.

There was one interesting point though that I think it's worth commenting on and this is with regards to UK housing. The coalition has pledged up to £130bn for mortgages where buyers can only afford 5% deposits - in effect they are guaranteeing high risk mortgages. The reason to me why this is quite alarming is that high risk (or sub prime) mortgages in the US were what brought on the credit crunch. In effect banks were lending money to people who simply shouldn't have been lent money; this created demand for housing, forcing up prices. Once it became apparent houses were over valued and that many people could not maintain mortgage payments house prices tanked, triggering the start of the credit crunch. 

Since then, it has been a lot harder, and rightly so to acquire a mortgage, with banks demanding bigger deposits. So it seems a little strange that the coalition is now willing to support these house buyers who regular banks would deem not fit for a mortgage. 

For now we will have to wait and see what happens. Home builders such as Taylor Wimpey saw their stock price rally yesterday on the back of this news, with markets foreseeing demand for housing and new homes growing.

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.

Rural Expansion and the Control of Urbanization

The process of economic development usually begins in the capital city, or most built up areas.  As we have seen with China over the last decade, rapid expansion occurred within its major cities prompting a necessity for huge investment in infrastructure and housing.

This pathway to becoming a developed economic country is a tricky one as acceleration within urban areas can cause the economy to collapse onto itself if this occurs too quickly.

China, over the past decade has had double digit growth as a cheap workforce stormed this huge nation into a competitive superiority over other developed countries.  As with all things, this cannot go on forever.  Industry and construction fuelled demand on a global scale for raw materials and machinery boosting company profits around the world.  Infrastructure spending in China was vast, Bejing’s underground railway had only two lines up until the start of the century, today there are 15 lines spanning  300 miles, with just under 8 million people using it daily and further expansion planned.  As with the underground system, housing has expanded at a similar pace.  With urban areas reaching capacity, there are a number concerns around the state of the economy in China.  The property market has seen rapid price increases and the government has warned it may increase taxes on second homes in order to curb further inflows into the property market.

The problem arises from rapid expansion in the urban areas, with little development outside.  This results in a greater demand for the built up areas causing a further divide.   This process is unsustainable and will eventually lead to asset bubbles and subsequent crashes.  A tempered approach is needed to structurally grow the rural areas as well.   In China this is starting to occur, but savvy infrastructure spending is a necessity.  

China has a long way to go in developing its vast nation further, but with wage increases and growth slowing, a number of hurdles are still to come.  The property and banking sectors are in my opinion the areas of major concern.  Such a rapid demand for new homes and mortgages begs the question, can these people repay their debt?  If this is not controlled, it may lead to a banking crisis similar to what we saw in 2008.

Enough about China… Another major economic player is Latin America.  Brazil especially has seen similar rises in its urban areas (maybe not at such an extreme pace).  With a majority of the wealth within its major cities, there will come a point where more rural areas begin to follow suit.

Wage inflation has started to occur and demand for more mature food stuffs are on the up.  There is much development still needed. The amenities available in rural areas are slim, and this follows through into demand for temporary measures such as generators.  Companies benefiting from this specifically are Aggreko, the largest generator maker globally.  Also, JCB announced strong demand for their vehicles(diggers) as construction ahead of the Rio Olympics is well under way.  After some good results recently, it is inherent demand in emerging markets is on the up and up. 

Emerging market investment funds will be your best bet to capture some of this upside.  First State Global Emerging Market Leaders would be my choice, however with such a pull on infrastructure spending still such a necessity, First States Global Listed Infrastructure fund is prime for growth.

These rapidly expanding countries have the size and ability to become some of the leading economies in the world, however it will not be a smooth ride and the management of growth throughout the whole country is needed.

Auto Sales - A Sign of Improvement

Construction and industry are what many great nations have been built on. In the midst of the industrial revolution the first automotive was created in 1806, since then they have played a fundamental role in the growth of the global economy.  Now around 62 million cars are sold around the world each year. 

During the credit crisis one of the most affected sectors hit was the automotive industry.  As many see cars as a luxury, new car purchases crashed to the floor.  A number of companies sought emergency loans, most notably GM Motors, Ford and Chrysler receiving a record bailout from the U.S and Canadian government of around $85bn. 

These big three have recovered somewhat since 2008, however global competition has been ever increasing.   Since the start of the Eurozone, Germany its primary contributor has benefited hugely and as one of the major producers of cars they have seen profits rise significantly on the back of a weaker currency. 

Asia follows suit as currency plays a key role in exports.  Japan has historically been a major producer of cars, such as Toyota and Honda.  However, these companies have been hampered over recent years by the strengthening Yen and until recently has had trouble competing with the likes of South Korea and China. Since the introduction of the new Prime Minister, Shinzo Abe, the Yen has weakened significantly by around 20% and this will inadvertently roll through to company profits. 

The gathering pace in automotive industry should start to show in company profits by April, and a number of funds are well positioned for this.  Aberdeen Japan Growth and JOHCM Japan have a heavy weighting in the automotive sector and would be my pick.

Over the past twelve months, we have seen consecutive rises in auto sales and this is a good sign the global recovery is gathering pace.  This lagging indicator has a powerful message and is one to look out for.

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!