Investment Newsletter August 2013
Mark His Words By Mike Deverell Investment Manager
There have been plenty of headlines in the past week about Mark Carney, the new governor of the Bank of England. The fact that Carney’s recent press conference was the top story on the BBC when he announced no changes to interest rates, no increase in quantitative easing (QE), in fact very little new at all, is quite remarkable and shows how times have changed. Central bankers are being seen as more and more powerful as the global economy continues to struggle after the financial crisis. We only need to think back to May and June this year when the FTSE dipped from 6,840 to 6,040 in a matter of weeks, all because Ben Bernanke - Carney’s US counterpart - said they might stop QE if the economy continued to improve! So what did Carney actually say and what does it mean?
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission
Investment Newsletter August 2013
Forward Guidance
Carney has introduced a greater degree of “forward guidance” to the Bank of England. He has explicitly stated that interest rates are likely to remain low at least until unemployment falls below 7%. At present that isn’t seen as likely before early 2016. The intention of forward guidance is to give confidence to individuals and companies that they can borrow and spend without worrying that rates might rise unexpectedly. Of course, this isn’t great news for savers, but that is partially the point. The Bank would like to see savers invest their cash rather than leave it on deposit doing nothing.
Coincidentally, the Bank’s own inflation report, released on the same day, is predicting inflation of 2.4% in 18 months’ time, just 0.1% below the so-called “knock out” level! Inflation has overshot the Bank’s predictions consistently over the past few years, so it is very easy to envisage rates having to be increased earlier than 2016.
This forward guidance comes with a big caveat. Should the anticipated rate of inflation 18 months to two years out look likely be more than 2.5%, they may consider increasing rates earlier.
A New Approach?
Inflation - A New Target ?
So actually how different is this tactic to that of the Bank under the leadership of Mervyn King? Well, not very much to be honest.
King had also previously said that rates were unlikely to be raised in the near future, so some forward guidance was already being used.
Under King, inflation has been consistently higher than the 2% target for several years, with no signs of interest rates being increased. Officially, this was because the Bank has consistently predicted that inflation would drop below the target 18 months into the future. However, there was also some suspicion that the target was being basically ignored whilst they tried to stimulate the economy.
One of the biggest differences is that Carney has directly linked monetary policy to unemployment, in a similar way to the Federal Reserve in the US. Unemployment is not technically within the Bank’s remit, which is to ensure price stability and inflation within a target range.
Perhaps the most significant thing to take away from Carney’s speech was his reference to increasing rates if he believes inflation will be above 2.5% in 18 months to two years’ time.
as oil and gas, and from currency movements given the amounts we import. Or perhaps we’re reading too much into it and they’re just giving themselves some wriggle room!
The Bank’s official target is CPI of 2% pa. If it is less than 1% or more than 3% pa, the governor has to write to the Chancellor to explain why and what they are planning to do about it.
Despite the potential for higher inflation, it seems very unlikely that interest rates will rise in the near future. It is somewhat helpful to have more of an idea of a potential timescale and what would trigger an increase in rates, although it has to be said that this was in line with the market’s expectations. In fact, the market was slightly disappointed that the governor didn’t announce more stimulus, although he left this possibility open.
Carney seems to have shifted the target by 0.5% by referencing 2.5% instead of 2%. This is still within the allowed range but towards the upper end. Has he subtly changed the Bank’s target and will they now tolerate higher inflation? Perhaps the Bank has no choice given most of the UK’s inflation comes from external sources such
What is certain is that investors will be looking at the employment and inflation numbers even more carefully from now on.
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission
Market Views August 2013
General Economic Overview Developed market economies around the world have improved, with the UK picking up and Europe now officially out of recession. Interest rates are likely to remain low for perhaps the next two years, subject to unemployment figures and inflation. We expect inflation to remain above the Bank of England’s target for the foreseeable future. Asset class key + positive - negative = neutral (normal behaviour)
+5 -5
strongly positive strongly negative
Asset Class
Score
Equity Markets After the recent recovery in equity markets we are now starting to think they look around fair value. Further growth needs to be supported by growth in earnings. We have therefore downgraded our score to a -1, which means we still expect a positive return but slightly below our long term 10% pa assumption.
-1
Fixed Interest It seems likely that the 30 year rally in government bonds has now come to an end. This could drag down corporate bonds in turn, although there is value in selected funds. We have reduced fixed interest and increased property in the past month.
-4
Property Capital values appear to have stabilised and may even be marginally increasing. Should this continue, the asset class could produce reasonable returns primarily from the rental yield. Cash With interest rates remaining at record lows, returns on cash could remain below average for some time.
-2 -5
Balanced Asset Allocation For a typical balanced portfolio we are overweight equity and alternative equity, underweight fixed interest and are increasing property exposure. A neutral score (=) means we expect the asset class to move in line with our long term assumptions: 10% pa for equity, 7% for property, 6% for fixed interest, 5% for residential property, and 3% for cash. A +5 score means we think the asset class could outperform by 50% or more. A -5 means we think it could underperform by 50%. A negative score does not necessarily mean we think the asset class will fall. These represent Equilibrium’s collective views. There are no guarantees. We usually recommend holding at least some funds in all asset classes at all times and adjust weightings to reflect the above views. These are not personal recommendations so please do not take action without speaking to your adviser.
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission