Investment Newsletter June 2012
A Spaniard in the Works Euro 2012 got underway last weekend, perhaps providing some welcome relief from Euro Crisis 2012. On the pitch, Spain completely destroyed the Irish and off the pitch their economic woes are also putting the Irish in the shade! Whilst issues in Greece have been caused by an over-indebted government who have spent too much and took in too little in tax, the issues in Spain have arisen in the banking sector. Spain’s property boom dwarfed even that in the UK. From 2004 to 2008, house prices rose by 44%.
Prior to the crisis, Spain’s government ran a relatively balanced budget. However, the banks had lent huge amounts to fuel the property boom and, once the credit crunch hit, default rates started to rise. Since 2008 house prices have dropped by 25%. Much of the lending from Spanish banks had come from international money markets, rather than depositors. Since the credit crunch it has become much harder to borrow on the money markets, and many Spanish banks therefore ran into funding difficulties. Spain has always insisted that this situation was under control and they had set aside enough capital to bail out their banks. Up to the end of April, the government had injected £34bn Euros into the banking system. However, many were worried that the full extent of the drop in property prices had not yet been factored in. This came to a head when Bankia, Spain’s fourth largest bank, asked for 19bn Euros of funding. Bankia had only been formed last year by a merger of several small regional banks which had ran into difficulties. This led to rampant speculation that Spain might need to be bailed out so they could in turn bail out their banks. Spain has now been given up to 100 billion Euros from the European bailout fund. It appears that this is specifically targeted at banks and is technically a “loan” rather than a bailout. It therefore does not appear to come with all the conditions that a full bailout would come with. This is important, as Spain’s economy is suffering badly and unemployment is running at almost 25%. Around 50% of the under 25s are out of work. If economic conditions were attached to the bailout funds, their economy could suffer even more. Markets initially welcomed this deal and the FTSE 100 rose by around 1.3% to over 5,500 on Monday morning on the day after the package was announced.
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA 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 | June 2012
VolatileTimes! We suspect markets will remain volatile in the short term and could well fall back again. There remain many questions to be answered about Spain and the other European economies that have run into difficulty. This weekend sees the re-run of elections in Greece, and it is possible they could elect an antiausterity government and crash out of the Euro, just like their football team! Depending on the outcome of the election we could easily see markets 200 points higher or lower within a couple of days.
Equilibrium Portfolios In our last newsletter we explained that we had sold property holdings and were instead holding cash for most clients. This was to provide some protection against further downturns, but also to provide liquidity to buy into equities if they continued to fall. If markets continue to rise then we may have missed an opportunity. However, if that is the case, we will not be kicking ourselves. Markets fell to below 5,300 in late May. At that stage, we could see the FTSE going to 5,100 or even lower if the turmoil continued. Having already bought into markets in April, we felt it was important not to commit more money until markets got to more extreme valuations or if we saw some signs of a sustainable turnaround. Some of the issues have been resolved and so if markets fall back to that level again, we may be more comfortable with buying. As always, preserving your capital is important and we have to carefully balance risk and return.
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA 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 | June 2012
Valuations We have been banging on about markets looking very cheap for some time, so will not bore you with it too much. Suffice to say, as markets have fallen they have only got cheaper! At the risk of repeating ourselves, companies continue to post reasonable earnings results. Nothing spectacular, but generally they are growing earnings rather than seeing them fall. On a price/earnings ratio basis, if earnings are rising but price is falling, then valuations are looking more and more compelling. The price/earnings (p/e) ratio of the UK market has now dropped to 9.9 (source: Thomson Reuters 8 June 2012), well below the long term average of around 14. If earnings remain the same, the UK market would have to rise by over 40% to take the p/e ratio back to the long term average. Taking a longer view, we are convinced that equities are a good place to be. Our discretionary portfolios are therefore generally towards the top end of what we believe is a suitable equity exposure for those portfolios. This is another reason we have to be careful when deciding whether to commit some of the cash in portfolios to the equity market. Despite our confidence in long term returns, we know markets could move against us in the short term. We will therefore wait for a more compelling opportunity. If one does not arise, then that means markets will be rising and our clients should benefit as a result. Mike Deverell Investment Manager
Equilibrium Asset Management LLP Brooke Court Lower Meadow Road Handforth Dean Wilmslow Cheshire SK9 3ND United Kingdom Visit us at www.eqasset.co.uk t : +44 (0)161 486 2250 f : +44 (0)161 488 4598 e : askus@eqasset.co.uk Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA 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 | June 2012
General Economic Overview Global economic growth is likely to remain muted, but positive, with the US and Emerging Markets still expanding. The UK is technically in recession whilst the Eurozone technically is not. Interest rates are likely to remain low for the next 18 months at least. European debt issues will concern markets for some time. Inflation is falling back but not as far as many had expected. We believe it could remain persistently higher than the Bank of England’s 2% target. Asset class key + positive - negative = neutral (normal behaviour)
+5 -5
strongly positive strongly negative
Equity Markets We remain very positive based on valuations such as the Price/Earnings ratio. European debt fears may cause short term volatility and markets could fall before they rise. However, at this level, equities look fantastic value in our opinion. We particularly favour the UK market.
Outlook
+5
Fixed Interest Interest rate risk has receded for the short term but inflation could hurt bonds in the long term. Corporate Bonds still provide decent yields and could do reasonably well in this environment. We are avoiding Gilts whose values have been inflated due to recent risk aversion.
-1
Commercial Property Whilst the rental yield on commercial property remains attractive at over 6%, this is diluted by high levels of cash in property funds. We can foresee some capital losses although we believe these will be small and that overall returns will still be positive.
-5
Residential Property
-5
We believe prices are likely to remain flat over 18 months. Cash With interest rates remaining at record lows, returns on cash could remain below average for some time. However, there is a short term safe haven appeal. Balanced Asset Allocation For a typical balanced portfolio we are overweight equity and cash and underweight the other asset classes. Based on our above scores and current tactical positions we’d expect a Balanced Asset Allocation (excluding client cash) to return approximately 10.9% pa rather than the normal 8%pa.* 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.
-5