Investment Newsletter May 2012
Acropolis Now? After a strong rally over the past 6 months, volatility has once again returned to equity markets. After hitting over 5,960 in mid-March, the FTSE 100 has slipped back to below 5,400 as I write (the morning of 16 May 2012)
Greek Default? The market falls have been caused in the main by renewed turmoil in Europe. Elections in France and Greece could mean a move away from the austerity packages previously agreed with the European Union. Once again, political uncertainty is leading to market uncertainty. Whilst the two traditional main parties in Greece have vowed to stand by the austerity measures, between them they do not have enough seats to form a coalition. The far left anti-austerity Syriza party gained significant support but again don’t have enough seats to form a government. New elections are likely to be held in early June, and opinion polls suggest that Syriza could gain the most seats (though again, not a majority). If Syriza gain power then they will likely renege on previously agreed spending cuts. This will probably mean that they will not receive bailout funds, will default on their debts and leave the Euro. As we have always said, Greece defaulting and leaving the Euro should not cause massive problems in itself (except for the Greeks) due to the small size of their economy. The danger has always been the knock on effect on both the banking system, and then on other peripheral nations like Portugal. Much has been done in the past 6 months or so to shore up the banks and to put in place “firewalls� to stop contagion. There is debate about the size of the European bailout funds and, whilst it may deal with Greece, it is not large enough to also deal with issues in Portugal, Spain and Italy as well.
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 | May 2012
However, although banking shares have fallen, there does not seem to be the knock on effect to the banking system and the drying up of credit markets that we saw last year. For example, the LIBOR and EURIBOR rates are much lower than they were 6 months ago. These are the rates that banks charge to lend to each other. As risk increases in the banking sector, these rates tend to increase. However, rates are barely changed and in fact are still falling slightly. This leads us to believe that the risks to the financial system have perhaps been overstated. Likewise, the election of Francois Hollande as the new President of France, has also caused some nervousness. He has promised to focus on economic growth rather than austerity. However, he also promised to balance the budget by 2017, only one year later than Sarkozy’s target of 2016. Interestingly, France hasn’t balanced its budget for more than 30 years! Whilst there are some other proposals, essentially it seems that Hollande wants to keep things pretty much the same, but with fewer spending cuts. Investors want reassurance that Hollande and Germany’s Angela Merkel are still able to agree on the main issues and provider leadership at the heart of Europe. If this occurs, then we can perhaps move forward.
Market Outlook Whilst uncertainty always causes volatility, our view is that the companies that make up the stock market remain undervalued. Companies continue to do well with over 75% of US firms that have reported earnings since the beginning of April (known as earnings season) beating estimates. We live in a global economy these days and the global economy continues to grow, albeit at a slower pace. Although the UK is now back in recession, this is just a numerical technicality. It is a clearly difficult economic time but whether we had slight growth or a slight contraction in the UK economy makes little odds. Despite how it is portrayed in the media, this isn’t technically a double dip recession, since we have not been in recession since early 2009. A recession is defined as two successive quarters of negative GDP growth. A double dip generally means a return to recession after a quarter or two of growth. We have had three years of recovery, albeit a bumpy ride at times! The official UK GDP figures differ quite markedly from many business surveys and so many economists expect growth to be revised upwards as more data is available. The initial estimates are based on incomplete data, and so are often substantially revised. The below chart from Markit Economics shows how different initial GDP estimates can be from the final figures: UK GDP, quarter on quarter % change 2
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p Revision 2.0 % oints
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Latest estimate
1.5 1.0
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-1.5 -6
-2.0 '98'
99
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So urce s: ONS , Ma rk it.
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 | May 2012
Investment Strategy As we still believe equities remain undervalued (the UK price/earnings ratio at 10.3 is 35% below the long term average of 14), we believe the current turmoil is a buying opportunity. As you will know, we have previously traded volatility to good effect, buying tracker funds on dips and selling as markets rise. For most clients, we have held 5% of your portfolios in “tactical” cash in case we saw another fall in markets. We have now put that 5% to use, buying a FTSE Allshare tracker when the FTSE 100 was at circa 5,600 for most clients. We are currently selling down our position in UK commercial property as the outlook for this asset class remains relatively poor. For clients in our ideal discretionary property portfolio, we are selling Aviva UK Property and SWIP UK Property Trust in full today. The other two property funds we held, run by Ignis and M&G, we are selling in smaller chunks over a number of weeks due to the danger of a “re-price” of these funds (which could drop the value by circa 5%). We intend to hold this money in cash with the aim of taking advantage of further investment opportunities as they arise. Our philosophy is always to try and “make volatility our friend”. Whilst those of you receiving valuations in the next few weeks may be disappointed, we do believe this is a short term dip and represents a great opportunity to buy equities cheaply. Of course, we remain vigilant and if the facts change, we will not hesitate to change our minds and our strategy.
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 | May 2012
General Economic Overview Global economic growth is likely to remain muted, but positive, mainly due to US and emerging market growth. 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 reasonable 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 probably be positive, but low.
-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. * Includes Defined Returns holdings. See previous briefings for details. 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