Tuesday, 15 July 2014


Investors have been treated to a game of two halves this week. On the positive side the underlying economy continues to make progress, with the US and UK as standouts. However, on the negative side investors became concerned that we could be seeing the re-emergence of the Eurozone banking crisis. However, we have good reason to believe that these fears are overdone and markets somewhat stabilised later in the week as cooler heads prevailed.
We think one of the biggest plus points was that we now know that the US Federal Reserve plans on ending the tapering of its quantitative easing programme by October this year. We see this as an encouraging sign that the world's largest economy appears to be well on the path to returning to normal. Back in the UK, a new report from the British Chambers of Commerce [BCC] revealed that company bosses believe that the underlying economy is still improving and continues to move in the right direction, however, they signalled that growth may moderate from its current strong pace. We believe that slower but still robust economic growth actually helps to ease the pressure on Bank of England Governor Mark Carney to hike interest rates earlier, which could put at risk some of the progress made so far.
Events in the European banking system put a dampener on things, after Portugal's second-largest bank missed a repayment on its bonds. Investors reacted quickly and markets sold off, but we believe that fears over further bank contagion are overblown and the three factors highlighted below detail why we think this to be the case (more detail can be found in Background to Latest EU Bank turmoil below)
  1. Portuguese bank assets account for 'just' 1.6% of the Eurozone financial system
  2. Exposure of foreign banks to Portugal remains low
  3. European Central Bank [ECB] guarantees remain in place, ready to assist firms in need of cash [or liquidity]
Stock markets recovered some ground towards the end of the week as investors further digested the news. Ultimately we think that the positives of the global economy will start to shine through with greater clarity over the longer-term. With the second-quarter earnings season upon us, the picture in Europe looks to be generally stable, along with a moderately weaker Euro. We think European companies will be broadly in line or perhaps even slightly better than some are anticipating. Whilst over in the US the consensus is calling for around 8% growth in earnings, but we believe that given improvements in consumer and business activity, that we may even see a decline in uncertainty, which may benefit investments for growth, along with mergers & acquisition activity.
The UK economy has been one of the stars of the ongoing global recovery, with rates of growth that have at times exceeded global peers. Encouragingly – in a strange way - the pace of growth looks set to moderate, after a strong surge in the first quarter, yet it should still remain stable in the second quarter. This should help ease the previously mounting pressure on the Bank of England to hike interest rates even as early as the end of 2014.
A new report from the British Chambers of Commerce [BCC] that surveys over 7,000 UK businesses suggests that company bosses believe that the economy remains strong and continues to move in the right direction, but some indicators point to a slight softening in the services and manufacturing sectors, following the strong pace seen in Q1. The BCC were keen to stress that the domestic banking system still needed more unclogging and further work to allow it to provide the loans that businesses need to finance themselves and any expansion plans they may have ready to go when the timing looks right. They warned Bank of England Governor, Mark Carney, not to make any 'hasty decisions' on increasing interest rates in the short-term.
The BCC said that any early rate hikes could drive up the cost of obtaining finance and crimp the 'growth ambitions' of fast growing firms, the very same businesses that the economy is counting on to help drive growth forward. The BCC believes that Mr Carney's priority should be ensuring that companies have the 'security of working in a low interest rate environment'
Another area singled out by the BCC was that of the strength of sterling, particularly for its impact on making British exports more expensive overseas. Talk of earlier than anticipated interest rate rises has led to the Pound being one of the best performing major currencies around the world.
We think two of the key things the Bank of England will be monitoring closely will be that of inflation and earnings. Inflation has currently moved below the long-term target and wage increases have clearly turned positive, but earnings growth still lags that of the rate of inflation, which may mean that Mark Carney is under less pressure to increase interest rates sooner rather than later. An early interest rate hike could act to dampen consumer demand and dent optimism at just the time when businesses are beginning to feel secure enough in the underlying economy to start expanding their firms in a meaningful way and we think this would help underpin economic growth over the long-term.
We believe that the Bank of England will take some comfort from this latest survey. We note that whilst UK economic growth has been relatively strong compared to its global peers, it does not appear that the country has reached the 'escape velocity' that may warrant higher interest rates just yet.

Tuesday, 8 July 2014


The second quarter of 2014 ended with positive, albeit somewhat pedestrian investment returns. For UK investors, the rise in the value of £-Sterling by a near double digit rate, took some of the shine off overseas investments. Year-to-date (Ytd) lower risk, fixed interest investments have still generated slightly higher returns than higher risk equity investments.

This is very much at odds with last year's picture, when equity dominated investment strategies outperformed fixed income strategies at a rate of 3:1. Despite this, the first days of the new month and quarter have seen a surge in stock markets around the world as various economic news items persuaded investors that equities may have more upside potential than recently thought. On the one hand much improved industrial output and falling unemployment figures in the US and UK provided more evidence that the Q1 slip was indeed caused by adverse weather and not a reversal of sentiment. Just as important for market dynamics were comments from 3 of the 4 major western central banks (US, Eurozone, UK), that they would not let excessive market valuations dictate monetary policy for the real economy. I.e. they would not raise rates even if perceived asset bubbles started to build. Markets would have to deal with the volatility they seed and central banks would use their macro prudential intervention tool sets (E.g. mortgage restrictions et al) to prevent turbulence spill over from becoming a systemic threat for the financial sector. What felt like a concerted action by the central bankers (which probably was not), combined with the reassurance of the sustained growth scenario acted as a jolt for the lacklustre stock markets of late. US stocks hit new all-time highs while UK and Eurozone markets reclaimed previous 2014 highs. Central bankers may have felt obliged to clarify their position after the Swiss based Bank for International Settlements (BIS) called for a hike in interest rates. This was to prevent further asset price increases, which they see as being driven by the continued low interest rate and QE driven monetary environment. The BIS is often portrayed as the 'Central Bank of Central Banks' although it's role is more that of a global central banker association rather than having meaningful authority towards national central banks. The BIS has changed tack from warning about the inflationary pressures of QE to warning about the destabilising potential of asset price inflation. With deflation currently being the far more relevant issue, it feels as though we are witnessing a growing divide between 'Germanic' and 'Anglo Saxon' central banking perspectives. From my standpoint I side with the 'Anglo Saxon' side, with a focus on getting the real economy properly back on the growth track, while using regulatory oversight measures to reign in potential excesses in the financial sector. To be clear, the 'near death' experience of the 2008/2009 Financial Crisis is in my opinion likely to prevent bank excesses for the foreseeable future on its own (See UK banks own mortgage tightening long before the BoE became active). The so called shadow banking sector of credit and loan securitisation for investment by the general public is a slightly bigger concern, because the decision makers here are not finance professionals. It is therefore not surprising that the US Fed's chair Janet Yellen singled out leveraged-loan debt securities and corporate bond valuations as areas where macro prudential oversight measures may be used to prevent potentially destabilising market developments. 

To summarise: As the expansion of the global economy picks up momentum again, company earnings will improve which helps justify higher stock market levels and thereby investment portfolio gains. As a side effect and late rumble of the financial crisis, the unusually low interest rate levels at this stage of the cycle, have the potential to confuse valuation measures compared to the very straight forward metric just mentioned. This is highly likely to result in more volatile asset prices than we are historically used to. Temporary overshooting and undershooting within the longer term positive trend of an expanding global economy is going to be an on-going market characteristic for the foreseeable future. Itwill be quite risky to anticipate and even out from a portfolio management perspective. At Tatton we will do our best to steer client's investment portfolios through these choppy markets, but have to advise that investors are likely to have to withstand having to bear more short term ups and downs in order to reap the longer term higher return rewards of capital market investments, than they may have been historically used to.

Vist Kassius Annuities News for more

Thursday, 3 July 2014


Equity markets retreated slightly during the past week as the second quarter of 2014 draws to an end and investors are nervously awaiting whether the Q2 economic results will have made up for the poor winter quarter. Meanwhile the big news for the British public was (not football) that UK's central bank, the Bank of England (BoE) walked the talk and introduced what we had been expecting for a while: A set of direct mortgage lending restrictions on banks, with the objective of slowing the further rise in UK residential property prices without having to begin raising interest rates. The restrictions will only apply if house prices continue to rise at a rate which would amount to more than 20% over 3 years (roughly 6.3% p.a.). Mortgage lenders would then not be allowed to lend more than 15% of their mortgage book to mortgagees where the LTI (loan to income ratio) exceeds 4.5%. They will also have to make sure borrowers would be able to afford a 3% rise in mortgage rates from their discretionary income component. On the basis that not a single lender currently breaches these limits, they are more a message and warning from the central bank, than an outright market intervention. However, I noted with great interest the threshold level of an additional 3% for the mortgage affordability stress test. This strongly suggests that the BoE is not expecting that they will be raising interest rates above 3.5% during this economic cycle – well below the long running average of 5%. During a BBC Radio4 interview on Friday morning the bank's governor Mark Carney became even more explicit and said that their expectation was for interest rates not to exceed 2.5% at the end of the cycle. The implication of this is that the public's rate expectations are probably too high, while the markets are potentially now for the first time underestimating the potential for rate rises over the coming years. This would also explain what seemed to many observers as confusing and apparently contradictory statements by the bank's governor Mark Carney over the past 2 weeks (more on this below).

I was delighted to learn that UK business investment is further accelerating, exceeding last year's levels by a strong 10.6%, having now grown for a consecutive 5 quarters back to pre-recession levels. Reviving business investments into productive capital is very important for the longevity of this economic cycle and I have stated since the end of last year that only a meaningful pick up in company investment will extend this recovery into a meaningful expansionary cycle in which equity valuations can gain far more headroom than they have had so far. Economic news flow in the US continued to be strong for the current environment, which is to some extend a catch-up and rebound from the economic contraction the frozen out first quarter produced. Europe has no such excuse and the fact that the recovery there has begun to lose momentum, gives me hope that the Eurozone's central bank (ECB) will pick up the courage and engage in similar extraordinary monetary support that has lifted the US and the UK out of recession. This will be good for the Eurozone economy and by virtue of our high trade volumes also provide a further boost to the UK – watch this space!