STOCKS AND BONDS BOTH MAKE THE HEADLINES

Market action over the first part of the past week appeared to make sense – the second half left market participants wonder whether they had collectively gone slightly schizophrenic. First equity markets in Europe and the US rallied to new highs as economic data and central bank statements appeared to create the Goldilocks environment of ‘not too warm, not too cold’, stock markets like so much. In Europe equity markets seemed to ‘salivate’ over the prospect that the ever falling rate of inflation will force the ECB to finally launch its own program of quantitative easing (QE) - aka - printing money. Then on Thursday and after the Bank of England’s governor Mark Carney had talked down exceptionally good UK data they appeared to realise that monetary easing actually is a consequence of things not being quite alright. Stock markets fell quite abruptly by up to 2% and even more extraordinary, longer maturity bond yields fell back sharply. This bond rally (yield and bond values move inversely) was even more astonishing as most market participants have for a while now expected a break out from the recent tight trading range, but on the downside, not the up! On Friday stock markets came back to their senses and recovered somewhat, however, 10 year gilt and treasury yields have stubbornly remained at around the 2.5%.

It seems nonsensical that bond investors should be willing to accept less return for their locked-up money, when the economy is expanding and therefore better return alternatives are available and inflation eventually rises and eats away at the purchasing power of bond values. So what has happened? The simple answer is: The central banks got their way but market participants can’t quite explain why.

When longer maturity bond yields almost doubled last year on better economic prospects, central bankers were not best pleased, because markets were undoing their QE efforts of keeping not just short term rates, but also the longer term cost of capital low. This was to absolutely make sure that both the credit markets and the wider economy can sustainably recover. It seems that only over the past few months markets have come to actually believe central bankers’ assurances from last year that this time they will keep rates low for longer. Various reasons were banded around this week trying to explain why yields were falling when things actually look up a lot more. My humble opinion is simply that amidst last year’s euphoria over the economic recovery, bond yields overshot and what we have seen now is a re-adjustment towards a more gradual incline, as would have made sense all along. I therefore strongly disagree with those who (once again) interpret this temporary countertrend movement as heralding the end of this economic cycle. I expect that a more measured and gradual rise in yields will resume fairly soon. There is a positive here which too many market commentators have failed to mention, which is that low cost of finance is supportive for economic growth. Last week’s disappointing GDP and industrial output growth figures in the Eurozone serve as timely reminders that there is still not much reason to get carried away and to expect cyclical overheating symptoms any time soon. The gradual normalisation process is to some degree unchartered territory, because central banks have never before been as determined to see the economy and the financial sector heal, before withdrawing their support. This causes unintended side effects, the UK house price inflation pressures being one of them. However, we must not confuse cause and effect here. A house price rally in the past may have been experienced as a late cycle occurrence, which this time around is very unlikely to be the case. As such expect the UK’s Bank of England to unleash their arsenal of macro-prudential defence instruments instead of early rate rises, once they come to the conclusion that further price rises (beyond London) are posing a risk to our future prospects. Lower loan to value and/or mortgage to income ratios enforced through the banks will prove very potent means of calming things down. I now don’t expect the first UK rate rise before the general election in 2015.

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2014: DON'T SELL IN MAY AND GO AWAY

The first week of May, brought some interesting developments and economic stats which make me believe the old English adage of 'Sell in May, go away and don't return before St. Ledger day' has a low likelihood of providing a successful market timing strategy for 2014.
Last year if one managed to time the exit correctly, at the end(!) of May, most of 2013's available returns would have been realised. This year things are looking different.   Firstly stock markets are hardly up and secondly the first 4 months of 2014 have seen an overweight of doubt and unease amongst market participants, compared with the first months of 2013 when the confidence hike in the global economic recovery drove up valuations. I also suspect that equity markets have misinterpreted the rebound in government bonds as a sign of a potentially more significant downturn in market sentiment. The much observed 10 year government bond/gilt rates have fallen from the 3% mark they reached back in December to 2.6 - 2.7%. The inverse relationship between yields and bond values has made gilts and treasuries some of the best performers in 2014 so far. Falling yields are usually a sign of a deterioration of market sentiment and as a result the usual ("perma-") bear commentators have taken this as evidence that the end of this market cycle is nigh (again). I disagree. Most of the observed fall is explained by firstly the previous overshooting at the end of last year and secondly and in my mind of far greater relevance, a marked change in inflation expectations, as the chart below shows.

The red area shows the change in implied inflation expectation as can be derived from the prices of inflation linked government bonds. Since the beginning of the year this component part of long term yields has fallen by almost as much as the yields have fallen in total. The rationale for this is that more and more investors have come to realise that despite the QE programs of the past years, inflation in the next years is likely to remain below average, because surplus capacities and weak consumer demand will keep inflation pressures at bay longer than is normally the case. The resultant expectation adjustment to such a "Lowflation" environment has resulted in a temporary yield step down. There has also been a limited 'flight to safety' downward pressure over Ukraine/Neo-Cold-War concerns, but with the economic climate continuing to improve I expect 10 year gilt yields to now gradually move back to the 3% level. After last year's violent move from 1.6 to 3% this move is much smaller and potentially so gradual that together with yield payments, outright losses from gilts seem much less likely this year.

Now back to the developments mentioned at the beginning. The European Central Bank (ECB) surprised this week, not by keeping rates unchanged, but by announcing that they will be easing monetary conditions after their next meeting. Mario Draghi stated that the governing council was dissatisfied with the projected path of inflation and therefore "comfortable to act next time". After getting peripheral Eurozone government bond yields very comfortably under control (Ireland now has borrowing costs below those of the UK and Spain's and Italy's 10 year yields have dropped below 3%) with his 2012 "whatever it takes" threat, the Eurozone is now challenged by the resurging strength of the Euro and very subpar credit  availability to expanding businesses. When looking at the above chart this is not overly surprising, as the Eurozone's monetary base has shrunk because of its impaired banking sector, while the economy is expanding, leading to very tight credit and capital inflows from abroad pushing up the currency.

The other meaningful development has been around Ukraine. Contrary to how it may seem against the newsflow, from a global economic and markets perspective the deterioration of the conflict towards a civil war has actually led to a limitation of the wider economic consequences. Paired with Putin's more conciliatory tone towards the end of the week, when he spoke of pulling back Russian troops from the border and advising the separatists not to pursue the independence referendum, it lowers the probability of the West having to impose more painful sanctions. Markets reacted positively with the Russian MICEX index rising more than 7%. As sad as the developments are for Ukraine's people, the geopolitical dimension of this conflict has just been significantly reduced.

A raft of positive economic data, with the exception of Japan and the Emerging markets, helped to push markets higher and particularly the US Fed's Yellen's regular testimony before Congress assured markets that monetary tightening is still far out on the horizon.

Altogether therefore a strong start to May and a good perspective that over the coming months the UK and European equity markets will break out of their trading ranges and reflect the more resilient and positive  economic growth picture that is presenting itself.

APRIL BROUGHT MORE 'SUNSHINE THAN RAIN'

April ended on a positive note for equity investors, however, because of a disappointing January and March, 2014 has so far not generated meaningful positive returns for most investors, when compared to the same period last year. In our 2014 outlook last December, we did advise that this was possible to happen after equity markets stormed ahead in late 2013. This was in anticipation of what was to come in terms of more positive economic news in 2014.

As it happened the first quarter's economic progress turned out to be positive, but less than anticipated in the US (because of cold weather) and in China (because of credit market overheating) than anticipated. Given these two had been the Global growth engines of late, the limited progress in the stock markets seems a sign of prudent investor behavior. This gives us comfort that capital markets are not overheating as some of the permanently bearish commentators have been suggesting.

Low risk assets like government and corporate bonds have generated the highest returns so far this year. This seems counter intuitive against the backdrop of a worldwide improving economic picture which normally drives up yields and thereby reduces bond values. It can be explained as a temporary counter movement after last year's significant declines in bond values and resurgent concerns over geopolitical stability caused by the Ukraine crisis. Since the middle of March we have seen broad confirmation of the sustainability of the recovery, with a broad range of forward looking indicators turning positive, once more.

This has re-established 2013's general market environment, whereby investors are now awaiting the better economic environment, to feed through into company earnings. At the moment it is too early to see a feed through yet and so market participants are eagerly observing companies' outlook statements for any hints

During the past week equity markets continued their strong upwards movement and came close to previous highs. This was not on the back of strong company results which were positive but uninspiring, but rather a general positive sentiment swing. The surprisingly good US employment growth figures and the continued mergers and acquisitions announcements helped to persuade more investors that the likely way for the economy over the coming months is up, not sideways as in the first quarter

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ECONOMIC DATA IMPROVES PUTIN'S 'WALL OF WORRY'

The Easter Week 2014 kept a balance between encouragement and disappointment. Encouragement came from the economic and company results, disappointment from global politics. Economic indicators from China to the US showed a pick-up of economic activity and corporate earnings after a disruptive winter in the Northern hemisphere. The once again increasing tensions between Ukraine and Russia ensured that investors didn't forget their concerns and worries about everything that can at any point go wrong and 'spoil the broth'.

Hopes that the Geneva Accord would bring a truce to the crisis were quickly crushed and the increasingly hostile environment does not bode well for a peaceful resolution of this stand-off. Judging by the muted market reaction, there appears to be an expectation that this is all a big game of chicken, in which Russia's president Putin is trying to bully the weaker Ukraine into concessions towards more influence and control by Russia of the heavily industrialised Eastern Ukraine. It isn't entirely surprising that this coincides with a notable economic slump in Russia's economy and a sizeable amount of nationalistic distraction is there-fore quite possibly intended. We continue to follow the developments around Ukraine closely, because a sizeable geopolitical upset has become pretty much the only event which could currently derail this recovery.

The continued rumbles around the Ukraine tensions are unhelpful, but need to be put in context, of a relative minority causing trouble in a post revolution power void, rather than a majority desperately seeking to break away and join Russia as was the case in the Crimea.
During our monthly Tatton investment committee meeting we deliberated at length on the developments of the first quarter and whether our central scenario of a pick-up of the economic recovery momentum has changed. The answer was a resounding 'no change' and so we have kept our portfolio allocations unchanged with only a few fund changes which have become necessary and opportune. The one area where we might introduce changes in the coming months is fixed income. With the risk of a severe deterioration of bond values dissipating as the yield and (low) inflation environment stabilise we are looking to reposition the Tatton portfolios to reintroduce their gilt 'stabilisers' as soon as is this makes good investment sense.

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MARKETS PROVE THEIR RESILIENCE AS UKRAINE FLARES UP

Equity markets have once again proved their resilience this week as tensions in the Ukraine flared up again on the news of a number of clashes involving pro-Russian and pro-Ukrainian forces. These events however, did not completely overshadow the positive economic news flowing out of the US and the UK, the two best performing economies in the world today.

Stock indices in the UK have remained largely range-bound. Over in the US, both the large cap-focused Dow Industrial and the broader S &P 500 saw solid gains on the back of some fairly decent corporate earnings reports, particularly within the healthcare sector, and some strong consumer spending data. The Dow bounced off key technical support levels early in the week to rally nearly 400 points – or 2.5% - later on as investors took some positive signals from the release of the latest US Beige Book. Overall, the core assessment of the economic conditions of the US were quite bullish, noting that growth 'increased in most regions' and that the labour market was 'generally positive'.

Retail sales across the US appear to be recovering, particularly in hardest-hit New York as weather conditions improved and consumers returned to stores. As we head towards the summer, we would expect that further progress looks likely given the solid rebound in the jobs market

The UK economic recovery reached another milestone this week on news that wage growth has now caught up with the rate of inflation and it appears increasingly likely that income growth could outpace the rise in prices in the near-term. We think that this could help provide a further boost to consumer sentiment, as people feel wealthier. This could therefore have a positive effect on spending patterns.

The Chinese also provided investors with more good news. China revealed that its quarterly GDP number beat expectations, which now extends their continuous run of market exceeding growth to over 10-years. There were some slight negatives within the data, suggesting a slightly softer patch of economic growth may be on the horizon. We would like to note that China is currently engaged in wholesale measures aimed at cleaning up its financial system and removing any systemic threats that could crimp its growth. We feel that investors should be mindful of those risks but that they should also remember Chinese leaders have rarely put a foot wrong in dealing with these threats and we believe rates of GDP growth of over 7% whilst simultaneously de-risking its financial system is mightily impressive.

The flaring up of tensions in the Ukraine acted as something akin to a dark cloud hanging over markets and by all accounts, the situation is serious and dangerously fragile. What do we think are the global economic and asset implications? We view these impacts as likely being more local than global. Despite the large size of Russia's economy, it has relatively limited integration with the world economy outside of supplying energy and natural resources, which could suggest that the global economic and asset implications, even for Europe, could remain limited. The impact on Russia itself could be somewhat larger, which enjoyed a generally promising outlook for 2014. Its fortunes may have already been temporarily derailed and financial assets have underperformed. The worst-case scenario, which includes a disruption in oil and natural gas deliveries, could potentially cause more economic and asset damage, but we feel it is likely that oil prices could fall rather than rise, suggesting that such a scenario could actually prove to be deflationary.

Overall, we see very little that would cause us to alter our investment views, even our longer-term positive stance on Russian equities. We remain happy with our current market positioning and we still see a very positive global growth story unfolding, particularly in light of the improvements seen in the US and British economies.

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MARKETS WOBBLE AS TECH SPECULATORS TAKE FLIGHT

What felt like yet another equity market correction in short succession, at Tatton we interpret this latest wobble more as an overdue refocus of investors on what fundamentally drives long term value in companies' stocks – their actual earnings and realistic future earnings potential. As the Q1 2014 earnings season kicked off against a backdrop of very subdued earnings expectations by analysts, investors seemed to lose their faith in the future earnings prospects of companies which had recently reached sky high valuations against their existing actual earnings. Bio-tech, technology and internet stocks lost heavily and dragged down markets overall. Particularly recent IPOs suffered and most fell below their stock market debut prices, which we actually welcome as a healthy warning to those speculative investors who were driving recent excesses. We believe that the refocus on fundamentals will stabilise markets and hopefully reduce the recent bouts of volatility for a more consistent market trend (more on this further down under separate heading).

Otherwise news flow was broadly encouraging with the IMF upgrading their 2014/2015 growth and stability forecasts, better unemployment claims figures from the US and buoyant UK consumer and corporate expectation surveys. We also noted with interest a joint initiative by the ECB and the BoE to finally de vilify the structured credit markets. These were undeniably at the centre of the 2008/2009 financial crisis, but I would argue for lack of proper legal structure and regulatory oversight, rather than systemic weakness. Compared to the US, Europe is only slowly catching up in their structural reform efforts to the finance sector, which still hampers the economic recovery. The US on the other hand has once again a fully functional credit sector after force-recapitalising its banks and reforming the structured credit markets, the European lending sector is still largely relying on refinancing from the ECB, the central bank.

The continued rumbles around the Ukraine tensions are unhelpful, but need to be put in context, of a relative minority causing trouble in a post revolution power void, rather than a majority desperately seeking to break away and join Russia as was the case in the Crimea.

During our monthly Tatton investment committee meeting we deliberated at length on the developments of the first quarter and whether our central scenario of a pick-up of the economic recovery momentum has changed. The answer was a resounding 'no change' and so we have kept our portfolio allocations unchanged with only a few fund changes which have become necessary and opportune. The one area where we might introduce changes in the coming months is fixed income. With the risk of a severe deterioration of bond values dissipating as the yield and (low) inflation environment stabilise we are looking to reposition the Tatton portfolios to reintroduce their gilt 'stabilisers' as soon as is this makes good investment sense.

2014 Budget: your top ten questions to us - answered

2014 Budget: your top ten questions to us - answered

When George Osborne stood up and said he had good news for savers in his budget he wasn't kidding! We now have pensions appearing on the front pages of all the national newspapers - and for all the right reasons. And with changes to ISA limits and the starting rate of income tax it is a huge boost to long term savings.
The changes announced on Wednesday have created plenty of interest from advisers and customers alike. Our phones have been ringing off the hook:

Pension changes from 6 April 2015
The radical pension proposals for 2015 reflect the government's vision for a more flexible regime giving clients more choice, control and responsibility over how they access their pension savings. But nothing is set in stone yet and, as always, the devil will be in the detail of the forthcoming consultations.

1. Will it really be possible to take unlimited income from any DC scheme after 6 April 2015?
From 6 April 2015, the government intends to remove all retirement income limits for DC pensions. Effectively, everyone retiring with a DC pension pot will have access to flexible drawdown - without having to satisfy any 'minimum income requirement' or give up on future pension saving. This gives much more scope for innovative 'at retirement' financial planning tailored to client needs.
There will, however, be circumstances where the new flexibility isn't available:

• Existing annuities or scheme pensions:Those who have locked into a lifetime income using annuities, or scheme pensions, can't undo them. This means many existing pensioners won't have access to the new flexible income options.
• Defined benefit pensions: The new income flexibility won't be available for DB pensions. We're hopeful, however, that they will be available for DC pots held within DB/ mixed benefit schemes (such as AVC pots).
• Scheme/ product restrictions: There's no obligation for every DC pension scheme or provider to offer the new flexibility. Some pension schemes may not have systems in place or scheme rules may not allow the new flexible income withdrawal. So it may be necessary to transfer benefits to a pension scheme that is able to facilitate this.

2. If Defined benefits are transferred to a defined contribution scheme before 6 April 2015 will they be able to have full access to benefits when new rules are introduced?

The future of transfers from DB to DC schemes is uncertain. Anyone looking to give up the guaranteed income from their DB scheme for the new found freedom in the DC world may need to act quickly before any legislation is introduced. But a DB scheme will still be right for a great number of pension savers and it is important they understand what they are giving up before transferring.

The proposals include introducing legislation to stop transfers from public sector DB schemes into a DC scheme. With public sector schemes unfunded this is an understandable attempt to stop money flowing out of the government coffers to those seeking greater flexibility.

There will be consultation to determine whether similar measures will be necessary to restrict transfers from private sector DB schemes. But unlike their public sector cousins, private sector DB schemes are pre-funded, so transfers don't create the same financial strain for the sponsor. Indeed, transfers can often be beneficial both to a scheme's funding position and the sponsor's balance sheet - as well as meeting the member's needs.

There are a broad range of suggested options for the private sector ranging from business as usual to half way measures which give the scheme trustees the power to decide whether to offer transfers or at the other end of the scale a ban in line with the public sector. It would be surprising, and disappointing, if the government chose to unduly restrict the options available to private sector sponsors of DB schemes.

3. At what rate will drawdown lump sum death benefits be taxed from 6 April 2015?
There are plans to cut the rate of tax payable on drawdown death benefits from April 2015 but as yet there's no suggestion as to what any new rate would be.

Having a rate of tax on death which is greater than the income tax on withdrawing income could see the tax tail wagging the retirement income dog, driving inappropriate client decisions. Therefore it would appear to make sense to have the death benefit charge aligned to the income tax rate.

The Government has recognised the need to have a tax system that supports pension savers and helps them take the right decisions for the best financial outcome for them and their loved ones.
This should see the ability to pass on pension death benefits to loved ones given a further boost and make the use of bypass trusts even more appealing.

4. Where did the government get the 55% charge if you take your pension as a lump sum?
This one has had many of you scratching your heads. It is actually the 55% unauthorised payment charge. This rule prevents providers from knowingly making an unauthorised payment - which includes paying a pension above the current limits. Of course in reality the provider would simply prohibit someone taking all their benefits as cash except for certain circumstances such as serious ill-health or triviality lump sums.

27 March 2014 pension changes
The government is making some temporary changes to give pension savers a bit more flexibility until the 2015 changes come into force. While these changes are not subject to consultation some of the fine detail will only be known once the Finance Bill is published on 27 March.

5. When can drawdown users access 150% GAD?
For existing drawdown users, the new, higher income limit will apply from the start of their next drawdown year after 26 March 2014. This is the anniversary date of when drawdown was originally started, so some drawdown users won't feel the benefit of the increased limit until March 2015. This seems anomalous when the limit is scheduled to be completely removed from April, so don't rule out further interim changes.
Anyone starting drawdown under an arrangement for the first time after 26 March will have immediate access to the 150% limit. Of course, this assumes the provider is geared up to do this.

6. Is it possible for clients with pensions worth more than £30,000 to get a lump sum using the new triviality relaxations?
Provided that benefits are taken in the correct order, and are structured in the right way, it will be possible to get lump sums of much more than £30,000 under the new triviality rules. But they still can't be used before 60.

This comes by combining the new 'stranded pot' and trivial lump sum rules.

• Any stranded pots below £10,000 would need to be taken before triviality on the main pots to get the maximum effect. The new stranded pot rules can be used for up to 3 personal pensions and unlimited occupational pensions.
• If total remaining pension rights, after eliminating any stranded pots, are worth less than £30,000 these can then be paid as a lump sum under the beefed up triviality rules

7. Can clients who have just bought annuities rethink their decision following the Budget announcement?
Some clients will want to rethink their decision in light of the radical changes proposed in the Budget. But, for many, the reasons that drove their original decision will remain valid. The new flexible income options won't be right for everyone.

The usual cancellation rights apply to recent annuity purchases. And many annuity providers have extended the cancellation period following the Budget.

Of course, annuity cancellation doesn't give an automatic right to reinstatement as a pre-retirement member. Some schemes, particularly occupational schemes, aren't able to do this. So cancelling with one provider may simply trigger an obligation to buy a replacement annuity with another - and there's no guarantee that the same terms will be available on the new purchase.

NISA
8. If contributions have been made before 30 June 2014 is it possible to pay a further £15,000 after 1 July?

Unfortunately this won't be the case. Any contributions made before 30 June 2014 will count towards the new £15,000. So someone paying the maximum £11,880 before 30 June 2014 will be able to make a further subscription of up to £3,120 after 1 July.

9. Will it be possible to contribute to different NISAs in the same tax year once the stocks and shares and cash definitions have merged?

Yes it will be possible to subscribe to a Cash NISA and a Stocks & Shares NISA in the same year, with separate providers, splitting the overall £15,000 allowance between the two in any proportion.
Changes to savings rate of tax

10. Will non-taxpayers be able get up to £15,500 in chargeable gains from their investment bonds tax free?

There was one further little nugget buried in the budget statement which could be pure gold for financial planners and offshore bonds in particular.

There was a double boost with the starting rate for savings income reduced from 10% to zero and the band almost doubling in size to £5,000. Savings income includes interest earned from deposit accounts, fixed interest securities and more importantly offshore bonds gains. This could see a non-taxpayer realise chargeable gains of up to £15,500 each year completely free of tax from April 2015.

But there are a couple of things to remember:

• Savings income comes after earned income in the tax pecking order. So if someone has earned income of more than £15,500 they won't benefit from starting rate tax on their savings income.
• Onshore bonds gains are deemed to have paid tax at basic rate so won't benefit.

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