For Greece it's play ball or make the call!

1994 World Cup Stamp

Tomorrow’s expected confirmation of recession for the eurozone as a whole will add little new to the growth dynamic now in play. It will however add to the momentum of the changing tide on fiscal austerity and make Mr Hollande’s meeting with Mrs. Merkel well timed. 

As for the growth dynamic, this is evident in the European Commission’s (EC) Spring forecast released last week which reinforces the point that fiscal austerity not only compounds recession but hinders rather than helps the adjustment to debt sustainability.

Also, playing ‘catch up’ for budget deficits that miss targets by a prescription of forcing through more budget cuts not only deepens and/or prolongs recession but also adds to the prospect of more problem loans for the banks. By spelling greater provisioning for more bad and doubtful debts it discourages any bank, even one adequately capitalised, not to mention amply fortified with LTRO money, from wishing to lend and risk weakening its financial position. 

Europe’s reaction to austerity is not only spreading but not discriminating either between politician and technocrat. Germany’s state election over the weekend was won by the Social Democrats on a go-slow ticket to reducing the state’s debt. In Italy, Prime Minister Monti, the technocrat with no political axe to grind but in charge of a tough job that needs doing has seen his popularity plunge hugely since taking office. More >

Mike Lenhoff
Chief Strategist

Week in Review: Unstoppable force to meet immovable object…

"Ballots are the rightful and peaceful successors to bullets" said Abraham Lincoln. In Greece they are the successors to bailouts - hopefully we won't get to bullets.

The week began with the much anticipated election results from France but, as we feared (Little Greece still matters more than Big France) it was the Greek ones that shocked investors. When the results were posted it was the unconventional, inexperienced but untainted Syriza (the Coalition of the Radical Left) who were the moral victors, falling just short of being the largest party in government.

The results made forming a government in Greece, the cradle of democracy, problematic. New Democracy had the first attempt but failed, passing the role on to Syriza. Their uncompromising attitude, promising to tear up Greece's bailout commitments, made an agreement impossible, but it did inspire the electorate meaning their chances of winning an election re-run outright are disconcertingly high (as confirmed by the latest poll-based projections).

PASOK (the left-wing half of the centrist duopoly) were the clear losers so it is with no small irony that the week ends with them having their turn at trying to form a government of Greece.

Source: Brewin Dolphin

Germans long on Machtpolitik…

                                         

Syriza's combative tone was matched by fiery rhetoric from their potential benefactors in Germany. For those of us hoping that the ECB would provide some stimulus the Bundesbank President, Jens Weidman, declared that "monetary policy is no panacea for Europe."  Shame – we all love a good panacea.

The government also got in on the act as finance minister Schaeuble helpfully declared “If Greece decides not to stay in the euro zone, we cannot force Greece" and foreign minister Westerwelle reiterated that the fiscal pact “is decided and stands.”  Such rhetoric is either brave or foolish. While the euro club may regret Greece's original entry into the zone, they will be aware that its exit risks an unknown degree of crisis and contagion.  Furthermore, it necessitates the loss of all outstanding loans previously advanced to the Hellenic Republic.

…but short on Schadenfreude

The other reason that Germany should be thankful for its profligate peers was underlined as trade and industrial production figures were reported.

The Eurozone itself has on average run a balanced current account (spending what it earns) but that masks a host of imbalances that lurk within.  Unsurprisingly those countries which have competitive underlying labour and product markets (Germany and the Netherlands) have moved into surplus, while those with rigid underlying markets (Portugal, Italy, Greece and Spain) have moved into deficit. Germany’s exports rely on its neighbours maintaining their imports. 

Source: Datastream/Brewin Dolphin

Economic news, dull but not dismal…

Apart from Germany’s expectation-beating industrial production numbers, the other European and major economies were close to expectations. That included China, where a series of numbers released on Friday confirmed that the Chinese economy is slowing and inflation is falling.  That should pave the way for further fiscal loosening as the year progresses, with a reacceleration of growth tentatively hinted at by modestly improvement in purchasing managers indices.

Source: Datastream/Brewin Dolphin

Such trivialities as economic growth however seem set to remain an afterthought as politics dominates investors risk appetite. There was however, still time for JP Morgan to throw its stock specific spanner in the works too.

Credit & credibility…

News of investment banking’s safe pair of hands dropping a $2 billion credit derivatives whoopsie was just what nervous markets didn’t need. The group earns around twice that in the average quarter and so it is far from a ‘systemic’ event.  Nevertheless it does cast doubt on the group’s internal risk controls and the reputation of CEO Jamie Dimon, who, had reportedly bemoaned that regulators “make trading sound like someone's sitting there, guessing.” Yesterday Mr Dimon had to admit the group had engaged in “a bad strategy, it was badly executed. It became more complex, it was poorly monitored.”

So ends a week of poor headlines overshadowing underlying progress. Hopefully by the end of the weekend we will see a unity government, allowing investors to focus on next weeks inflation data from both sides of the Atlantic.

Guy Foster 

Head of Portfolio Strategy

Investing in Fear: Part One

Ever since the financial storm of 2008 blew Lehman Brothers from the market’s shores, both stock prices and investor sentiment have been as capricious as the British weather. Since this defining and pivotal event the Chicago Board Options Exchange Volatility Index (the VIX or “fear index”) has become one of the most followed and highly publicised “barometers” of market turbulence.  And, as the number of complex derivative contracts on volatility mushroomed, the VIX, which generally moves in the opposite direction to equity markets, has been increasingly touted as the ultimate windcheater with which to protect one’s portfolio.

Source: Brewin Dolphin/Bloomberg

Indeed it may reflect the conviction in this view that over the last four months there have been enormous inflows into volatility trading strategies. To qualify this further, according to a research piece from Morgan Stanley, seven out of the top 10 fastest growing funds in alternative investments offered exposure to volatility.

Mathematically, volatility is simply a measure of the magnitude that stock prices have moved in the past, with a bigger number signifying greater moves. Given this price swing can just as easily be down as up, stocks with higher volatility are assumed to posses higher levels of risk. However, the Volatility Index does have some subtle but crucially different features.

The VIX was created in 1993 by Professor E. Whaley to provide a forward looking measure of volatility that investors are expecting to see in the equity markets (specifically the S&P 500 Index) in the short term. It tells us that, based on today’s reading of 17 “volatility points”, the S&P 500 index is expected to move over the next month by 17% on an annualised basis (which is a monthly move of just under 5%).

An important contributor in the calculation of this index is the cost of derivative contracts used to insure portfolios (known as ‘put options’). And, as the market mood swings from smug confidence to neurotic anxiety, the VIX will faithfully reflect this by moving higher. Indeed the speed with which the VIX moves will often reflect the perceived severity of a crisis, rising sharply or ‘spiking’ at times of acute market turmoil – hence the VIX’s fearful nickname.

It is a similar theory in any insurance company’s pricing model; think what would happen to home insurance premiums in areas which the Environment Agency dictates are at risk of flooding. The same applies to the financial world.

The chart below highlights the unsettling events which drove the index to leap up at various times over the last 20 years.

Source: Brewin Dolphin/Bloomberg

So, given the behaviourally opposed pricing moves (to equity markets), investments based upon the VIX index have been considered extremely attractive of late. However, we would suggest investors consider the infamous words of Franklin D Roosevelt, delivered in his inaugural address, “let me assert my firm belief that the only thing we have to fear is fear itself”. In that respect, we have observed that using ‘the fear index’ as one’s sole insurance policy might not always be sufficiently rewarding…but more on this in my next blog.

Shakhista Mukhamedova

Investment Analyst

Happy Europe Day

On this day 62 years ago Robert Schuman called on his native France, Germany and other European countries to pool their coal and steel production as "the first concrete foundation of a European federation". That day is remembered as the day the European Union was born.  This one may be remembered as the beginning of the end as discussions between the Greek radical left coalition, Syriza, and the so-called pro-austerity centrist groups, New Democracy and PASOK about forming a government seem set to be brief. The euro continues to drift lower reflecting a looming confrontation between the creditor nations who demand austerity legislation and the Greek people who will have no government to pass it.

Source: Datastream/Brewin Dolphin

Germany meanwhile posted its fourth highest current account surplus of all time following a very robust performance from German exports and yesterday’s forecast beating German industrial production figures.  France’s trade balance was not as bad as expected. So it’s not all bad news…particularly if you’re German.

Source: Datastream/Brewin Dolphin

Guy Foster 

Head of Portfolio Strategy

Greece’s bailouts & ballots…

The ballot boxes have been emptied, the votes have been counted, but wrangling over Greece’s new government continue.  As discussed, Greece’s system of reinforced proportional representation is designed to prevent minority governments but our fears were realised when the slim majority forecast by opinion polls for a centrist government was not achieved.  The previous behemoths of Greek politics, New Democracy and PASOK (the Pan-Hellenic Socialists), won 149 seats rather than the 151 that had been our central projection and are now unable to command a majority in parliament.

Source: Brewin Dolphin

There were other losers too: the Democratic Alliance (the party which split from New Democracy because it supported the May 2010 EU austerity package); the

Greens; and, with Python-esque irony, the Popular Orthodox Rally, all failed to achieve the 3% threshold to win seats.

Indeed the real winners were the political extremes as the Golden Dawn (generally referred to as neo-Nazi) and Syriza (the Coalition of Radical Left) dramatically beat expectations.  New Democracy’s seat advantage came from the 50 extra seats awarded to the largest party but their share of the vote at 18.8% was just 2% more than Syriza at 16.8%.  Adding in the poor showing from PASOK and the strong showing from caucuses such as the Independent Greeks,  whose very conception was in opposition to the bailout, to see that this is a comprehensive rejection of the existing deal which has been struck between the EU and Greece.

Now it’s like déjà vu all over again: Greece needs a further bailout payment in June; its payment is dependent on a further series of swingeing austerity measures; but such legislation now seems politically impossible without a government.  But things are different now – unemployment is even higher.

Source: Eurostat

Guy Foster 

Head of Portfolio Strategy

UK housing market stagnates

Today’s RICS Survey “House Price Balance” measures the proportion of surveyors reporting a rise in house prices minus those reporting a fall. 

Although any negative number is disappointing, the result, -19, was especially disappointing as it breaks a trend of improvement which had continued since October.  

The index is a reasonable leading indicator for property prices and so, just like mortgage approvals which I mentioned in last week’s Week In Review, Rob’s mention of Buy to Let yields and his analysis of affordability, the opinions for surveyors point to further stagnation in the UK housing market.

Source: HBOS/Bank of England

Source: Royal Institute of Chartered Surveyors/Nationwide

Guy Foster 

Head of Portfolio Strategy

US payrolls show modest loss of momentum

Although the headline figure for the US non-farm payrolls came in below expectations, those of previous months were revised upwards by some 53,000. Overall then the employment picture is not as bad as might have been inferred from the April numbers and what matters from the Fed’s point of view is the underlying trend.

As the chart shows, the monthly addition to the private sector payrolls has slipped below the 3 and 12-month moving averages but the former (the 3-month) still lies above the latter, though just. On that basis, there is a loss of momentum coming through in the job numbers despite the upward revisions to previous months. That said, it is worth bearing in mind that prior to March, the job numbers had been better than expected. More>

Mike Lenhoff

Chief Strategist

Week in Review: Europe's kingdom of the blind...

Last week's WIR highlighted the tense race for the Premiership. Having secured a 1-0 win in the Mancunian derby, it seems Manchester City will do just enough, just in time to secure their first league title since 1968.

'Just enough, just in time' has become the unofficial motto of the eurozone as each member's procrastinations stretch the union to breaking point. Last week's collapse of the government in recession-hit Netherlands shocked investors but this week began with the news that the residual elements of the government had managed to submit a stability plan by Monday's deadline.

At least Europe still has some strong economies! Er...

What is particularly worrying about the travails of the Dutch is that they are one of the region's strongest links. Not only is the Netherlands triple-A rated, it also has a liberal economy. It should be the poster child of the zone for its fiscal discipline and competitiveness - indeed unemployment, whilst rising, remains low as the region has been able to sell into less competitive parts of the Eurozone and EU.

Export markets have however been a source of weakness as economic data in Europe remains woeful. 

All the purchasing managers surveys which we described last week were revised lower this week.  Then unemployment rose to the highest levels experienced, not just since the Eurozone's conception, but for years before too. If ever the political strains being put on the Eurozone needed further stress these kind of "never had it so bad" statistics are sure to provide it.

Even Germany was given reason to worry about its jobs market. A slight uptick in the number of unemployed is barely visible on  the long-term chart, but weakness in hiring intentions from surveyed German companies, and a declining number of vacancies, suggests that employment is likely to reverse some of its gains of the past few years.

Draghi drags his feet...

All eyes therefore turned to the European Central Bank (ECB) press conference for signs that policy might provide some relief. But little comfort was found in ECB President Draghi's repeated commitment that policy was already accommodate, that real interest rates are negative in most countries (i.e. inflation is higher that interest rates) and therefore  no further reduction in interest rates had been discussed.

Further stimulus would likely come from some form of unconventional monetary policy, quantitative easing for example.  We have been discussing the various policy options which the ECB cold consider at length during our strategy deliberations and will try and post a few suggestions on the blog next week.

Suffice to say, however, that Sr Draghi will require higher threshold in terms of weak inflation numbers than his peers in either the US or the UK to cross the Rubicon into quantitative easing. That mindset alone is dangerous as the Bank of Japan's half-hearted attempts at QE have shown.  Expect the ECB to do 'just enough, just in time', again...

China's resurgence threatens to overshadow US strength (again)...

Away from the Eurozone, China showed further evidence that its slowdown had ended with various PMI surveys continuing to tick upwards and showing a particularly strong service sector.

US data showed signs of wavering as disappointing falls in some of the regional surveys. However optimism was snatched from the jaws of despair by the national Institute of Supply Management survey which confounded expectations to indicate a strong expansion.

The question on investor's mind then was could employment news perform the same trick? Claims for those remaining out of work and those making new unemployment claims both declined more than expected but saw their previous readings revised up (as they have been every week this year). The ADP survey of employment change was lower than hoped and saw its previous figure revised down.

The headline of 115,000 new jobs added in April was disappointing however revisions were positive; most notably with a further 45,000 new private jobs were added to March’s figures. The unemployment rate declined to 8.1% and wage growth was weak. Therefore should be nothing overly worrying about this report in terms of the likelihood of policy being tightened or the recovery stalling.

Europe's weakness continues to hurt us here in the UK where house price data from Nationwide and Halifax released this week and both show prices falling. Bear this in mind if you haven't read Rob's piece on the Buy to Let market yet. Mortgage approvals, which tend to lead house prices, have fallen too which augurs poorly for UK residential property prices.

Looking ahead to next week we have a quieter week in terms of economic news but politics will return to centre stage. Investors will hedge the double election result first thing on Monday.

Expect that trend to be with us for a while. Even at home UKIP appears to have performed well in the local elections.

Guy Foster

Head of Portfolio Strategy

Which way next for the buy-to-let market in the UK?

In an earlier blog piece, “Which way next for the Residential Property Market in the UK?”, I looked at the long term relationship between house prices and average earnings and drew the conclusion that, in my opinion, it seemed unlikely that house prices could make substantial forward progress in the absence of growth in average earnings.

It was interesting, then, to see a number of articles highlighting the attractions of the buy-to-let property market, which has prompted me to fire up my abacus again and consider this more fully. The website FindaProperty.com has composed the FindaProperty.com Rental Index using a statistical methodology developed by Calnea Analytics, the company who produce the official Land Registry house price index. This seems like a reasonable place to start to consider what kind of rental yields are available across the UK. As importantly, it also gives some idea about what direction rental yields are moving in. This makes very interesting viewing.

© FindaProperty.com

Rental yields across England and Wales would seem to average around 4.5% whilst in London and Scotland this figure is around 5.5%. Moreover, London aside, rental yields look, at best, flat and, most importantly, below inflation. Unfortunately longer term information on Rents (which form part of the Retail Price Index) only goes back as far as 1987, but, as you can see from the chart below, they do show a strong correlation with average earnings.

Source: Brewin Dolphin

This should be no surprise, but it does call into question the idea that rents will carry on rising, especially in an environment in which average earnings are not. So, we have already seen house price moves fail to keep pace with inflation over the last two and a half years and we should add to this a letting market that, outside London, has seen little in the way of rental growth.

Of course, for the individual who is looking at the paltry returns available on cash deposits and government bonds – traditional “low risk” investments for those seeking income, the attractions of property are clear. It is a solid asset that, on the face of it, is easy to understand. The market in London, too, is distorted by clear demand and supply issues, coupled with a “safe haven” status for both domestic and international investors. However, property must, in the end, be affordable and this link of prices to average earnings will have to reassert itself in one way or another, either through lower prices or higher earnings.

Investors should be aware, too, that the current ultra low interest rate environment will not be with us forever. While we do not anticipate this happening in the near future, at some stage rates will rise at which stage property investors will be reminded of the fundamental illiquidity of residential property. Add to this, for the individual investor, agent fees for managing the property (for those who do not want to be woken up at 2am to deal with a faulty boiler), void periods, refurbishment costs, government stamp duty, estate agents fees on disposal, income tax due on rental yields and a likely flat property market, I would question whether even 5% property yields are particularly attractive.

For this reason, for investors looking for longer term, real (i.e. inflation adjusted) returns, should consider a well diversified portfolio which, depending on your individual circumstances, may contain a substantial equity content.

Rob Burgeman

Divisional Director

Little Greece still matters more than Big France

The prospect of a socialist victory in France’s second round next week is one to have mixed feelings about but, in my opinion, not one to dread.   François Hollande sounds far from hard-line and his rhetoric may be driven more by the need to get elected than by what he reasonably expects to achieve. Meanwhile Sarkozy has been a bit of a flop as a reformist President.

More worrying, in my opinion, is the complete political disintegration of Greece.

Between them, the Panhellenic Socialist Movement (PASOK) and New Democracy have contested the last 12 legislative elections in Greece. The only election in which they didn’t take over 250 of the 300 available seats between them was the 1974 election immediately following the end of the 1965-74 military Junta.  

The hegemony of the Greek political elite…

Source: Various/Brewin Dolphin

 

That hegemony now looks to be over.  Polls, as you would expect, now show that many voters don’t know who to vote for. They also show the fragmentation of the Greek vote with votes switching to fringe or new parties.

The fragmentation of the Greek vote…

Source: Various/Brewin Dolphin

Greece has been through extreme hardship, but its outlook remains extremely poor. The only prescription being offered is extreme austerity, for an extreme duration, with extremely low chances of success.  The human condition therefore prompts people to vote passionately for change on the “it can’t be worse than this” basis, without necessarily thinking about what they are voting for.

So at the forthcoming elections, which coincide, next Sunday, with the second round of the French presidential elections, no party is close to getting 50% of the vote.

Fortunately the Greek system of “reinforced proportional representation” guards against this by allocating 50 extra seats to the largest party – hoorah!  Even so a party ought to have to get 39% of the vote in order to win an artificial majority current front-runners New Democracy have only polled as high as 23% in recent weeks – oh dear!

The projected result therefore looks like New Democracy winning 100-110 seats with an approximate split for the rest as follows.

The projected results of the Greek 2012 election (huge margin for error)…

Source: Brewin Dolphin/MARC/Pulse RC/Public Issue

 

If the votes fall as the polls suggest, the slimmest of centre right majorities (1-2 seats) can be created through the tenuous assertion that the Greens could be courted into government, but the biggest stumbling block would be the block of 30-ish seats which may be controlled by the Independent Greeks.  The group are former members of New Democracy who voted against the technocratic coalition government Lucas Papademos. They are tangibly anti-European believing that Greece has fallen victim to an “international conspiracy”.

It looks likely that the Greek people will, by Monday, have rejected Europe with a strong enough voice that makes any further austerity measures very difficult to pass. Only a week will tell whether the ballot boxes are kinder than the polls.

In terms of turnout, by the way, there are reasons for optimism as voting in Greece is mandatory. Although the punishment for non-compliance has never been administered – naturally.

Guy Foster

Head of Portfolio Strategy

America has its own ‘growth pact’ - it’s called the Fed!

Pressure to respond to fiscal austerity with a ‘growth pact’ for the eurozone is building. Not a bad idea if it doesn’t compromise the substance of the fiscal compact. As for what would constitute a growth pact, this might take time to gel. Meanwhile, Spain along with Italy and the Netherlands, not to mention Greece, is in recession.

Europe, including the UK, faces the headwinds of fiscal austerity and stiffer banking regulation but the Eurozone faces one other difficulty. This is a central bank committed to its single mandate of price stability and committed to the view that price stability is the greatest contribution it can make to economic growth.

Not only is this the mindset that the aspirant leaders, Monsieur Hollande and Mr Samaras, confront but as discussed in a recent note, not all political leaders want to see the fiscal compact picked apart to accommodate measures aimed at growth. Mrs Merkel for one can now point to the Dutch, which wants growth as much as any eurozone member, but whose Finance Minister managed to secure late last week support for budget cuts that might get through parliament and secure budget deficit targets. More >

Mike Lenhoff

Chief Strategist

Heavenly tax breaks for angel investing

Following the recent budget the government has firmed up its intention to make tax breaks the main incentive for ‘angel’ investing in the UK. Brewin Dolphin have received confirmation from HMRC over the last few days regarding the tax treatment of the new Seed Enterprise Investment Scheme (SEIS) which is the latest scheme to encourage investment into small start-up companies. These offer some of the largest tax breaks ever available for a personal investment in the UK in order to, in the words of the Chancellor, ‘stimulate entrepreneurship and kick-start the economy’.

In recent correspondence HMRC have indicated that loss relief (at a rate of 50%) could be available in addition to the main income and capital gains tax breaks. This means that an additional rate tax payer could receive total tax relief of 103% (or 100.5% after the tax rate is reduced to 45% in 2013/14) on an SEIS investment.

The total tax breaks could be:

• Income tax relief of 50% of the amount invested regardless of investor’s marginal tax rate
• Exemption from CGT on proceeds of the sale of other assets during the 2012/13 tax year to the extent that the gain is reinvested in a SEIS company
• Exemption from CGT on the proceeds of the sale of a SEIS investment
• Loss relief at a rate of 50% on losses on the investment which has not already received income tax relief. So on a SEIS investment of £100,000 (the maximum permitted each tax year) you could receive:
• £50,000 as a reduction in your income tax liability (this could be split over the current and preceding tax year),
• you could exempt £100,000 of capital gains by reinvesting in a SEIS, saving £28,000 of CGT,
• and finally you could offset £50,000 of losses (if the investment completely failed) against your income tax liability, potentially saving a 45% taxpayer £22,500.

Giving total tax relief of £100,500 on a £100,000 investment.

For individuals with large gains raised this tax year who have an income tax liability to offset a SEIS against, this can mean an investment where no net financial loss is possible when loss relief is accounted for.

The main qualifying conditions for SEIS investments give them extremely high risk exposure to very small UK companies. The criteria are:

• Investors cannot control, the company receiving their capital
• The business must be a UK company
• The company must not employ more than 25 workers
• The company must be a start up business
• The company must have assets of less than £200,000
• The company has to trade in an approved sector – generally not in finance or investment, for example, a property company cannot raise capital as a SEIS.

Please note that the loss relief will be restricted by the new limits on uncapped tax reliefs allowed in a single tax year of £50,000 or 25% of income recently announced. The income tax and CGT reliefs for SEIS will not be effected by these limits.

Nick Burt

Divisional Director - Financial Planning

Disclaimer: SEIS investments are extremely high risk and tax benefits are based on very specific personal circumstances. Furthermore, tax allowances and current legislation is subject to change.

Week in review: The race for the Premiership(s) intensifies…

It was 2003 when Sir Alex Ferguson coined the phrase “squeaky-bum time” to describe the end of the football season when every game assumes a greater importance. Back then though he couldn’t have anticipated Monday’s Manchester derby between the UK’s highest flying clubs. But the fixtures list has an uncanny knack of building tension in the race for the footballing Premiership.

Surprisingly, the European political calendar seems keen to build a bit of excitement of its own. The definitive round of France’s Presidential elections falls on the same day as Greece chooses a new parliament – Sunday 6 May.

Political tensions weighed on equities at the start of the week as France’s François Hollande produced a narrow socialist victory in the first round of the French elections but, as that had been expected, it was probably more Holland than Hollande that troubled the markets. The collapse of the Dutch coalition following the Freedom Party’s withdrawal of support has raised an important question regarding the functioning of the fiscal pact and the role of the ECB. Agreeing upon fiscal rules in the conference rooms of Brussels or Frankfurt may be difficult enough, but passing the resulting finance bills in national parliaments might actually be impossible. 

All of which has helpfully re-highlighted the lack of growth in the Growth & Stability Pact (known waggishly by some as the Suicide Pact) that makes it only slightly more bemusing than the UK’s hosepipe ban during what seems set to be the wettest April on record.

If policymakers hoped that a resurgence in economic data would pull Europe out of the mire they were disappointed on Tuesday. Purchasing managers index surveys (PMIs) implied both services and manufacturing sectors were contracting faster than thought. In a familiar tale, German services retained some buoyancy but the sectors French equivalent unfortunately soured the tone. 

European survey data continues to disappoint…

 Source: Markit/Brewin Dolphin

Wednesday’s release of UK GDP figures announced a slide back into recession with a second consecutive quarter of economic shrinkage – 0.2% after last quarter’s 0.3% decline. How long this recession will last is a hotly debated topic. Indeed it may cease to exist altogether as this advance number is routinely revised. Recent years though have tended to see it revised down more often than up and some optimistic-looking estimates of construction activity in March within the advance figure suggest, that the same may be true again this year.

House prices remained mixed in the US but data continues to suggest that gains are likely with home sales picking up substantially.

As anticipated Mitt Romney won the race to be the Republican’s least-worst candidate. Burdened as he is by his reputation for policy flip-flopping, his Mormonism and his sub-15% income tax rate, it remains to be seen whether the conclusion of the race for the nominee can boost his head-to-head polling against Obama. Nevertheless, the nature of the competitors means that the election campaign should be fought over the centre-ground of the economy rather than the distraction of social issues.

A line of attack the Obama campaign is sure to take will centre on Romney as a pawn of big business and Wall Street. Indeed, for all the tentative signs of recovery for “ordinary households”, corporate America continues to boom. Halfway through the first quarter earnings season twice as many companies are beating analysts forecasts as are missing them, and revenues as well as profits are growing – Apple being the highest profile example. 

S&P 500 company earnings and revenues continue to impress...

Source: Bloomberg

Such strong corporate results helped investors climb the wall of worry built by Europe’s ongoing crises of philosophy, politics and economics. Leaving the only potential hurdle as today’s advance estimate of 1^st quarter GDP. The headline number was slightly disappointing but modest rises in prices and employment costs offered reassurance that the Federal Reserve stand to support the economy as the year progresses.

After all that investors are now left looking forward to another busy week with US survey data, UK house prices, and the all-important US employment news next Friday where we would have to fear downward revisions to previous months (based upon the revisions already seen to unemployment claims). More than half an eye though will be on the double election on the following Sunday, the results of which are sure to move the market Monday morning.

But before that relax and enjoy the Manchester derby…

Guy Foster

Head of Portfolio Strategy

Europe staggers and reflation drives Wall Street

On the face of it, and despite the austerity backlash, two things are almost certain not to happen:

• One is that the European Central Bank (ECB) will not change its colours. Its ethos is based around the view that the single greatest contribution it can make to economic growth in the eurozone is nothing other than price stability. Only through a change in the charter laying out its statutes could its behaviour be altered but such a change would not be viable or acceptable under the lead role played by Germany’s Bundesbank and probably not viable either under the Presidency of Mario Draghi.

• Another is that the European Commission (EC), with the backing of the ECB and the IMF, is unlikely to let the Reinforced Growth and Stability Pact be picked apart by Hollande, Samaras or any other would be political leader. This Pact underlies the Inter-governmental Treaty setting out the framework for the fiscal adjustment intended to put the European Union onto the medium term path to debt sustainability and to which all but two EU members (the UK and the Czech Republic) have signed up.

Under Prime Minister Rutte’s coalition government that was until yesterday, the Dutch were committed to the Pact and to fulfilling the obligation to achieve budget deficit targets. That meant budget cuts of some 9.5 billion euros, or 1.7 percent of GDP (other figures put the cuts at 15 billion euros or 2.5 percent of GDP). The coalition government resigned after losing the support of the Freedom Party headed by Geert Wilders. Rutte and his cabinet remain in charge of a caretaker government ahead of elections that are now to be called. In the meantime, Rutte and his Finance Minister are determined to secure support for the discipline it intended following and to preserve the triple A rating on sovereign debt. This includes submitting a budget to the EC before the April 30th deadline. More >

Mike Lenhoff

Chief Strategist

24 hours is a long time in the equity market…

Source: DataStream, Brewin Dolphin. Past performance is not a guide to future performance.

Following Apple’s forecast beating results last night I recall reading an interesting observation from my colleague, Rob Crawshaw. While reviewing the US equity market’s 1st quarter of 2012 he noted that  Apple, which rose 48% over the quarter, has seen its value as a company (its market capitalisation to use the appropriate nomenclature) rise by $200bn.

As is so often the way in the modern age, comprehending such mammoth numbers is difficult so Rob points out that the 1st quarter rise is equivalent to the addition of “a Wal Mart” (the supermarket chain that operates 8,500 stores under brands including Asda).

This morning, however, our dealers inform us that Apple will likely open 8% higher this afternoon after last night’s expectation thrashing after-hours results.  To put that in context that’s a $42 billion increase in Apple’s market value - equivalent to a whole new Ford Motor, and pretty close to a new News Corp (perish the thought)!

All in all a pretty meaningful daily move.

Guy Foster

Head of Portfolio Strategy

Waterloo

Waterloo Station. Image: Sunil Prasannan

The first round of the French elections at the weekend has left the present incumbent of the Elysée Palace with some work to do if he wants to stay in power for another five years. The socialist challenger, François Hollande holds a slender lead and, as feared, there was a considerable vote for the extremist parties of the left and the right. Before you think this was a result based on political apathy, it is worth noting that the participation rate was around 80%, a figure that the UK last achieved in 1951.

On the face of it, the lead enjoyed by the PS candidate does not look insurmountable. After all, 28.63% v 27.18% does not seem too extreme. Moreover, traditional left of centre parties – the Left Front, the Greens and other smaller groups – probably make up around 44% of the vote, while more “natural” supporters of M Sarkozy make up around 47%. The moderate and centrist Mouvement Démocrate of François Bayrou (around 9%) potentially holds the balance of power in the second round.

All of this, however, is to slightly misunderstand the nature of French politics.  The first round of voting, it is said in France, sees people vote with their hearts. The second round sees them vote with their heads.  Jean-Luc Mélenchon has urged his Left Front supporters to back François Hollande, allowing the Socialist Party candidate freedom to target the centre ground.  Marine Le Pen, however, has been far less accommodating to Nicolas Sarkozy.  The traditional National Front voter tends to come from more of an urban, working class background whose second round vote, therefore, is more likely to be determined by social issues as much as immigration.  This leaves Nicolas Sarkozy with a difficult strategy to adopt.  On the one hand, he needs to appeal to a set of voters who are further to the right than his natural supporters. At the same time, he needs to appeal to the centre ground, who are likely to be alienated by precisely those policies.

Perhaps his best chance of an electoral victory, then, is that some crisis erupts in the next fortnight.  Love him or hate him – and for most of the French it is very much the latter – he is perceived as someone at his best in difficult circumstances.  By contrast, François Hollande has not held any governmental position and has not had the opportunity (or misfortune depending on your viewpoint) to see his metal tested. In those circumstances, the electorate might – just – decide that a safe pair of hands is the order of the day.  Otherwise, Nicolas Sarkozy, like another famously diminutive Frenchman before him, may be facing his own Waterloo on Sunday week.

Rob Burgeman

Divisional Director

Mike Lenhoff: Europe in turmoil but improved US earnings are a big surprise

François Hollande © Matthieu Riegler

In Europe, an election and a collapse in budget talks renew the turmoil and are now likely to dominate market sentiment but across the pond there is a different and positive story for the markets.

For the US, either someone has done a great job ‘beating’ down analysts’ earnings estimates for the current reporting round, or Wall Street really does face the prospect of genuinely better fundamentals as the year progresses. More on this shortly.

In Europe, round one of the French elections has gone François Hollande’s way thus casting uncertainty for the markets over what the prospect of a Socialist victory on May 6th could mean for ratifying the Inter-governmental Treaty on the fiscal compact and resolving the debt crisis. Among other things, Hollande has indicated an intention to re-negotiate the terms of the fiscal compact to include measures aimed at growth, an ambition that will take some doing.   

In Italy, fiscal austerity and the weak economy are leading to slippage in deficit targets as demonstrated last week by a document due to be approved by parliament this week. GDP growth is forecast to fall more than previously expected, thus forcing the government of Mario Monti to raise next year’s budget deficit to 0.5 percent of GDP from a previous target of 0.1 percent and pushing out to 2014 the target of budget balance. In the Netherlands, the leader of the centre-right coalition has had to acknowledge the collapse over the weekend in talks on budget cuts thus making elections likely and adding further to the concern about a resolution to the eurozone’s debt crisis. More >

Mike Lenhoff

Chief Strategist

Rising dividends fuel real returns

(1) The current Asset Allocation for the FT APCIMS Balanced Portfolio Index is 67.5% equities, 20% UK Government Bonds, 7.5% Alternative Assets and 5% in Cash (2) Average income on the FT APCIMS Balanced Portfolio Index – the difference between the Total Return Index and the Income Taken Index being 3.77% over this period (3) As measure by the Retail Price Index

Evidence from Capita today suggests that UK dividends have increased to a record level over the last quarter, rising by 6.6% excluding special dividends.  This is all the more remarkable, given the collapse of dividends from the banking sector which, in December 2006 accounted for 18% of the FT All Share and the suspension of payments from BP following the oil spill in the gulf.  This highlights the robust health of the remaining large UK corporations and the role that they can play in long term income planning for private investors, particularly those who are planning to provide income in retirement from a portfolio of investments.

Indeed, our own research shows that an investment of £100,000 in March 1993 in a balanced portfolio (as measured by the FT APCIMS Balanced Portfolio Index (1)) and which had reinvested the income as it arose, would have seen the value of the portfolio rise to £379,606 by the end of March 2012. Moreover, an investor who had chosen to spend the income as it arose, would have seen their capital rise to £196,615 and, as importantly, the value of the income rise from £4,100 to £7,400(2).  This is over a period where inflation (3) has risen by 72.86%, the annualised equivalent of 2.92% and a period during which global equity markets have been the most challenging since the 1930s. 

This ability of a well balanced portfolio of investments to provide growth in both capital and income above inflation over the longer term should make it a key component of longer term savings for investors which, I would suggest, is vital at a time when increasing longevity and falling state provision makes an individual’s personal financial planning key to their long term financial wellbeing. 

Rob Burgeman

Divisional Director

Election red, white and blues

Image: John Bullar

Nicolas Sarkozy is the latest incumbent leader to face the music as the first round of voting for the next French president takes place on Sunday. The role of president in France is rather different to that of other European leaders. Since Charles de Gaulle ushered in the Fifth Republic at the height of the Algerian crisis in 1958, the president has far wider powers and relies far less on parliament than his peers elsewhere. Indeed, even the most hardened Francophile would be hard pressed to name the current Prime Minister (François Fillon, if you are interested). As a French colleague once said to me, “France is the only country in the world where, every five years, we vote for our king”.

However, the latest poll results do not make very happy reading for le petit Nicolas. Socialist rival François Hollande looks set to make it through to the second round and, if the opinion polls are to be believed, will comfortably beat M. Sarkozy. This is a candidate who is proposing a tax rate of 75% on earnings over €1m, who has promised to return the retirement age to 60, who refers to the world of finance as his “greatest adversary” and who is planning to “renegotiate” the hard fought EU fiscal compact. It is as if he is totally unaware of what has happened in other parts of Europe over the last three years or so, although no doubt the grim realities of Eurozone economics would reassert themselves fairly swiftly were he to be elected. Nevertheless, France’s credit rating – already downgraded from the much cherished AAA to AA by the rating agencies – could find itself under more pressure in the event of a Hollande victory.

Of as much concern to Euro watchers should be the wider picture presented by the pollsters. Voter apathy and disillusionment with existing parties is endemic – and not just in France as witnessed by the astonishing by-election victory of George Galloway in Bradford recently. In France, the right wing National Front party led by Marine Le Pen (daughter of Jean-Marie Le Pen) and Jean-Luc Mélenchon of the Left Front are polling 16% and 14% respectively. In other words, 30% of the electorate feel so disenfranchised from the current system that they are prepared to support radical alternatives to the traditional ruling parties. This should be far more worrying to other politicians seeking re-election from an austerity weary population.

Rob Burgeman

Divisional Director

Can Wall Street go it alone despite Spain’s woes?

With the markets having got it in for Spain and focusing on where the government and the banks might be heading, they are likely to keep pushing yields up. That might invite the ECB to respond via its Securities Market programme. Yields on the sovereign’s debt ended last week fractionally below 6 percent. Ahead of tomorrow’s and Thursday’s auctions they start this week just fractionally above. 

So while another testing week lies ahead for equity markets, the other feature that is likely to occupy their attention is the US earnings season. This gets underway with some 86 companies in the S&P 500 reporting this week. Analysts having been warned by the pre-announcements not to expect great things because of depressed economic activity in Europe and the loss of momentum in the developing world, but more on this shortly.

In his Sunday Times column Irwin Stelzer makes the point about how history can shape attitudes towards policy. Germany’s deeply rooted fear of inflation and, in the US, fear of its antithesis serve to demonstrate a fundamental difference that lies at the heart of monetary policy.

For the ECB, the concentration on price stability contrasts the Fed’s dual mandate of employment and price stability. In its present-day context, the difference is between the ECB’s financial assistance, however bold, aimed at stabilising the banking system and the Fed’s all out commitment to a reflationary effort aimed at the broader economy. More >

Mike Lenhoff

Chief Strategist