This weekly Briefing Note aims to pick out some of the key financial and economic issues touched on in the press over recent days, and from time to time includes the views of some of our independent fund managers.
- Latest minutes from the US Federal Reserve indicate QE3 is less likely
- Equity markets fall back as a result
- US employment numbers disappoint
Financial markets were mixed last week with equities put on the back foot following the release of minutes from last month’s US Federal Reserve meeting that showed the chances of more quantitative easing have diminished. The US dollar was the main winner in the currency markets as it appreciated almost 2% against the euro following a series of lacklustre eurozone data. This is in stark contrast to a steady flow of more positive economic news from the US in recent weeks, although data on Friday showed that the pace of job creation had slowed sharply in March. Employers created 120,000 new positions – below economists’ expectations of 205,000 and the weakest set of payroll figures for six months. Despite the weaker numbers, the unemployment rate fell from 8.3% to 8.2%, reflecting the fact that dispirited workers have given up looking for work. The latest figures revived worries on Wall Street about the health of the US economic recovery and contributed to further share price falls – along with most other markets, the S&P 500 Index ended the week about 0.8% lower.
In the commodity markets gold, silver and copper all fell as a consequence of the stronger dollar – gold ended the week down $30 per ounce to close at $1,632. Over in the oil markets there were the first signs of prices easing after the largest two-week rise in US crude stocks in more than ten years helped to dampen fears of a shortfall. As a result, US oil prices fell to their lowest level for almost two months; whilst in the UK, Brent crude slipped to $123 per barrel. Falling oil prices will be welcomed by Mr Obama as rising petrol prices, alongside unemployment, have become an important battlefield in the US presidential race.
The issue of high unemployment is certainly not peculiar to the US. Figures out last week illustrated the shockingly high cost of the austerity policies being pursued in the southern eurozone states. The unemployment rate among Spain’s under-25s rose to 50.5% in January and to 50.4% in Greece according to the latest data available from Eurostat, the EU’s statistics office. These high rates contrast sharply to those in Germany where just 8.2% of youngsters are unemployed and compare to an average eurozone rate of 21.6%. The extent of Spain’s problems is further underlined by a housing market crisis with one in four homeowners in ‘negative equity’. The need for austerity was further underlined last week when Spain’s latest budget announcement failed to impress investors. Madrid managed to sell just €2.6 billion of debt, disappointing the markets and causing Spanish bond yields to rise to levels not seen since January. Investors’ reluctance to support the auction rubbed off on Italian bonds where yields also began to rise. By coincidence or otherwise, Mario Draghi, President of the European Central Bank (ECB), dismissed as premature Bundesbank demands for an “exit strategy” to unwind the ECB’s crisis fighting measures which have supported the markets this year.
- Latest US jobs data unlikely to sway the Fed to change policy
The release midweek of the most recent minutes from the US Federal Reserve’s regular monthly meetings was the main cause of concern for the markets. In recent weeks, hopes of further monetary stimulus in the form of quantitative easing (QE) have grown following comments from Fed Chairman Ben Bernanke. Mr Bernanke has voiced concerns that the improvement in US labour market conditions might prove unsustainable thus requiring further policy action – dubbed ‘QE3’ by the markets. The reason that the latest minutes caused disquiet in the markets was attributable to what might appear, to casual onlookers, as only a slight change in nuance in the wording. In March, only “two” of the ten voting members felt that further stimulus could become necessary if the economy lost momentum. This was in contrast to a “few” members who, back in January, thought “economic conditions could warrant the initiation of further securities purchases before long”. The minutes revealed that, overall, the Fed had not sharply revised its views on the economic outlook.
In respect of the jobs data, economists warned against reading too much into one month’s jobs figures, citing
the possibility that the January and February figures were flattered by warmer weather. Friday’s poorer payroll numbers are not, though, expected to sway the Fed from its wait-and-watch attitude to the economy; although the weak figure will no doubt reinforce its caution. These latest figures are likely to reinforce economists’ forecasts that growth in 2012 will be nearer 2% than the hoped-for 3%.
“One number is not going to see the Federal Reserve make any knee-jerk reaction but it will serve as a reminder to the hawks that the US is not fully up and running again”
David Semmens, senior economist at Standard Chartered
- UK unlikely to slip back into recession, say business leaders
- Latest ONS data appears to contradict most recent business surveys
Last week was a good example of how numbers can dominate and sour investors’ mood – at least in the short term. Here in the UK we’ve also been seeing some much better-than-expected economic numbers which has raised hopes that Britain could avoid a double-dip recession. According to the latest quarterly survey of leading finance directors by accountants Deloitte, business optimism is rising at its fastest rate since 2007 as fears over an imminent eurozone break-up abate and few expect a double-dip recession. And there was a wealth of other survey data out last week which supported a more optimistic view on the outlook for the UK. According to the Markit Purchasing Managers’ Index (PMI), the construction industry rose from 54.3 in February to 56.7 in March – with any number over 50 indicating growth. In quick succession came the latest snapshot of the all-important services sector – accounting for around 70% of GDP – which showed the PMI rising from 53.8 to 55.3 in March. Over the first quarter of this year, the surveys were the strongest since mid-2010. Finally came the news that the CIPS manufacturing PMI which combines output, orders and employment, rose to a 10-month high of 52.1.
So far, so good. Until, that is, last Thursday, when the Office for National Statistics (ONS) threw a spanner in the works by publishing figures showing industry back in the doldrums. Unlike the latest PMI surveys, the ONS data covered February, calculating that manufacturing output fell 1% and was down 1.4% on the same time last year. While overall industrial production was up 0.4%, it was 2.3% lower than in 2011. Revisions to official data, though, are always expected – the ONS has a history of having to revise its numbers – so it was no surprise that the British Chamber of Commerce’s chief economist said the numbers raised “serious questions” about the official data. As ever, it will only be with the benefit of hindsight that the true picture will emerge; but here and now, there seems to be plenty of evidence that the UK remains on track for recovery.
- Investing in equities long term still makes sense
With the outlook for interest rates unchanged and inflation falling, it is clear that returns from cash will remain very low – the Bank of England’s (BoE) latest inflation report is predicated on the basis that the base rate will remain at 0.5% until 2014. Whilst our core advice remains to stay well diversified, it’s worth weighing up the outlook for shares and bonds (fixed-interest investments). At present, equity valuations relative to bonds appear to more than compensate for the extra risks – indeed many companies’ shares yield more than their corresponding corporate bonds. Of course equities will suffer if the BoE is wrong in its near-term forecasts for inflation in either direction, as neither significant inflation nor deflation are positive for the valuation of equities.
In its report on the outlook for equities, investment manager Schroders makes the following observations.
“Many equity valuations have fallen to levels where long-term investors are sufficiently compensated for taking this risk. Profitability is high and this creates risks too as it will revert to the lower mean over time. However, we do not see wage pressures acting to put downward pressure on profitability over the next 1 to 2 years. For now, the greatest threat to equity markets remains an unexpected downturn in economic growth. We continue to favour quality companies, defined by characteristics such as strong balance sheets, a secure dividend and a sustainable business model. We also see value in ‘value’: those companies trading on low valuation measures relative to the market. Buying companies in out-of-favour areas of the market has historically proved to be a successful strategy, but must be seen as a long-term investment as managers pursuing this strategy can suffer prolonged periods of outperformance.”
Schroder Investment Management manages funds for St. James’s Place.