All that Glitters | AAG Wealth Management

All that Glitters

Posted: June 23, 2014

China flew into town last week in the shape of the People’s Republic’s premier Li Keqiang and his entourage to meet Prime Minister David Cameron at Downing Street, with some tea on the way at Her Majesty’s in Windsor. The Sino-British delegations covered trade, finance and sundry affairs of state – with only Cameron’s number two, Nick Clegg, impolitely raising the matter of human rights in this the 25th anniversary year of the Tiananmen Square protests. But the price of expediency is an alluring array of multi-billion-pound deals for UK business and industry, ranging from investment in high-speed rail links to energy contracts, nuclear power collaboration pacts and an agreement for the City to become the leading offshore market for China’s currency. Seven months after Cameron and his trade mission swept into Beijing with fine words and high hopes, the Party’s leadership and mandarins have returned the call and provided Britain with deals worth £14 billion.

Li’s declaration that the UK and China are “indispensable partners in economic and social development” was flattering indeed, and the talk of £60 billion-worth of bilateral trade by the end of 2015 an encouraging addition to Cameron’s Chinese inventory (despite Beijing’s complaint to Downing Street that the red carpet that separated Li from Heathrow’s tarmac had rolled out some three metres too short). Tellingly, as George Osborne, the UK chancellor, last week led a meeting of international financial leaders on global free trade, China declined the advance of the world’s three largest container shipping firms to work as an alliance to serve China’s seatrade needs. Beijing remains focused on what benefits its economic interests, not those of yáng guǐzi, or foreigners, in the name of free trade. (Incidentally, as the coalition deepened trade and investment ties with the world’s second-largest economy, the Confederation of British Industry warned that the strength of the pound could frustrate the growth in UK exports.)

China’s premier also declared during his visit that a ‘hard landing’ for the world’s second-largest economy was not part of his script, despite recent concerns aired by the International Monetary Fund (IMF). AXA Group’s chief economist Eric Chaney identifies policy mistakes by China over the next six months as key global risks. Moreover, he warns that China’s rise as a superpower, if mismanaged, also poses a long-term threat. Chaney also highlights the threat that the escalation of conflict in Iraq, the world’s seventh-largest oil producer, and in the wider Middle East, poses to the global economy. Brent crude edged up $1.40 over the week to $114.81 a barrel and nearer to the $120–125 danger zone when global growth could start to strain.

Rational Exuberance?
Global markets remain buoyant, despite renewed talk of complacency in the face of macroeconomic risks – and a jihadi army on the outskirts of Baghdad. Apart from the Nikkei 225 Stock Average, the major equity indices have advanced so far this year, with the MSCI Emerging Markets index up 4.1% in the wake of its 5% retreat in 2013. But a fresh concern for markets will be the knowledge that spikes in oil prices since the early 1970s have been followed by recession in the West. Moreover, in 2011 and 2012, the rise of oil to $125 a barrel set in motion a ‘risk-off’ reaction from investors and a downward correction of equity markets. Oil price rises could also raise difficult questions for the Fed’s strategy to end quantitative easing (QE).

On Wall Street, the S&P 500 closed on Friday at a record high of 1,963 points, after its sixth consecutive daily rise; an advance of 1.3% over the week. The CBOE volatility index – known as the ‘fear gauge’ – remains near to a seven-year low as the S&P 500 nears the 2,000 point. Markets were boosted by the supportive stance taken by the Fed’s chairwoman, Janet Yellen, as she unveiled a further $10 billion cut to the monthly asset purchase programme to $35 billion. Yellen said that inflation is in line with expectations and that the near-zero base rate would be “well below longer-run normal values at the end of 2016”. Meanwhile, the IMF cut its growth forecast for the US economy this year to 2% from 2.8%, although this reflects the one-off impact of winter weather. The IMF said that the Fed could hold its base rate for longer than markets expect.

The accommodative message from the US central bank helped Japan’s Nikkei 225 advance 1.7% over the week to close on Friday at 15,439 points. Although the Nikkei is down 5.7% this year, global investors are treating the decline as an investment opportunity. A Bank of America Merrill Lynch monthly survey found that fund managers have become more positive on the outlook for Japanese equities; in part reflecting their approval of reforms of corporate taxes and the Government Pension Investment Fund. However, trade figures were less promising, with May exports down as US and Chinese demand weakens.

In Europe, fears continue to mount that the Eurozone could follow the path of the Japanese economy in the early 1990s into a prolonged bout of deflation. The scale of the task facing Mario Draghi, president of the European Central Bank (ECB), was underlined last week by data that showed inflation fell to a five-year low in May. Meanwhile, the IMF urged the ECB to consider QE to stimulate growth. Amid these uncertainties over growth in the eurzone, European equities continue to offer value, as corporate profit margins in the region remain at low levels compared with the US. Fund manager AXA Framlington expects earnings to grow 10–15% in 2014 and 2015 as these margins rebound. Meanwhile, the big corporate development at the weekend was the news that Paris has given its blessing to US conglomerate General Electric’s $17 billion bid for Alstom.

Aisles War
In Britain, as a resurgent China prised open the former colonial power for its industrial and financial knowhow, supermarket discount wars and a sharp fall in air fares helped push the Consumer Price Index in May to 1.5% from 1.8% in April, the lowest level since October 2009. Competition between the UK’s supermarkets intensified last week with Morrisons cutting prices by an average of 14% as part of its £1 billion campaign to improve its market share. Sainsbury’s also unveiled plans to reintroduce Danish discount grocery store Netto to Britain. Meanwhile, the Office for National Statistics reported that the average cost of a UK house rose by 9.9% in the year to April, the largest annual rise since 2010, powered by an 18.7% rise in London prices over the period. Despite rising concerns over a UK-wide housing bubble, the threat is focused largely on London.

The cost of Britain’s houses continues to dominate public life. Cameron has said he could rethink the Help to Buy scheme; while the Bank of England governor Mark Carney has pledged to “take further proportionate and graduated action”, if needed, to cool the housing market. Stuart Mitchell of S. W. Mitchell Capital observes that the political message is unclear, and the signals from the Bank are opaque. “Carney linked unemployment with interest rates, to great fanfare, when he became governor, but has since dropped this target because it didn’t suit him,” says Mitchell. “He also talked of rates not rising until 2016 and yet recently said they may rise sooner than expected.” A welcome upshot is that the outlook for the UK’s house builders remains “very strong even if we have a small rate rise over the next six months”, adds Mitchell.

Meanwhile, minutes from the Bank’s Monetary Policy Committee suggest that members are more circumspect about a base rate rise than suggested by Carney’s recent comments. Fund manager Schroders believes that the first rise could come in February 2015 with a 0.25% rise per quarter to 1.50% by the end of that year. Of course, the prospect holds little comfort for savers faced with negligible returns from cash deposits. However, next week holds a ray of hope with a welcome increase in the Individual Savings Account (ISA) allowance to £15,000 and more flexible rules that permit any combination of stocks and shares and cash. The new ISA regime gives individuals more freedom to build a balanced portfolio to suit all manner of investment needs.


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