Regularly, Allenbridge holds an investment committee meeting comprising of investment strategists and economists, unit trust experts, hedge fund specialists and senior executives. It looks at the trends it expects in markets over the next months. These help to form Allenbridge's strategy both for clients generally and for the funds it manages.
Here are the findings of the July meeting.
We are going through some turbulence in the markets, which has pulled down all the strong gains of the first quarter. Equities are roughly down about 10% across the major markets. The UK seems to be leading the pack having fallen quicker than other markets, although this could be partly to do with BP. On a valuation basis equities look attractive on current and expected profit forecasts. However, if we are in a double dip environment then those earnings figures aren’t as sound and in which case we are facing higher P/E multiples.
We’ve had a flight to quality, as in contrast to equities government bond markets have rallied, with yields going down to totally unexpected levels. There has also been a bit of an uptick in corporate bond spreads which is another risk asset class where sentiment has turned negative.
GBP has picked up a little against USD and EUR. USD has strengthened particularly against the EUR, with the USD seen as safe haven. A good thing for the UK is that our export sector has become a lot more competitive over the last couple of years due to Sterling depreciation which might trigger off some business spending.
Possibly there has been a slight overreaction in sentiment jumping across to a double dip economic scenario. There has been some weak economic data coming from the US; home sales aren’t looking good again, confidence indicators have crashed, and employment figures have been weak. All this would suggest that the economic recovery is running out of steam. This isn’t that surprising considering we have had 4 quarters of strong recovery and because of the nature of the inventory cycle where you would typically get a v-shape at the bottom of the business cycle. So we’d assume that the recovery would begin to slow down, although some have gone further suggesting that we are in for a double dip. Sentiment has taken a knock, consumer real incomes have been significantly stretched and we have a significant fiscal retrenchment in Europe and the UK.
In the US there certainly seems to be some juice left in the fiscal tank. In the UK we are moving from a 10/11% deficit to GNP ratio to 2/3% over 4 years, which is taking almost 2% a year out of GNP with multiplier effects. That’s a severe contractionary influence. Most of the fiscal restraints don’t come in till next year, when we will see the VAT hike and the public sector pay restraints. The important thing is to make sure we don’t nip the economic recovery in the bud which is a material risk at the moment.
Germany has taken the lead in Europe in trying to get their budget deficit under control even though it isn’t too bad and their credit worthiness isn’t under attack. That is slightly unfortunate as it does leave the European economies down just when they need as much stimulus from Germany as possible. At the same time the ECB has pushed out all this money through its support operations for weak sovereign debt. The bottom line is that we have a situation in both the UK and Europe of lax monetary policy and contracting fiscal policy. That leaves some people a little worried about inflation, although the inflation scaremongers are diminishing rapidly as we move back in terms of market psychology towards a deflationary type environment.
The public sector stepped in to save the private sector, but is now beginning to retract that support line. Only low interest rates and quantitative easing will keep the economy going, and maybe QE will need to be increased further which will increase inflationary pressures. However, in the UK QE hasn’t had a transmission into the money supply at all. The monetary base has increased a lot as banks are parking cash with the Bank of England, but M2 (money in circulation) figures are only growing at 2 or 3% which suggests that there isn’t a short-term monetary risk to inflation.
Inflation in the UK has remained higher than expected, although it has now begun to back off. CPI peaked at 3.7% and is now at 3.4% so its heading down. It has been high due to exceptional factors such as higher gasoline prices and the changes in VAT. We have had enormous volatility in inflation over the last couple years, prior to which inflation had been stable for near 15 years. It has been a problem in the short-term, but given the new emphasis on deflationary forces we can probably be a little more relaxed on inflation. However, next January VAT will go up again which will lead to another spike up.
China has announced a change in policy regarding the Renminbi where it will tolerate some movement against the USD within bands. Also, they are trying to impose quantitative restriction on bank lending in an attempt to reign in China’s rapid growth which has inflationary consequences. This has also unnerved markets.
In equities the bull run to March looked like it had gone too far so we’d expected some pull back, but the correction has gone further then hoped. The drop over the last couple of weeks has really been down to renewed doubts over the economic recovery led by the US and by the general European move towards fiscal consolidation.
Our optimism on markets holding and finding a floor now has to be tempered. In the short-term momentum and sentiment will drive the markets and that could go either way. Some investors may feel that there is value here but the most recent economic news hasn’t been encouraging. However, it’s hard to believe that we will be facing a double dip scenario but there are lots of pressures. A positive is that at least the UK is no longer seen as a credit risk.