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A robust end to 2010 and confident
start to 2011
January 2011
Christoper Lee
It is that time again when we look back
at where we have come from over the last 12 months, and
forward to where we think we are going over the next 12
months. We are certainly at a very different point now than
we were one year ago. The tried and trusted market emotions
of fear and greed continue to rule the roost and they
currently feature as strongly as ever. The fear of a double
dip has diminished considerably with some good reason, but
it still lurks in the shadows, primarily in the form of
concerns about the sustainability of the European currency.
In market terms this fear has manifested itself through
concerns in the bond markets with investors to some extent
appearing to step to the side-lines whilst values are
re-assessed.
Greed has found a home in the equity and
commodity markets where prices have firmly established
upward trends. Although these gains can be put down to an
inflationary push, fuelled by successive bouts of QE, there
are also good reasons to join the party, not least the
appetite for quick capital gains. Investors have to put
their money somewhere and with interest rates remaining
historically low, and the interest rate curve building in
risk premium based on credit fears and anticipation of
future rate increases, equities in particular are as good a
place as anywhere.
Battles have undoubtedly been won in the
global economic markets giving good reason for some
restoration of confidence, but the war still rages with key
structural weaknesses still to be addressed. Although
international co-operation and co-ordination is clearly
evident it remains broadly below the surface and for that
reason somewhat disjointed.
Markets
The markets remain perverse and sentiment
is heavily influenced for intervention by the various
central banks around the world which, whilst restoring
confidence, does nothing to help re-establish soundly-based
comparative values. It can only be hoped that 2011 is the
year when such false support for the market not only
diminishes but disappears altogether, although this cannot
be achieved painlessly.
Equities
It can be seen from the FTSE chart that
it has been a rocky road this year despite ending near the
annual highs. The basic statistics show a low of 5,196.81
one year ago with a close on 17 December 2010 of
5,871.75 representing a 12 month rise of 12.98%. Not bad
when measured against the current level of interest rates!
So what is the story behind the numbers? Well apart from the
obvious fact that the market has certainly had its ups and
downs in getting to where it is now we must try to assess
how much of this truly reflects an economic recovery, if not
now at least in predicting the future.
The key driver has clearly been
quantitative easing across the major markets. This has had
two effects; firstly to create an inflationary impact simply
based on cash trying to find a home somewhat more rewarding
than current returns on cash; secondly how this strategy has
affected relative values within the indices. As far as the
latter is concerned it appears that the stocks that should
have done well if this was truly based on economic recovery
have not faired as well as those that have been underpinned
by government intervention. In short investors have taken
the view that where companies have been supported, primarily
the financial sector, there is little capital risk in buying
those shares, whereas as other sectors reliant on broad
economic strength have struggled.
This does not mean that equities will not
be the place to be going forward because economic activity
will pick up eventually even if 2011 proves to be a
difficult year. It does mean that relative values will also
adjust over time, particularly as QE is reversed. My view
would be to selectively build equity investments with no
need to rush but certainly to maintain an increasingly
equity element in portfolios. As often stated in this
column, structural changes are taking place, and they
certainly have not run their course.
Currencies
Sterling has generally had a difficult
year and this is illustrated by a gradual weakening and
would suggest the jury is still out in terms of how
successful current government policy will be. This does not
necessarily imply that UK limited cannot re-structure
successfully but does recognise that there is no quick fix
and shifting from an economic model based on a credit
fuelled consumer economy to one with sounder foundations
will not be easy.
It also reflects the fact that our
historical economic strength in the financial sector is
clearly under threat from three directions; increased
regulation; higher taxation; and demand for increasing
amounts of capital. In reality in the area of capital UK
banks are comparatively well placed but even so there will
be a need to raise even more.
Commodities
Brent crude oil
Inflation is now feeding through quite
quickly none more so in the area of petrol and heating oil
where prices are reaching all-time highs. Obviously the
severe weather conditions have added to demand but there is
also an underlying increase which given the relatively soft
economic global recovery suggest some re-building of stocks
and reserves.
Gold
Gold has maintained its’ position as a
safe haven for funds seeking a hedge against inflation as
well as the obvious sector to build reserves whilst the
future remains uncertain. I expect gold to maintain value
but the impetus of the upward move has certainly weakened in
recent months resulting in a broadly sideways movement and I
would expect this to continue at least into the first half
of 2011.
Conclusion
As we enter 2011 it will, for many in the
UK, be stepping into the unknown. Public sector employees
can expect a torrid time as savings are short with many
losing their jobs. Some will of course move into the private
sector as certain services are transferred from one to the
other to achieve net savings, and in the big picture
removing waste and increasing productivity. The future
remains uncertain for all of us as the squeeze takes effect
and will certainly result in more civil unrest and increase
the unpopularity of the government. The latter need to keep
their nerve and maintain their unity if re-structuring is to
succeed.
People generally are dipping into savings
to finance some short-term pressures such as the seasonal
effect of Christmas. Unfortunately pressure will continue as
prices and taxes are increased, the ability of people to
re-build savings will be impaired. Financing these
difficulties through credit will, I suspect, be a last
resort whilst economic confidence remains fragile and job
security uncertain. This of course will not help government
funding from domestic sources so we will be heavily reliant
on international investors, hoping they believe the UK is
not only sound but represents good value in terms of
returns.
Inflation is back! As it becomes more
established and moves from providing a warm glow for
economic recovery to a threat to that recovery, interest
rates will rise. Inflation is not bad, too much inflation
is. Credit is not bad, too much credit is. Bonuses are not
bad, bonuses that are too large and unrelated to adding
value are. It is all about balance and 2011 will be a year
for the government getting it right. We must all hope they
do.
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