Market View - August 2010

"No need for double dip" (recession) was the encouraging title of a recent article in The Times by its Chief Economist Anatole Kaletsky.

Kaletsky argued that the "ex-post" rationalisation following adverse short term market movements all too often are the cause of gloomy predictions on the global economic outlook. This, he suggested can be very misleading in terms of identifying the real threat to the global recovery, namely over zealous fiscal tightening, and he believes there has thankfully been little evidence of this to date except ironically here in Britain by the new coalition government's Chancellor George Osborne.

Anatole also believes central banks are still holding most of the aces since they can effectively persuade businesses and homeowners to resume investing and spending again instead of paying down debt, through reinforcing the message that interest rates will remain close to zero for the foreseeable future. The additional ammunition for this lies in their ability to push longer term interest rates on bonds and fixed term mortgages down to close to zero.

Thankfully global equity markets appear to have responded to a more positive outlook over the past few weeks as the FTSE 100 here in the UK rose 8% during July to close at 5258, albeit still 9.87% below its twelve month closing high of 5834 achieved on April 16th of this year. Similar rises during July occurred in other major stock markets (S&P 500 rose almost 7% to close at 1102) and even the Shanghai Composite which has been in a bear market for almost a year joined the party, rallying almost 10% to close at 2648!

Just as positively, city rents in London appear to be signalling healthy growth demand following a 25% increase since January taking the average to £53 per square foot. This is effectively the strongest six months in rental increases since 1988!

In addition a recent poll by the American Association of Investors showed that only 25% of the respondents were bullish which historically has often proven an invaluable contrarian indicator! Elsewhere in the United States, Barron's reported that the forward Price earnings ratio (a useful valuation tool for stocks) on the S&P 500 index is now below 12, which is the lowest since the late 1980's!

Meanwhile an article in The Economist's finance and economics section reported on the exciting plans by the Indian government to speed up private financing for infrastructure development and help raise another $150 billion by 2012. The report titled "Infra red" explains how the government hopes the introduction of infrastructure-debt funds (backed with a government guarantee) will help achieve this goal.

It was not all good news in July however, and the enormity of the challenge facing Western Sovereign Nations was summed up by Jean-Claude Trichet (President of the European Central Bank) who said "Our economies are emerging from the worst economic crisis since the Second World War, and without the swift and appropriate action of central banks and a very significant contribution from fiscal policies, we would have experienced a major depression. But now is the time to restore fiscal sustainability.

"The fiscal deterioration we are experiencing is unprecedented in magnitude and geographical scope, and by the end of this year, government debt in the euro area will have grown by more than 20 percentage points over a period of only four years, from 2007-2011. The equivalent figures for the US and Japan are between 35 and 45 percentage points."

The challenge for investors to find investment options that deliver attractive yields was highlighted during July when National Savings and Investments closed its popular inflation beating certificates to new investors while cutting rates on a number of other accounts. The inflation linked bond had proved increasingly popular as the retail prices index rose to 5%.

With interest rates on cash deposit accounts and yields on gilts and other government bonds near all time lows, equity income funds both here in the UK and overseas in regions such as emerging Asia look increasingly attractive. For example the yield on the FTSE 100 index here in the UK is currently 3.36%, while the yield on the FTSE 350 Higher Yield index is 4.88%, which compares very favourably with the that on 10 year gilts of 3.33%, 10 year US Treasuries at 2.93% and 10 year German bonds at 2.67%.

Additionally equities have historically proven to be one of the best performing asset classes during periods of higher inflation. Overall while risks remain to the downside particularly should the recovery in the US economy stall, equities continue to be our preferred asset of choice for the foreseeable future.