Market View - April 2014

“Never stare a gift horse in the mouth” is an adage we all know and love. During the last quarter, the consensus in the marketplace seems to suggest that the “equity bull gift horse” which the Federal Reserve (Fed) presented investors with back in 2009 - through a combination of various post Lehman stimulatory policies “Zero Interest Rates” (ZIRP) and “Quantitative Easing” - remains solidly in place despite the perception that these market assisting wonder stimulants are either already being wound down (QE), or will next year have to begin normalising (ZIRP).

Due, in part, to the market being a little confused as to the true intentions of the Fed (since further tapering of the current QE programme during the quarter would ordinarily signify credit tightening), together with continuing doubts surrounding the economic recovery and, hopefully brief, geo-political tensions in the Ukrainian and Crimea, the first quarter ended with most markets little changed from where they started the year.

At the end of March, the S&P 500 in the US closed at 1872.34, for a gain of just over 1% during the quarter (which was the fifth successive gain), and is now up more than 177% since the post Lehman low of April 2009. Meanwhile the quarterly performance of the FTSE 100 in the UK at 6598.37, showed a loss of more than 2%, while the CAC in France at 4391.5 was up almost 3%, and the DAX in Germany at 9555.9 was broadly flat. Most Asian markets had a tough first quarter with the Nikkei 225 in Japan at 14827.83 down almost 10%, the Hang Seng in Hong Kong at 22151.06 down almost 5%, and the Shanghai Composite in China at 2033.06 falling more than 3%. Bucking the trend however was the BSE Sensex in India at 22386.27 which rose more than 6% during the quarter.

At the end of March Janet Yellen, the newly appointed Chairwoman of the Fed, during a speech given in Chicago, reassured equity and government bond markets that, while the US recovery was on track, it still had some way to go before the Fed would be in a position to cease monetary stimulus altogether. Key economic indicators included unemployment rates peaked at 10% in October 2009, since when the economy has added more than 7.5 million jobs with a fall in the unemployment rate of more than 3% to 6.7%. Progress has been gradual but remarkably steady - February was the 41st consecutive month of payroll growth, one of the longest stretches ever.

There remains little doubt however, that the economy and job markets are not yet fully resurrected to normal health and that small and medium-sized businesses remain cautious about the strength and durability of the recovery.

Chair Yellen went on to say “The recovery still feels like a recession to many Americans, and it also looks that way in some economic statistics. At 6.7%, the national unemployment rate is still higher than it ever got during the 2001 recession”………….. “One reason why I believe it is appropriate for the Federal Reserve to continue to provide substantial help to the labour market, without adding to the risks of inflation, is because of the evidence I see, that there remains considerable slack in the economy and the labour market.”

The relief felt by markets following this speech was in stark contrast to that following comments Chair Yellen made after her first Federal Open Market Committee (FOMC) meeting a few weeks earlier when she announced a continuation in the tapering of the Fed’s bond purchase programme as well as suggesting ZIRP may come to an end sometime in 2015 following the completion of the tapering exercise. Understandably most commentators and investors took this to mean the Fed’s tightening strategy was continuing, reflecting good news that the US economy was still improving but also suggesting an end to the QE money which has been driving assets higher in risk markets such as emerging equity and bond over the past several years.

However John Butler, Head of Commodities Hedge Fund Amphora Capital made an interesting observation after the FOMC announcement suggesting that tapering was something of a mirage and that in reality Fed strategy was still loosening credit as opposed to tightening within the US (and by implication global) economy. Explaining that the Fed was facilitating this through the increased purchases of longer term bonds (with all the tapering at the short end), of maturities beyond 10 years, where far more 'duration' and 'convexity risk’ can be taken off the banks, while the new money they receive can be lent out regardless, he concluded that “the data show the Fed is continuing to increase its purchases of ten year plus bonds, which are the ones that really take the bulk of interest rate risk off the banks.”

Another important observation came from Larry Fink, CEO of the world’s largest asset management group Blackrock ($4.3 trillion AUM), who wrote in a letter on the 21st March to the leaders of companies in the S&P 500 “It concerns us that, in the wake of the financial crisis, many companies have shied away from investing in the future growth of their companies. Too many companies have cut capital expenditure and even increased debt to boost dividends and increase share buybacks. We certainly believe that returning cash to shareholders should be part of a balanced capital strategy; however, when done for the wrong reasons and at the expense of capital investment, it can jeopardize a company’s ability to generate sustainable long-term returns,”

Blackrock’s concerns that short term growth through a combination of share buybacks and increasing dividends may be at the expense of longer term investment in capital expenditure (capex) have been echoed by other commentators, but from an investor’s perspective it is good news (at least for now), as the attractive yield and capital returns available from less risky blue chip international stocks listed both in New York and London have made equities the asset class of choice for an increasing number of investors whom would otherwise have had to settle for low yields from cash and bond alternatives. While we accept that equity valuations on several historic metrics look challenging in the US, the same cannot be said for UK stocks (where price to earnings (PE), price to book (PB) and other ratios remain reasonable), or indeed in many European markets where the long running EU banking crisis has kept equity valuations cheap on a comparable global.

Additionally it could be argued that the surprise changes to pension annuity rules that were announced in March’s budget by UK Chancellor Osborne should be good news for the UK equity market, as from next year sizeable pensions assets that otherwise would have been used to buy predominantly bond and cash based annuities, will now be available to potentially invest in higher yielding equity portfolios, albeit in return for higher risk.

We at Ash-Ridge Asset Management believe that higher yielding stocks both in the UK and selectively in European companies continue to offer value for money and attractive risk reward profiles. In the UK, our portfolio investment funds have increasingly been identifying attractive opportunities in both medium sized (FTSE 250) and smaller (FTSE Smaller) companies, whilst also seeking to identify some of the excellent growth potential available in higher yielding blue chip companies where the yields of Vodafone (8.70%), Sainsbury’s (6.17%), GlaxoSmithKline (4.89%) and BP (4.74%) for example, show what is available.

The aggregate yield on the FTSE 100 group of companies at the end of March was 3.61% and the FTSE 350 Higher Yield (which is where many of the stocks we are invested in via our UK funds are represented) was 4.76%, which compares most favourably with the yields available on long term government bonds (10 year gilt 2.25%, 10 year Treasury 2.75%) and cash (2.50% Halifax 5 year fixed).

In summarising, some of the opportunities we believe exist in UK, European and global equities, we reiterate one of Warren Buffett’s less well known but highly relevant sayings - “Just because the market is frequently efficient, does not mean it is always efficient. The difference between these two propositions is night and day.”