Market Round Up

UK

• Growth has been surprisingly resilient in recent months
• However, cuts to government spending are likely to have a dampening effect on future growth and unemployment is still rising
• UK stocks regain positive territory for the year-to-date but mixed economic data suggests a challenging outlook
• The International Money Fund gave an upbeat assessment of the UK’s economic prospects, endorsing the government’s deficit reduction plan and declaring the economy to be “on the mend”
• At the end of October UK regained its “AAA” financial rating
• In summary, the economy is slowly recovering, but jobs continue to be cut, taxes hiked and spending slashed to address the huge deficit.

US

• The anticipated Fed announcement on its second round of quantitative easing, (dubbed ‘QE2’) has now been made. The Fed will buy $600 billion of longer-term Treasury bonds by the middle of 2011, at a pace of about $75 billion per month
• Risk markets have reacted positively. There was some initial disappointment in bond markets that further purchases would only be made if economic conditions justified them. However, the early signs are that the Fed seems to have put just enough juice into this easing program to get investors excited. The UK is not following suit after stronger-than-expected economic growth data
• Addressing the huge budget deficit is likely to hinder growth and high unemployment is a headwind to consumer spending
• The housing market remains very weak but better-than-expected macro data dampens down fears of a double-dip recession

Europe

• Manufacturing is rebounding and a weaker euro is benefiting exporters
• Equities are proving vulnerable to risk aversion amid negative news flow
• Austerity packages are severely constraining growth in peripheral economies (Greece, Spain, and Portugal).
• Spain’s credit raging was downgraded while Ireland bailed out its banking sector
• A credit rating downgrade to near junk status on state-owned Anglo Irish Bank hit the Euro and increased the price Ireland must pay to borrow in the money markets

Asia & Emerging Markets

• Governments' financial positions are relatively healthy.
• Banking systems in the region are in fairly good shape with cash reserves
• China's moves to tighten bank lending have unsettled markets.
• Asian markets are vulnerable to setbacks in risk appetite.
• The region's exporters to Europe are affected by the weaker euro.

Japan

• The economy has emerged from recession and the second quarter’s GDP figures were revised up to an annualised rate of 1.5% from the initial estimate of 0.4%
• However deflation remains a concern and long term structural problems, an ageing population and high government debt all weigh heavily on the economy

Fixed Interest

• Corporate Bond valuations remain good relative to government bonds
• There are significant levels of supply of government bonds in relation to demand
• Pension fund demand continues to be a long-term support of government bonds
• Markets are pricing in unlikely levels of company defaults
• Corporate bonds are relatively vulnerable to risk aversion
• Investment-grade securities in peripheral European markets suffer from poor fundamentals due to sovereign debt issues in these countries.
• Inflation pressures remain relatively subdued.

M&G Fixed Interest Update

Teleconference with Richard Woolnough on 22.10.10

• Mervyn King previously described economy as NICE (non inflationary constantly expanding).  In Richard’s view economy is no longer “nice” and it is his job to navigate through the headwinds such as deflation, no growth and unemployment.
• Low inflation environment is positive for bonds and they have no concerns over inflation.
• Financial crisis has changed the shape of the yield curve. The shrinking banking system means a steeper yield curve and they are getting paid for duration risk.
• The effects of the credit crunch will be around for some time and Richard feels that not all banks will emerge as strong companies, so it is still very important to analyse every single bank. He is relaxed about investing in banks where economies are good, but avoids countries such as Ireland and Portugal.
• He has concerns about the domestic economy for the UK but feels that there is still opportunity for good companies who can avoid what Richard terms “the cuts and chaos” to become stronger.
• He is comfortable with holding high yield credit because he is receiving a higher yield for the increased risk.
• Sovereign credit will become attractive
• Richard is looking to increase credit risk within his Optimal Income Fund as again he is being rewarded for the risk taken.

Threadneedle Strategic Bond Fund (and others)...

During recent weeks we have seen announcements from Threadneedle and other investment companies indicating that they wish to change their Corporate Bond fund mandates to enable managers to hold derivatives. We see this as a very positive step as it enables the fund managers to take advantage of better opportunities across fixed interest markets to enhance returns. Derivatives can also be used as a defensive measure when markets are volatile which will, again, benefit investors. We are therefore in favour of such changes and recommend investors vote positively for them if given the chance to do so.

Conclusion

Whilst equities have rallied since the middle of the year they are still the preferred asset class as gilts and investment grade bonds look increasingly vulnerable to interest rate moves. Corporate Britain results continue to show a recovery in profits and stronger balance sheets with many companies benefiting from growth in overseas markets. With Christmas approaching, the high street will be hoping for a strong performance before the cuts in public spending start to feed through next year. Steady as she goes.


Date of Next Meeting:  7th December 2010