A Few Trillion More

Please do not hesitate to contact Andy Betts at Towcester Financial Planning to discuss any aspect of your financial affairs by e-mailing towcester-fp@sjpp.co.uk, or visiting www.towcester-fp.co.uk, or call 01327 354035.

Andy Betts of local financial advisors, Towcester Financial Planning writes…

This weekly Briefing Note aims to pick out some of the key financial and economic issues touched on in the press over recent days, and from time to time includes the views of some of our independent fund managers.

QE Too

It seems the Bank of England (BoE) has set a fashion trend in the financial world after its pioneering policy decision to adopt quantitative easing (QE) as a means of helping the economy out of its current recessionary slough. Just as the International Monetary Fund warned that more aggressive and concerted efforts were needed to key economies to quell financial market distress if the world is to avoid an even deeper and more prolonged downturn, the US Federal Reserve swiftly obliged by announcing its own QE strategy. Late on Wednesday Ben Bernanke, chairman of the Fed, stunned investors by announcing plans to buy $300bn of US government debt, plus its intention to double its purchases of mortgage-backed securities issued by housing groups Fannie Mae and Freddie Mac. The aim of the move is to bring down longer-term interest rates and support the housing market – seen as key to kick-starting the ailing American economy.

The need for action – not just in the US but also in Europe and Japan – was put into sharp focus last week as economic data on both sides of the Atlantic illustrated the depth of recession. American jobless claims hit a record 5.47m in the first week of March – the highest since records began in 1967 – bringing the rate of unemployment close to 10%. In the UK, unemployment rose above 2m for the first time in ten years, with the private sector bearing the brunt of the cuts and brings the jobless rate to 6.5%. And, in Japan, the central bank announced the latest in a series of ever more assertive measures to respond to the pressures created by the global financial crisis saying it intended to increase its purchases of Japanese government bonds by a third. The move will help hold down bond yields and increase liquidity in the financial system coincided with the Bank of Japan’s announcement to maintain its current 0.1% policy interest rate.

A Few Trillion More

The US Federal Reserve’s latest move confirms the view of many economists that Ben Bernanke will do whatever it takes to get some hold of the problem, but as The Financial Times observed, it all comes at a price.

The latest announcement will increase the size of the Fed’s balance sheet by another $1,250 billion to about $3,000bn even before the roll-out of a $1,000bn scheme to finance credit markets. Once the latest plan is fully implemented its balance sheet could approach $4,000bn or $4 trillion (that’s twelve noughts) – nearly a third of the size of the American economy. What concerns economists is that such a swollen balance sheet might make it difficult to manage down the money supply when the economy finally turns up, raising the spectre of higher inflation.

Here in the UK the BoE embarked on the next phase of its QE initiative by unveiling plans to start buying companies’ bonds (the first phase involved buying up gilts) in an attempt to ease the credit drought blighting corporate Britain. Corporate bonds are effectively IOUs issued by companies to raise cash – in return investors are paid an agreed rate of interest and receive their capital back on redemption although there are no guarantees attached. The Bank’s move is an attempt to increase money supply, but there is no certainty that it will succeed. Indeed as The Financial Times pointed out, large investment grade companies appear to be hoarding their cash following a booming global issuance market for corporate debt. Companies have already raised $353bn worth of bonds this year with UK businesses having raised the equivalent of $24.95bn whilst facing redemptions of only $16.88bn. The extra money is being raised for a number of reasons including insurance against uncertainty but also for building up acquisition war-chests.

A Whipping for Wall Street

As the White House endeavours to implement its policies for recovery attention is being diverted to Wall Street following news that the financial giant AIG is to pay out some $170m in bonuses even though it received billions following its bail-out by the US Treasury. News that employees are to be rewarded has angered US taxpayers and has caused a furore in Congress which as a consequence has led to new legislation taxing bonuses at the rate of 70% where the employee works for a business that has received state aid. The AIG storm has meant that President Obama has been distracted from the pressing need for more detail on his administration’s plans for recovery. The Sunday Telegraph said that Mr. Obama is poised to unveil a revised trillion-dollar plan aimed at helping America’s crippled banking system. Unlike the UK the US administration is reluctant to take large stakes in Wall Street’s banks, yet they are in desperate need of fresh capital so the new plan needs to address these issues. Yet even before details are known, some observers are sceptical that it will succeed highlighting the tightrope the President must walk.

But whilst Wall Street is seething, Ben Bernanke’s action nevertheless drew the attention back to the economy and following the announcement of his scheme financial markets were galvanised into action. Yields on US Treasuries fell sharply to 2.5% as the bond market reacted favourably – as the stock market did too with shares heading up sharply. But the dollar headed south as investors reacted negatively, taking the view that the impact on both nominal and real rates was adverse. Also heading up was gold where prices jumped $58 per ounce to $948 reflecting the view that ultimately the Fed’s policy was inflationary. The following day, as the Fed’s move began to sink in, commodity prices were the big winners with the dollar falling further. Hopes that stronger economic growth would boost demand helped push oil over $52 per barrel and gold continued to rally as expectations for higher inflation drove investors to their perceived haven. So by the end of the week investors’ focus had switched from the equity markets – where most of the main indices notched up some gains – to government bonds, commodities and currencies.

Thrifty Squeezed

Falling interest rates may be good news for borrowers but for savers it’s created a problem – how to replace the lost interest on their deposits to maintain their lifestyle. The Sunday Telegraph mulled over some of the income options currently available to investors and highlighted the pros and cons of both fixed-interest investments and equities. Starting at the lower end of the risk scale the paper explained that gilts – government issued bonds – are attractive because they are deemed to be one of the safest forms of investment. Whilst rates are very low – a ten-year gilt yields around 3% gross – there is the possibility of capital gain when interest rates fall or demand is very high. The BoE’s QE policy has been well received in the gilt market with the extra demand pushing up prices. To complement this strategy the paper also discussed corporate bonds which yield more than a gilt to reflect the higher risk. This part of the bond market also has two distinct categories – investment grade (perceived the safest part) and high-yield which is also viewed as having higher risk because there is a greater chance of corporate default. To reflect these differing levels of risk a typical investment-grade corporate bond fund yields c7% gross whilst a higher-yield fund containing a mix of bonds could yield over 10% gross.

Moving up the risk ladder to include share-based assets, investors could add equity-income funds to their portfolio which historically have produced good levels of income as well as capital appreciation over the longer-term. The paper pointed out that whilst dividends are not guaranteed and some companies are cutting payouts because of the recession, a good fund manager will endeavour to identify those companies that are most likely to maintain or even increase their dividends. Last week was a good example that, even in tough times, some businesses continue to look after their investors – the Prudential raised its dividend to shareholders last week by around 11%. One fund manager mentioned was Neil Woodford of Invesco Perpetual who has a strong track record of outperformance and who also manages the St. James’s Place UK High Income fund.

Quiet Optimism

One fund manager who has seen many bear markets during his long career in managing money is Richard Pierson of AXA Framlington and here he shares his thoughts on current events. “The markets continue to be very challenging and my aim has been to preserve the position of the portfolio so I have made no material changes to the funds’ asset allocation in recent months although with sterling weak the overseas exposure has moved up slightly. I still have high levels of liquidity; cash is about 10% but I have not increased the gilt weighting. I’m not convinced about quantitative easing – on the one hand the BoE is pumping £75bn into buying gilts, but on the other hand we know the government is planning to issue £146bn of new gilts.

The continuing volatility in the markets makes it difficult to make short-term judgements but I do feel that markets will be higher in twelve months time – they are, after all, very cheap. So whilst economic activity remains poor, I think we will see some of the proverbial green shoots later this year which will be positive for equities. In the meantime one needs to be careful – prices are still falling in parts of the market and investors remain very nervous indeed. The actions taken by policymakers are of massive proportion in terms of money being pumped into the system and ultimately this will work as borrowing conditions ease for businesses and consumers but we just don’t know how long this will take. Corporations are hoarding cash, banks are maintaining tight lending criteria and earnings visibility is poor but I do think we are now bumping along the bottom.

In terms of the portfolio we have been defensive, preferring to own larger stocks – in this way some of the risk is managed-out. But around 30% of the fund is higher beta – in other words small/medium sized companies who have the capacity to outperform once recovery is underway. Owning any small/medium cap stocks has been a headwind in these markets but I do not intend to remain cautious forever and at some stage I will put more risk back into the portfolios. Within defensive stocks I have been careful not to make any very large sector bets preferring to maintain a neutral weighting although two months ago I did reduce the weighting, in pharmaceutical stocks which had done very well and this has proved to have been a good move as they have since underperformed. I do own some banks and mining companies; sectors where I think there will be a recovery. There have been few hiding places during this crisis and whilst I am still being careful I am now more optimistic than I have been”.


Markets Spring Into Action

Andy Betts

Andy Betts

Please do not hesitate to contact Andy Betts at Towcester Financial Planning to discuss any aspect of your financial affairs by e-mailing towcester-fp@sjpp.co.uk, or visiting www.towcester-fp.co.uk, or call 01327 354035.

Andy Betts of local financial advisors, Towcester Financial Planning writes…

This weekly Briefing Note aims to pick out some of the key financial and economic issues touched on in the press over recent days, and from time to time includes the views of some of our independent fund managers.
Markets Spring into Action

One could be forgiven for thinking last week that stock markets know something we don’t. On the economic front the news remained predictably gloomy – in the UK, official figures confirmed that factory production is plummeting, with output down 6.4% in the three months to January. Economists are predicting that GDP is set to fall 1.8% in the first quarter of this year against 1.5% in the previous quarter. Of course it’s not a problem peculiar to Britain – Japan clocked up a record current account deficit in January, its first since 1996 and the largest since records began in 1985 – as falling global demand and a stronger yen have taken their toll on the country’s export-dependent economy. And as The Times reported, the global financial crisis has finally caught up with the world’s fastest growing economy, China, where exports too have suffered. The country’s slowdown is causing concern for the authorities who last week announced that it will reduce export taxes to zero and give more financial support to exporters as it tries to increase its share of global trade during the current downturn. The Financial Times observed that the government’s obsession with restoring high growth leaves it little choice but to revive the export sector.

Global stock markets though were undeterred by the gloom and responded instead by rallying sharply, which enabled equities around the world to enjoy one of their best weeks this year, with many indices – including the S&P500 – chalking up gains of as much as 10%. On Tuesday, London’s blue-chip FTSE100 index soared by almost 5%, as investors reacted positively to news that America’s leading banks may not be as sick as many thought. News that US banking giant Citigroup had returned to profit in the past two months was sufficient to propel stocks higher on Wall Street. Another fillip came when Barney Frank, chairman of the US House of Representatives’ Financial Services Committee, said that a key stock trading ruling that hinders short-selling [in the hope of buying stock back at a lower price] may be re-imposed. The feel-good factor rippled across the globe as this new found sense of optimism about the financial sector pervaded the markets and as The Financial Times noted, hopes that the US consumer could prove more resilient than feared offered a further buying incentive.

By the end of the week the big question for investors centred on whether the events of last week were the first signs of recovery in the equity markets or just another bear market rally. The Daily Telegraph posed the question to a number of stock market experts, including investment guru Anthony Bolton, who commented that all of the things he looks for to be in place for a market bottom occurred last week, adding that a new bull market could have started. “My strong message [for investors] is don’t give up now, you’re giving up you know, really at the last fence”. He went on to add “I’m not saying there isn’t going to be any more negative news but it should be much better by the second quarter”. But as The Financial Times pointed out, Mr. Bolton made the same call last year before a renewed sell-off in the market, which highlights how even experienced investors have been wrong-footed by the current downturn. As the paper went on to say though, there is good reason for wanting to pick the bottom of the market. The rewards of buying close to the nadir are very high because some of the best days of a bull market occur at the start of a new trend. But Anthony Bolton has not been alone in trying to call the bottom of the market and it illustrates the advantages of ‘drip-feeding’ money into the market over a period of months rather than trying to time a single entry point to catch what appears to be a low point.


After much fanfare, the Bank of England started its plan to ‘print money’ last week as part of its quantitative easing policy – QE for short or, as The Daily Telegraph mischievously suggested to HM Treasury, it should be colloquially known as queasing. The plan involves the BoE buying up government debt in the form of gilts plus some corporate debt too in return for ‘new’ money – it doesn’t need to physically print it of course, merely electronically credit accounts. The hope is that banks, pension schemes, sovereign funds and their ilk will sell debt in return for cash and then lend this money for mortgages, invest in enterprise or to take up rights issues thus helping the consumer and business. Last week, investors piled into gilts following the first official auction of £2bn worth of government paper, in what economists deemed to be a success, with the Bank receiving offers for more than five times the amount it sought. Whilst early days and with not everyone agreeing with the policy, it does appear to augur well for the scheme and experts are of the view that the BoE should have few problems implementing its plan to boost the amount of cash and credit flowing through the economy by £75bn over the next three months.

One immediate outcome was that gilt prices rose and yields fell – the yield on a ten-year gilt dropped to about 3% and this should help keep the cost of borrowing down. But it also means annuity rates are impacted upon and is likely to put pressure on those seeking to retire when funds are used to buy an income in retirement – a point picked up by the personal financial press. The Financial Times also commented that QE should also have an uplift on corporate bond prices, with yields coming down, meaning that investors could see lower income but capital gain. The paper said that whilst the longer term implications of QE are unknown, for corporate bonds QE should be a positive thing. Sovereign funds are not just interested in converting gilts into cash though – they might end up using the money to buy British commercial property it seems. According to the property specialist Savills, the sovereign funds are looking at buying, as are Middle Eastern buyers and German funds, as prices get close to the bottom. The Sunday Times reckons the German funds are at the front of the queue. Having lost confidence in their own economy, the arbitrage between the euro and sterling is starting to look compelling even if absolute bottom hasn’t been quite reached.

In Pursuit of Value

Stock market falls have left share prices at very depressed levels – so much so that Mark Evans of THS Partners, who manage funds for St. James’s Place, believes some shares offer extraordinary value for medium term investors. “Following the market lows in autumn 2008, stock markets tried to stabilize and indeed succeeded in staging a brief recovery at the start of 2009. However, as this year has progressed, further negative economic news and some disappointment with President Obama’s US recovery programme, have caused renewed weakness and produced fresh lows. Confidence is now at rock bottom and it is hard to exaggerate the awfulness of the economic statistics that are being produced. But, however difficult it may be to believe now, periods of such weakness always come to an end, and brave investors who recognise the potential of severely depressed valuations usually profit handsomely.

Indeed a significant proportion of the weak economic statistics are due to a vicious inventory cycle in response to the lack of credit. As inventories are run down, these figures should automatically improve. In the meantime, global policymakers are trying to replace some of the lost demand with their fiscal stimulus packages and thereafter they plan to tighten policy and reduce debt. For this reason I do not believe that recent actions will ultimately lead to inflationary problems, although there are those who may disagree. Of course, the solution if one has concerns over inflation is to buy equities which historically have done well in such times because it gives companies some pricing power. As to the latest policy of quantitative easing, I see this as a conventional idea. Rather than buy gilts – which may force those who have to own them, such as pension funds, to panic – the money should be spent on buying equities as they did in Hong Kong in the nineties which was very successful.

But here and now, valuations are now at extremely low levels; even solid, defensive companies have succumbed to market weakness. Vodafone, for example, which is a heavyweight FTSE 100 company with very little debt, a global presence and good growth exposure to major emerging markets such as India, is available at a P/E ratio of 6.7 and pays a dividend of seven per cent (which like all UK dividends is paid net of basic rate tax). British property companies have also been hugely affected by the downturn and the biggest company within the sector, Land Securities, is no exception. Its shares have fallen from over £20 to £3.60, in spite of the company taking early evasive action. The shares are now trading at a 50 per cent discount to the most recent book value, have secured their financial position with a rights issue and currently have a dividend yield of over 7.5 per cent.

The funds own shares in many other companies which are similarly solid, cheap and offer an attractive dividend. The travails of financial companies worldwide are well known. The funds own a selection of banks and insurers that we believe are survivors, and if we are right, based on current valuations, these companies should produce some very strong returns in future. These holdings include BNP, Deutsche Postbank and Allianz. At the moment, investors value security and liquidity very highly, but inevitably, at some point, the very low rates available for safe investments will drive some of the large amounts of savings on the sidelines into other asset classes”.

Taxing Times

As we approach the end of the tax year the press reminded readers that time is running out for last minute planning. The Financial Times said that it is still worth using savings and pension allowance – the personal ISA (Individual Savings Account) allowance is £7,200 and growth is free of Capital Gains Tax so using the ISA to hold asset-backed investments makes sense. Tax relief at one’s highest marginal rate is still available on pension contributions – it’s one of the few areas where the government will help you fund the cost of future retirement. So for every £1,000 invested basic rate tax relief brings the cost down to £800 and £600 for a higher rate taxpayer. With the Budget delayed until April 22, experts are advising that investors should still make the most of current allowances.

Cash is no longer king

Please do not hesitate to contact Andy Betts at Towcester Financial Planning to discuss any aspect of your financial affairs by e-mailing towcester-fp@sjpp.co.uk, or visiting www.towcester-fp.co.uk, or call 01327 354035.

Andy Betts of local financial advisors, Towcester Financial Planning writes…

This weekly Briefing Note aims to pick out some of the key financial and economic issues touched on in the press over recent days, and from time to time includes the views of some of our independent fund managers.
Scepticism remains

A growing scepticism over policymakers’ responses to the economic downturn, coupled with continued negativity within the financial sector, weighed heavily on markets last week, with all of the major equity indices finishing the week down. After announcing the biggest quarterly loss in US corporate history, the struggling insurer AIG had to once again go cap in hand to the US taxpayer for a further bailout and the UK insurer Aviva saw its share price fall sharply as it announced worse than expected losses for 2008. The FTSE 100 finished the week down 7.8%, its fourth successive weekly decline. Wolseley fell sharply following its announcement of plans to raise £1bn through a rights issue and share placing. General weakness within financial stocks pushed the S&P 500 to a twelve year low, down 7.3% on the week, as General Motors saw its share price fall, with the technology sector also coming under increased pressure. The FTSE Eurofirst index reached its lowest point in its short twelve year history, as the insurance and banking sectors came under further pressure. However, there was a little respite as oil and gas stocks outperformed the wider market. Japan fared little better with the benchmark index falling by 5.2% to close at a record 26 year low. In currency markets the dollar held up well for most of the week as the general weakness in equity markets reinforced its status as a safe haven, however this position weakened on Friday following the worse than expected US employment report.
Into the unknown

This coming week will see the Bank of England (BoE) take a step into uncharted waters as it moves a step closer to the first stage of its quantitative easing plan. The Financial Times reported that Paul Fisher, the Bank’s newly appointed executive, has made it clear that the initial decision to expand the money

supply by buying up £75bn in government bonds might just be one of the boldest initiatives in the central bank’s history. Should it be necessary, the Bank is prepared to buy even more gilts to ensure that commercial banks will use the money they receive to once again begin lending to the private sector. Since the widely anticipated announcement was made last Thursday, yields on the benchmark 10 year gilt have fallen by 53 basis points to 3.07% – the biggest fall since the IRA bombed the Baltic Exchange in 1992. Central banks across the world will be keeping tabs on the scheme as they ponder their next steps, with the highly cautious European Central Bank considering the possibility of using alternative methods to interest rate cuts to stimulate demand and US Federal Reserve also considering taking the step of buying its own Treasuries.

The article however went on to report that quantitative easing is not without its risks, and whilst these first steps have reduced yields on government bonds, the real questions will be asked, and answered, over the coming weeks and months. With little scope left for further cuts in the base rate, the BoE is left with no other weapons at its disposal. The real question now has become not so much will it work, but how much extra money do we need to print in order to stimulate lending? Mr Fisher stressed that the bank has no intention of making the same mistake that Japan made between 2001 and 2006, during which the money in circulation was increased by 74%, however even this was not sufficient to stimulate demand and revive a languishing economy. In contrast, the BoE aims to deliver its stimulus in a much shorter period of time, with it being set to increase the monetary base by as much as 80% in the next three months.

The first big test will come on Wednesday when the BoE will launch the scheme by buying £2bn of government bonds, which is likely to drive capital prices higher, precisely because the Bank is committed to buying such a large amount is a short period of time. For this reason, the Bank has decided to maintain its “reverse auction”, whereby investors are the sellers rather than the buyers, and has also agreed to buy a certain amount of gilts at what are called “non competitive prices”. This will allow insurance companies, pension funds and fund managers to be offered fixed prices, rather than risking selling their securities too cheaply. If the auction is successful, there will be further bi-weekly auctions over the next 3 months, until the full £75bn has been released.
Cash is no longer king

Last week saw the Bank of England cut interest rates for the 6th consecutive month to take the official bank rate to an all-time low of 0.5%. The Mail on Sunday reported that tens of thousands of homeowners will enjoy interest-free mortgages from next month as those on Tracker mortgages have gradually seen their repayments fall over the last six months. However, borrowers who took out fixed rate deals as little as 18 months ago could be trapped on rates of as much as 6.5%. A third of new borrowers decide on a Tracker mortgage, compared with 16% percent just over two years ago, however the deals on offer are now far less attractive as banks strive to restore their profit margins. At this point 12 months ago a borrower could get a three year deal at 0.06% percent below the base rate, however even the best deals available now are significantly in excess of the base rate.

Whilst this may be good news for some, many savers are beginning to feel the pinch as they see the returns on their savings accounts slowly dwindle. The Independent pointed out that the average savings account now pays considerably less than 1%, and whilst astute savers could have been earning more than £200 a month gross on an investment of £50,000 as little as a year ago, they will struggle to get half of that now and may be forced to begin drawing down on capital. However, the article went on to point out that, despite the FTSE 100 index approaching its March 2003 low last week, this has pushed the dividends on equities to increasingly attractive levels. The Times ran a similar article which listed alternatives to deposits in order of risk. Gilts were offered as the first alternative, however the deepening financial crisis has led to increased demand within the sector and current yields are at record lows. Corporate Bonds, debt issued by companies looking to raise capital, were listed as the second alternative, and went on to highlight the Invesco Perpetual Corporate Bond fund, managed by Paul Read and Paul Causer, who also manage the St. James’s Place Corporate Bond funds, as a way of diversifying risk. Fears that companies will be unable to meet their interest payments has sent yields soaring, however many feel that these fears are overblown and that there are attractive opportunities out there, especially among investment grade debt. The third option was to invest into income-paying shares. The income yield, the percentage of a company’s share price paid out as dividends over the year, is becoming increasingly attractive for many investors. The paper went on to say that investors should stick to companies that have strong balance sheets, such as Vodafone, BP, Royal Dutch Shell and AstraZeneca, all of which are yielding more than 5%. The Times also pointed out that for most investors the easiest way to get access is through equity income funds, and investors should consider a spread of risk, including exposure to corporate bonds as well as equities.

The Independent ran an article on how the last month has seen vast amounts withdrawn from banks and building societies, as investors go in search of more competitive returns. Many have been looking at the more exotic asset classes, however one sector seeing significant inflows is Corporate Bonds. As institutions have been forced to issue bonds to raise capital, this flooding of the market has seen yields on investment grade debt increase to between 5 and 7 percent. Whilst most commentators accept that defaults (companies failing to pay the interest on capital at maturity) will increase, the bond market is currently reflecting assumed default levels greater than the Great Depression and to many this is exaggerating the risk. A well managed portfolio is an obvious way to diversify the risk as well as offer a more attractive return than cash for those willing to take on a little more risk.
A good time to plan for the future?

The Times ran an article on why now could be a good time to consider making plans to save on Inheritance Tax. Since both property and equity markets have fallen over the last year and a half, almost £1bn has been wiped of the value of people’s estates, however despite this the nil rate threshold is set to increase to £325,000 on the 6 April this year. The article explained that each year taxpayers waste as much as £190m on unnecessary Inheritance Tax payments, however the current climate presents the ideal opportunity for those looking to avoid the hefty 40% tax on their estates. Whilst there is no guarantee that asset prices will increase, it now appears to be an ideal time to consider making plans. Whilst many may have seen the value of their estates fall, this could mean that they can make plans to gift a considerably larger part of their estate which could result in a further saving.