Download march market commentary

MARKET COMMENTARY – JANUARY 2008
1/1/08
4500
4000
2007 was another year of strong economic growth although progress in the developed world slowed during the second half as the lagged impact of higher interest rates
took their toll. The US sub-prime crisis was the catalyst for a severe bear market in corporate credit as risk was dramatically re-priced. The reduced visibility of repackaged financial instruments and their distribution to international investors meant the crisis extended well beyond the US causing serious dislocation in the money
markets. Central banks responded - initially somewhat reluctantly - by reducing interest rates despite the inflationary pressures. 10 year government bond yields were
little changed on the year. Merger and acquisition activity, continued growth in corporate profits and reasonable valuations helped equities produce positive returns but
commercial property began to wilt.
3500
Global GDP grew by 5% - similar to 2006 - but there was a significant gap between developing economies at 7.1% and the industrialised world at 2.4%. China recorded
the strongest growth of 11% and contributed more to global GDP than the US. Other economies with very high growth rates included India, Singapore, Venezuela,
Argentina, Peru, Russia and Poland. This has created a new wave of sovereign wealth funds and given them a window of opportunity to acquire significant stakes in
some of the world’s largest financial concerns without paying a premium or falling foul of protectionist issues. Although corporate profits rose 18%, it was the inward
flow of funds which helped push valuations to an historic 10% premium to the World Index.
3000
2500
2000
1500
1999
2000
2001
2002
2003
FTSE ALL SHARE - TOT RETURN IND
2004
2005
2006
2007
Source: DATASTREAM
1/1/08
2100
While growth in the industrialised world was slightly below that in 2006, US GDP of 2.2% was remarkably resilient despite a substantial downturn in housing
construction. After some initial hesitation during the credit crisis, the Federal Reserve cut rates aggressively by 100bp to 4.25%. Households were under pressure from
rising energy and healthcare costs but a steady employment market ensured these headwinds did not become a consumer spending recession. Beyond the construction and
financial sectors, business conditions held up reasonably well with robust capital expenditure and a weak dollar boosting exports. Companies with overseas earnings
typically increased profits by 10% but overall earnings for the S&P 500 grew by a more modest 4% allowing for the large write-downs by financial companies in Q4.
2000
Strong exports to China helped Japan produce GDP of 1.8% but weak wage growth, increasing domestic policy errors, political uncertainty and global shocks resulted in
negative investment returns for 2007. Exports were also a major contributor to European GDP of 2.6% as the region overcame the impact of higher energy costs and the
Euro’s 10% appreciation against the US$ to a new high. Consumer spending grew at a respectable rate, capital expenditure surprised on the upside and corporate profits
rose by around 8%. The credit crisis claimed a wide range of casualties from small German banks to the more speculative Spanish and Irish property markets.
1900
1800
1700
1600
1500
1400
1300
1200
1999
2000
2001
2002
2003
2004
2005
FTA BRIT.GOVT. FIXED ALL STOCKS - TOT RETURN IND
2006
2007
Source: DATASTREAM
1/1/08
600
550
500
450
UK GDP at 3.2% was above trend, higher than in 2006 and the strongest among the G7 industrialised nations. Although activity slowed towards the end of the year,
overall domestic demand again exceeded expectations fuelled by a 10% increase in house prices, easy availability of credit and the unemployment rate at a 32 year low.
Business investment was also very strong which in part reflected the high return on capital and narrow credit spreads earlier in the year. Trade and government deficits
both increased slightly. Core inflation breached the government’s 3% limit but eased back to 2.1% (RPI 4.3%) by November. There were no signs of a developing
wage/price spiral and inflationary expectations remained low. Interest rates peaked at 5.75% in July but Northern Rock’s problems and renewed liquidity pressures in
December led to a 0.25% reduction.
With the exception of Japan, most leading equity markets recorded a fifth consecutive year of gains although the second half was much more volatile as the credit crisis
unfolded and financials began to disclose significant write-downs. The advances in the US and UK were modest with the Dow Jones up 800 points at 13,264 (a 6% gain)
and the FTSE 100 closing up just under 4% at 6,456. European and Asian markets fared better with gains for sterling investors of 12% and 25% respectively. Year on
year sterling rose just over 1% against the US$ but fell 8.3% against the Euro. Large companies out-performed small ones and growth did better than value but this
disguises how stock specific markets have been. For UK investors, holding mining and avoiding banks were the two most profitable trades. Mid and small companies which tend to be concentrated in cyclical domestic sectors like building, support services and property - fell. A number of household names (Alliance Boots, Hanson and
ICI) disappeared as a result of buoyant M&A activity.
400
350
300
250
1999
2000
2001
2002
2003
FTSE W WORLD £ - TOT RETURN IND
2004
2005
2006
2007
Source: DATASTREAM
The risk of a mild recession - especially in the US - early in 2008 has increased but on balance appears unlikely and we expect GDP of around 2% for the industrialised
economies. Moderating growth in the developing world means current inflationary pressures should abate. Central banks are primed to make further substantial
reductions in interest rates if needed and this will help banks and consumers. Housing will continue to be a drag on activity overall but the employment trend is the more
important indicator and, given the strength of corporate balance sheets, there is little pressure to lay off staff. Bonds are already discounting a very gloomy economic
outlook and yields are likely to rise from current levels. Equities appear more reasonably valued but the prospect of slower profits growth in 2008 means they may be
vulnerable to adverse newsflow over the reporting season. The disruption in credit markets has made life difficult for leveraged private equity transactions but we expect
M&A activity to resume as companies seek out strategic alliances.
This communication has been prepared for information purposes only and is not a solicitation, or an offer, to buy or sell any security. The information on which it is based is deemed to be reliable, but has not been independently verified nor do we guarantee accuracy or completeness.