Quarterly Investment Report - Qtr ending December 2007
“Prediction is very difficult, especially about the future”
Niels Bohr (1885-1962)
Foreword
Certainly
there is never a time where there aren’t positive and negative factors
affecting either the global economy, the UK or individual securities for
that matter. The art is balancing these “for and against” factors and deciding
which is likely to dominate and thus cause downwards or upwards movements in
stocks.
Commentary
“Here comes the Repo Man” was the
headline from a recent article by Lorna Bourke posted on the Citywire website (http://www.citywire.co.uk/News/NewsArticle.aspx?VersionID=97229&re=1872&ea=110138&NewsPage=1).
This is set against the background of a fall in UK house prices for the second
successive month in September, according to the latest survey from the Royal
Institute of Chartered Surveyors.
Are
we headed for a meltdown in UK
house prices? The only possible saviour, in our view, is interest rates. Will
the BoE reduce rates as the US
Federal Reserve has done? Our opinion is no, they won’t, as there are still
considerable inflationary pressures in the UK economy and the BoE is too
concerned (rightly concerned in our view) about meeting its inflationary
target. If interest rates remain as they are or rise further, we foresee that the only way ahead
for prices is downwards. No stabilisation or plateau on our horizon, given our
opinion that the main housing market price driver for some considerable time
has been the expectation of further
capital gains. Once these evaporate, the residual forces driving-up prices will
be swamped by the opposing pressures.
Even
if BoE do reduce rates, these would need to feed through into lower retail
credit/mortgage rates for the effect to be felt by homeowners/consumers.
However, are we now witnessing a decoupling of the base rate from high street
lending rates? Certainly of late, the inter-bank money market rates have been
moving without any changes in the BoE rate and lenders have been reducing
credit limits/tightening lending criteria and will be looking to shore-up their
profit margins hit by bad debts.
This
all leads on to the Northern Rock debacle.
There is little that we can add to what has already been and continues to be debated
widely in the press and other media, except to say that we suspect that there
will be further
casualties. The market appears to be regarding NR as an isolated incident, but
that is, in our view, highly unlikely to be the case in reality. The emergence
of other banks/lenders with similar problems will be very bad news for share
values.
How
bad will a fall in UK house
prices be for the UK
economy? Good in some ways given that for some time the high price of housing
has been stifling the movement of labour around the country. However, bad in
most other respects given the considerable downturn in consumer sentiment that
we believe will result. Falling consumer spending will hit corporate earnings
and the multiples of those earnings that investors are willing to pay.
Outlook
As
we see it, the following are the major positives and negatives affecting
individual asset classes/Sterling:
Sterling
Negative: Rising UK inflation.
Positive: Rising UK interest rates. US$ will have to
fall further to correct US
trade deficit.
Our view:
That the £ will continue to strengthen against the US$ and remain broadly static against
other major currencies.
Variable interest
Negative: Rising UK inflation.
Positive: Rising UK interest rates. Safe haven
relative to other asset classes. Base rate still above inflation.
Our view: Hold
existing deposits. Add to cash through asset
disposals.
Fixed interest
Negative: Rising UK government borrowing. Rising UK
inflation. Rising UK
interest rates. Rising US
inflation. Falling US Treasury prices.
Positive: UK rate rises may have peaked.
Our view: Reduce fixed interest holdings.
Equities
Negative: High levels of consumer debt.
Rising bankruptcies and repossessions. Rising raw material costs.
Positive: Expected UK GDP growth in 2007 in
the region of 2.5%.
Our view: Sell cyclical stock. Hold defensive stocks.
Index-linked
Negative: Relatively low UK inflation
rates.
Positive: Rising inflation.
Our view: Hold
index-linked gilts and 2nd line index-linked securities.
Commodities
Negative: Significant rises have already
occurred in commodity prices. China’s
consumption of oil and raw materials may reduce. Threat of a world economic
downturn.
Positive: Increasing demand of late for raw
materials especially in growing economies such as China. Limited refining capacity
for oil.
Our view: Hold
commodities.
Gold and Silver
Gold
Negative: Denominated in US dollars.
Positive: World economic uncertainty.
Our view: Hold
Gold.
Silver
Negative: Declining use in photographic film
as digital photography gains popularity. Increased mining of lead, copper and
gold on the back of higher prices will lead to an increase in silver production
as a by-product.
Positive: Increasing demand given increasing
applications for the metal in areas such as power generation, water
purification applications and biocides. Just off an all time low relative to
Gold. Last year was the 14th in a row that demand for silver outstripped
supply. Silver ETFs have now been launched on both the US and UK markets.
Our view: Buy Silver.
Property
Residential
Negative: Ratio of UK property
values to earnings is substantially above its historic trend. Penal UK
Stamp Duties. High levels of consumer debt. Rising repossessions and
insolvencies. Rising UK
interest rates.
Positive: Anticipated influx of EU workers
into the UK.
More buoyant private rental sector with First Time Buyers being either unable
to get onto property ladder or awaiting a fall in prices at bottom end of
market.
Our view: Sell residential property.
Commercial
Negative: Penal UK Stamp Duties. Rising Gilt
yields. Weakening tenant demand in certain areas/sectors (retail and manufacturing).
Analysts predict little capital growth in the immediate term. Worsening
economic background. Rising UK
interest rates.
Positive: Expected UK GDP growth in 2007 in
the region of 2.5%. Stronger tenant demand in certain areas/sectors (offices).
Our view: Sell commercial property.
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