Quarterly Investment Report - Qtr ending June 2006
“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
The
MPC continues to maintain rates at 4.50% although there is now a trend within
the committee towards a rate rise. This is principally brought on by a concern
that rising commodity prices will feed through into higher inflation as
manufacturers attempt to offset their rising raw material and fuel costs by
raising prices and consumers then demand higher wages to compensate.
Consumer
spending has been the economy’s key driver in recent years and Britain’s
borrowing binge continues unabated despite having exceeded the trillion pound
mark and with consumers facing soaring household bills. Insolvencies are at
record levels with economists and bankruptcy experts agreeing that matters will
only get worse.
The
average house price is now 7 times the average wage – 75% above its historic
trend of 4 times earnings. We feel that house prices are significantly overvalued and a Reuters
poll of economists shows that the recent upturn in housing market activity will
likely run out of steam towards the end of the year. The latest survey of
members of the Association of Residential Letting Agents (ARLA) shows that the
return on residential property investment is 4.9% for houses and 5.1% for
flats. If the latter is not improved upon by rising capital values (which we
predict it won’t be), then residential property investors will doubtless look
to sell.
Unemployment
in the UK
is on the increase with significant lay-offs at car plants and telecoms
companies being announced of late.
US and UK
corporate profit margins are at 50 year highs. There are those that say this is
a new paradigm in the market but there are very rarely any new paradigms, so we
expect corporate profits to revert to the mean.
There
continue to be major imbalances in the global economy. Western countries are
running large trade deficits to the benefit of Asian nations who are ensuring
that their export-based growth is supported by cheap currencies. The US accounts for
10.4% of global exports but 16.3% of imports. The US deficit
being matched by equivalent surpluses in non-OECD countries including China and India but also
many oil producing nations. We believe that the recent slide in the
value of the dollar will continue as the means to correct the US trade
deficit.
The
UK
stock market has fallen markedly of late, down from its highs of over 6,100,
although there have not been any world events that have not been in evidence
for some time. It seems, once again, that the market has been driven by
momentum rather than fundamentals and as soon as the risk of loss becomes too
great, investors cease to risk any further capital (and in many instances
withdraw their stock positions) and brokers begin to mark stock prices down.
Outlook
As
we see it, the following are the major positives and negatives affecting
individual asset classes/Sterling:
Sterling
Negative: Static UK interest rates.
Positive: US$ will have to fall to correct US trade
deficit.
Our view:
That the £ will strengthen against the US$ and remain broadly static
against other major currencies.
Variable interest
Negative: Static UK interest rates.
Positive: 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 US
inflation. Rising US interest rates. Falling US Treasury prices.
Positive: Static UK interest rates.
Our view: Hold quality stock (BBB credit ratings and
above) and junk bonds (CCC ratings). Buy 2nd line fixed interest
securities such as Preference shares. Buy bonds rated B to BB, but be very
selective.
Equities
Negative: High levels of consumer debt. Rising bankruptcies and repossessions.
Positive: Bank of England expect
growth to accelerate to more than 3% in 2007.
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. Buy 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. Denominated in US Dollars.
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 ETF perhaps to be launched on the US market.
Our view: Buy
Silver, albeit that gaining exposure is difficult.
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. U-turn in pensions legislation disallowing residential property
investment.
Positive: Anticipated influx of EU workers
into the UK.
Static UK
interest rates. 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 turn. Many investors now committing funds to
this asset class. Worsening economic background.
Positive: Static UK interest rates. Expected UK GDP growth in 2007 in the region of 3%. Stronger tenant demand in certain areas/sectors (offices).
Our view: Sell
commercial property.
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