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Quarterly Investment Report - Qtr ending September 2009Foreword Certainly
there is never a time where there aren’t positive and negative factors
affecting either the global economy, the Commentary Knowing where to commit/maintain monies in the present economic
environment remains extremely difficult. The recent rally in share prices is in
part on the back of 10 out of the top 19 US banks requiring considerably less capital
than was predicted by the IMF (and others) – albeit that the “stress tests”
employed by the US officials were less onerous than the IMF’s. An additional
factor has been the feeling that there is less uncertainty, now the extent of
bank losses/toxic assets is better known. Nevertheless, whilst there are some
“green shoots”, the economic picture around the world remains pretty dire and
the recent rise in share prices might be short-lived. In the UK, the size of the government’s borrowing requirement for the
forthcoming year is worrying as are the Chancellor’s predictions as to the size
of the budget deficits in subsequent years, which the majority of economists
have described as far too optimistic. This, plus the additional “quantitative
easing” being employed by the Bank of England, does raise the spectre of
further weakening in the value of the Pound on the foreign exchanges. The
latter would make gilts far less attractive to foreign buyers and would
increase the pressure on Whither now for inflation? The RPI turned negative in March (deflation)
although CPI annual inflation – the Government's target measure – was still
positive at 2.2% in May, but down from 2.3% in April. Unlike CPI, the RPI
includes house depreciation and mortgage interest payments and these were the
main contributors to the decline. There appears to now be considerable excess
manufacturing capacity in the system plus unemployment is moving up. These
factors will have a downward effect on prices for some time. Against this, a
weakening currency and more money being pumped into the system is inflationary.
On balance, our view is that this will be a drawn-out recessionary phase for
the economy and that this, above all else, will keep inflation in check over
the near-term. Nevertheless, we are hedging out bets by maintaining an exposure
to index-linked stock. Watching for the turn in the RPI/CPI is also
traditionally the point to buy back into equities. These are strange times. Many of our leading banks became insolvent (and
some probably still are), but were not allowed to go to the wall through the
intervention of governments. Their loan stock and share capital should be
valueless. Where the government have intervened, will they continue to do
so/will they want or be able to raise the money to continue to do so? This is
the $64,000 question. If one believes that the likes of Lloyds and RBS will
survive (and certainly their involvement in the government’s Asset Protection
Scheme gives some further comfort in this regard), then some of their
securities offer tremendous value for money. One of the endemic problems with the present UK banking system would
appear to be that banks can engage in both retail and investment banking
simultaneously. Where losses occur within the latter sphere of activities, the
institution cannot be allowed to fail because of the knock-on effect upon the
former (i.e. upon retail deposits in the main). This would seem to be one area
in which new regulations will be enacted. 2nd
tier corporate bond prices (ratings BBB and below) appear to be factoring in a
doomsday scenario which we believe will not occur in practise. Even if
inflation does re-emerge, we feel that, as far as second-line stock is
concerned, the downward effect that this would have on bond prices would be
more than offset by the upward effect that an improving world economic outlook
would have. Overall, we are expecting little, if any, movement in asset values over
the near term and thus are looking for yield to generate portfolio returns. Outlook As we see
it, the following are the major positives and negatives affecting individual
asset classes/Sterling: Sterling Negative: Massive 2009 PSBR. BoE “Quantitative
Easing”. Positive: Weakness of other world economies. Our view: No view. Variable interest Negative: Very low yields on cash. Positive: Safe haven relative to other asset
classes. Our view: Hold
existing deposits. Fixed interest Negative: Rising Positive: Corporate Bond prices appear to be
factoring in a doomsday scenario which is unlikely to occur. Our view: Sell gilts.
Buy 2nd tier stock. Equities Negative: High levels of consumer debt.
Rising bankruptcies and repossessions. Economic recession (falling UK GDP). Positive: Hoped for return to growth in the
UK in 2010. Our view: Hold equities. Index-linked Negative: Falling RPI and CPI. Positive: Spectre of future inflation
brought about by the UK government easing its monetary policy. Our view: Hold
index-linked gilts and 2nd line index-linked securities. Commodities Negative: World economic downturn. Positive: Significant demand for raw
materials being maintained in growing economies such as China. Limited refining
capacity for oil. Increasing oil price. Our view: Hold
commodities. Gold and Silver Gold Negative: Recent price highs. Positive: World economic uncertainty. Our view: Sell 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. Our view: Buy Silver. Property Residential Negative: Ratio of UK property values to
earnings is substantially above its historic trend. Penal 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. Economic recession. Positive: Values perhaps marked down too
far. Our view: Hold commercial
property.
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