3 Month Commentary & Market Review
| 30/06/2008 | Local Currency | Sterling | ||
|---|---|---|---|---|
| Capital returns (equities) | 3m | 6m | 3m | 6m |
| UK Market | -2.4 | -13.1 | -2.4 | -13.1 |
| UK Mid Cap | -8.7 | -14.2 | -8.7 | -14.2 |
| UK Small Cap | -8.2 | -18.9 | -8.2 | -18.9 |
| US | -2.9 | -12.5 | -3.0 | -12.5 |
| Europe ex-UK | -6.7 | -21.3 | -7.7 | -14.8 |
| Japan | +8.9 | -10.8 | +2.1 | -6.0 |
| Pacific Basin | -4.2 | -16.3 | -3.6 | -14.3 |
| IFC Emrg Mkts | -2.7 | -13.3 | -2.8 | -13.3 |
| World | -2.2 | -13.8 | -2.7 | -11.7 |
| 10 year bond yields | Yield % | 3m ch. | 6m ch. | |
|---|---|---|---|---|
| US | 4.0 | +55 | -6 | |
| UK | 5.1 | +78 | +62 | |
| Germany | 4.6 | +69 | +25 | |
| Currency | 3m | 6m | Current level | |
|---|---|---|---|---|
| $ vs. £ | -0.1 | +0.0 | 1.990 | |
| $ vs. € | +0.1 | -7.4 | 1.575 | |
| € vs. £ (p/€) | -0.2 | +8.0 | 0.792 | |
| Yen vs. $ | -6.1 | +5.4 | 106.005 | |
| Brent oil in US $ | +33.7 | +48.6 | 139.4 | |
Source: Datastream
Equities have suffered relatively modest falls in the past three months but the period has been split into two distinct periods. The first half saw a relief rally, as the fears of major instability in the banking system were allayed by the measures taken to recue the US investment Bank Bear Stearns and by increased provision of liquidity to the banks by the monetary authorities. The second half saw the earlier gains evaporate, as growing inflation fears undermined the bond markets at the same time as corporate profits were being downgraded in the face of slowing economic growth. Global equity markets collectively fell 2.2% in local currencies and 2.7% in sterling terms in the three months to the end of June.
The UK market fell 2.4%, with mid-cap stocks and smaller companies lagging, down 8.7% and 8.2% respectively. The US market fell 2.9% in dollar terms and 3% in sterling terms. European markets fell 6.7% in local terms and 7.7% in sterling terms. In the Far East, markets fell 4.2% in local currencies and 3.6% in sterling terms. Emerging markets more generally also fell, by 2.7% in local currencies and 2.8% in sterling terms. Japan was a notable exception, the market registering an 8.9% gain in local currencies, although yen weakness reduced the gain to 2.1% in sterling terms. Government bond markets have been under pressure, as low yields were seen as offering little protection against rising forecasts for inflation. Yields rose by 0.6% over the period in the USA, 0.7% in Europe and 0.8% in the UK. The turbulence in the money markets, which had seen non-government bonds performing poorly, gave way to more orderly conditions, in which higher grade corporate bonds were able to rally for part of the period.
The US Federal Reserve [the Fed] cut rates by 1/4% in April, to 2%, although the minutes of recent meetings indicated that rates were unlikely to be cut further in the near term, owing to inflation concerns. The Bank of England also cut rates by 1/4% in April, taking base rates to 5% but it is clear that inflation concerns have overtaken this easing process, with the Bank of England Governor having had to account to the government for inflation exceeding its target level by more than 1%. The European Central Bank has left rates unchanged, while signalling the likelihood of a rise in July, to send a counter-inflationary signal to markets. Money market interest rates remain abnormally high, indicating that the central bank measures to restore confidence have not yet succeeded in significantly easing credit conditions.
The oil price is up 34% from the end of March and remains at record levels, close to $140 per barrel. This is creating inflationary headaches for the world's central banks, with concerns being exacerbated by price rises in food commodities such as wheat. Although it appears that growing investment in commodities may have contributed to the rises, their price strength also owes much to the resilience of growth in emerging economies. This is putting pressure on raw material prices, reflecting both immediate demand growth and, in the case of oil, fears that present consumption trends will use up current spare capacity within a few years.
On the currency front, the dollar was relatively stable against sterling and the Euro, while recovering some of its earlier weakness against the yen. Although sentiment towards the US economy remains negative, earlier complacency that other developed economies would be able to avoid the global slowdown has evaporated, creating a two way pull on the greenback. Sterling has been steady after its weakness during the winter months. Although the economy is weakening, interest rates now seem less likely to fall, providing some support for the pound.
Equity markets have come under renewed pressure, since weaker growth has undermined earnings confidence at a time when the world's central banks have been unwilling to cut interest rates further to help stimulate growth. The emerging market growth story, which has hitherto been a positive by supplying cheap goods for developed economy consumers and buoyant order books for capital goods, has developed a darker side, in the form of the inflationary strains that rapid growth has placed on raw materials prices. Whilst the credit problems in the financial system are being addressed by improved disclosure and the raising of fresh capital, this process has put strains on markets required to stump up the new money. The oil price appears overstretched in the near term and ripe for a correction but, until it comes, central banks are on inflation alert and will hold or raise interest rates. This is not a positive recipe for near term equity or bond performance, although much of this appears built into the relatively low ratings prevailing in most equity markets. It seems likely that until the process of financial sector rebuilding is more complete, or there is a sustained setback in oil prices, investors are likely to retain a defensive bias, emphasising earnings predictability and balance sheet resilience.
The FTSE 100 fell 76 points in the three months to the end of June, excluding the benefit of dividends, which particularly affect performance figures during seasonal dividend-paying periods. The 5 main contributors to/detractors from this performance were (in points):
| Royal Dutch | +87.3 | RBS | -48.3 | |
| BP | +57.7 | HBOS | -44.9 | |
| BHP Billiton | +39.8 | Barclays | -42.5 | |
| Rio Tinto | +33.0 | Lloyds | -33.4 | |
| Anglo American | +27.8 | HSBC | -27.7 | |
| Total | +245.6 | Total | -196.8 |
|---|
Source: Bloomberg
