6 Month Commentary & Market Review
| 31/12/2008 | Local Currency | Sterling | ||
|---|---|---|---|---|
| Capital returns (equities) | 3m | 6m | 3m | 6m |
| UK Market | -11.0 | -22.6 | -11.0 | -22.6 |
| UK Mid Cap | -19.4 | -30.5 | -19.4 | -30.5 |
| UK Small Cap | -27.6 | -38.9 | -27.6 | -38.9 |
| US | -22.7 | -29.4 | -4.2 | -2.3 |
| Europe ex-UK | -21.0 | -29.8 | -2.9 | -14.1 |
| Japan | -22.4 | -36.3 | +12.6 | +3.1 |
| Pacific Basin | -19.6 | -33.7 | -5.9 | -22.5 |
| IFC Emrg Mkts | -29.5 | -48.9 | -12.6 | -29.2 |
| World | -20.9 | -30.4 | -3.9 | -10.1 |
| 10 year bond yields | Yield % | 3m ch. | 6m ch. | |
|---|---|---|---|---|
| US | 2.3 | -157 | -173 | |
| UK | 3.1 | -135 | -204 | |
| Germany | 2.9 | -107 | -164 | |
| Corporates | Spread | Yield % | Spread Change | |
|---|---|---|---|---|
| US AA Corp | +2.53 | 4.8 | +66 | +108 |
| US BAA Corp | +6.74 | 9.0 | +298 | +397 |
| Currency | 3m | 6m | Current level | |
|---|---|---|---|---|
| $ vs. £ | +24.0 | +38.4 | 1.438 | |
| $ vs. € | +1.1 | +12.8 | 1.396 | |
| € vs. £ (p/€) | +22.6 | +22.7 | 0.971 | |
| Yen vs. $ | +17.1 | +16.9 | 90.650 | |
| Brent oil in US $ | -61.4 | -74.0 | 36.2 | |
Source: Datastream
The third quarter of 2008 was dominated by increased evidence of instability in the banking sector, which progressed to fears of a deep recession, in response to the ensuing credit squeeze. After heavy falls in the autumn, equities stabilised in December, registering small gains, although these were insufficient to moderate the scale of declines significantly. Fears about the viability of the banking sector have reduced but there is increasing evidence of the negative impact of the banking crisis on economic growth. Widespread interest rate cuts and increased government spending have been announced with the objective of mitigating the current downturn. The sharp fall in oil prices will also be of benefit. However, these measures have not yet had time to take effect, leaving markets prey to concerns that the present round of forecast downgrades could be the start of an extended recession. In the six month period, global equity markets collectively fell 30.4% in local currencies but this loss was almost mitigated by sterling weakness to a fall of 10.1%.
The UK market fell 22.6%, with mid-cap stocks and smaller companies lagging, down 30.5% and 38.9% respectively. The US market fell 29.4% in dollar terms but a modest 2.3% in sterling terms, as the dollar rose sharply. European markets fell 29.8% in local terms and 14.1% in sterling terms. In the Far East, markets fell 33.7% in local currency and 22.5% in sterling terms. Emerging markets more generally almost halved, declining by 48.9% in local currencies and 29.2% in sterling terms. Japan declined 36.3% in yen but currency factors reversed this to leave a 3.1% gain in sterling terms.
Waning current inflationary pressures and downward pressure in equities led to greater demand for Government bonds. This was increased by aggressive monetary easing measures, which so far have seen lower near term interest rates exert a greater downward influence on government yields than the upward pressure that would result from higher long term inflation fears. (However, there were signs of greater demand for index-linked stocks towards the end of the period.) 10-year yields fell by 1.7% in the USA, by 1.6% in Europe and by 2% in the UK. Credit spreads widened sharply, particularly for lower quality issues, as economic fears were compounded by forced selling, although the absolute level of corporate yields began to decline towards the year end.
The US Federal Reserve [the Fed] reduced rates further in December to their lowest ever level of "0-0.25%". UK rates were cut to 300 year lows at 2%, as the Bank of England responded to the peaking of inflation and the deterioration in the domestic economy. Even the European Central Bank (which raised rates as recently as July) cut rates sharply in the fourth quarter, suggesting a rapid reversal in its economic assessment. Money market interest rates have recently fallen sharply, indicating that the Central Banks' measures to restore confidence are starting to gain traction.
The oil price fell by three quarters from a peak of over $140 to under $40 by the end of December, as demand fell back in response to slower economic growth. This is already feeding into lower inflation rates, as well as boosting disposable incomes.
On the currency front, the feature was the sustained weakness of sterling, initially against the dollar, then resuming its earlier slide against the Euro. The dollar rose by 38% against sterling while the Euro rose by 23% against the pound. However, the yen was the strongest currency, rising 17% against the dollar, as it benefited even more than the dollar from the unwinding of borrowings that had been used to fund investment portfolios.
Equity markets have suffered one of their most traumatic slumps in modern history, hit by fears of a financial sector collapse and poor trends in economic growth and corporate earnings. The recapitalisation of the banks has averted fears of a financial sector implosion, although banks are continuing to rein back on lending, which is putting the brakes on economic growth. Economic forecasts now assume a recession for the main industrialised countries, with shrinkage of 1-1½% in 2009. These numbers assume that a steep dip in activity over the turn of the year leads to a modest recovery in the second half of 2009. Despite the substantial policy moves to stimulate growth, investors are disinclined to take this for granted given the shocks of recent months and the speed with which earlier and more optimistic forecasts have been downgraded.
Equities have remained nervous but volatility has abated and December saw a small recovery of ground lost in the sharp earlier falls. Valuations appear low but the momentum of news on growth, earnings and dividends has been poor. If forced selling comes to an end and forecasts stabilise (albeit at low levels), longer term investors would be encouraged to take advantage of the lower prices on offer, in the hope of a recovery. The decline in oil prices is a powerful beneficial force for consuming countries. The global authorities have also recently shown a common intent to reverse the recent collapse in confidence, with further rate cuts and fiscal easing expected. We would expect a combination of these official policy moves with lower fuel prices and declining inflation to improve the investment climate during 2009.
The FTSE 100 fell 1192 points in the six months to the end of December, 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):
| AstraZeneca | +40.2 | Rio Tinto | -189.3 | |
| Glaxo SmithKline | +37.2 | RBS | -113.5 | |
| Unilever | +8.0 | Anglo American | -110.4 | |
| Shire Pharma | +4.3 | Xstrata | -103.3 | |
| Diageo | +4.0 | BHP Billiton | -58.6 | |
| Total | +93.7 | Total | -575.1 |
|---|
Source: Bloomberg