By Mike Franklin, Chief Investment Strategist
Promises, promises and yet more promises, A General Election is upon us and the investment outlook has probably never been more polarised. As the bookies’ odds on the election outcome show, both main parties are running close and any polls favouring one party have been reversing fairly quickly. For investors, whether in equities, bonds or even capital projects, the extreme rhetoric from some politicians directed to stir disaffected grass roots voters has created a highly-charged and nervous investment environment in the run-up to the 7th May Election Day. However, as the accompanying chart shows, despite the uncertainty, the FTSE 100 and the 250 Indices have broken up to new highs since the start of the year.
The market value of the FTSE 100 Index constituents accounts for around 84% of the total value of the FTSE 350 Index, dwarfing the balance made up by the FTSE 250 stocks. Consequently, the FTSE 100 Index is generally taken as the proxy for the UK although the high weight of component companies (approximately 65%) with non-sterling earnings make it less representative of the UK’s fortunes than the FTSE 250 Index.
Since mid-July 2014, spot Sterling has fallen by 15% against the U.S. dollar and, undoubtedly, this has provided some positive bias for the FTSE 100 Index from companies with appropriate exposure. However, over the same period and after a 5% dip and rally, Sterling has strengthened by a net 11% against the Euro although it is reasonable to assume that the pace of recovery in the Eurozone economies may have more than offset the Euro’s weakness for individual companies. At the time of writing, Sterling is showing signs of recovering against the Dollar and resuming its rise against the Euro.
Election considerations aside, what are the global factors that have been providing a backdrop to sentiment in the UK markets in recent months and which could reassert themselves more directly at any time?
Naturally, the 60% fall and subsequent 30% rise in the price of crude oil (Brent) for a net 48% decline since June 2014 has had a big impact, partly through helping to reduce inflation levels globally but also directly on the energy sector. Since bottoming at around $45 per barrel in mid-January 2015 and recovering to the $63 pbl level in February, the crude oil price has meandered, leaving investors confused as to whether to expect yet lower prices or further recovery. Current speculation includes the view that an easing of sanctions on Iranian oil exports in return for progress in the Nuclear Program talks will push the oil price noticeably lower again. An inevitable consequence of the price fall has been an industry review of its operational cost assumptions and, as with the recent bid by Royal Dutch Shell for BG Group, further sector consolidation may be on the cards.
As we go to print and after an accelerated 65% decline since end-2013 to around $60 per metric ton, the price for iron ore is showing some tentative signs of trying to bottom. This may prove to be yet another false dawn in a saga in which the major low-cost producers have been boosting output in an attempt to squeeze out marginal players in the market. Although miners such as Rio Tinto and BHP-Billiton are still selling at above cost at current levels, any price recovery should provide useful support to their share prices.
Of course, the rate of economic expansion in China is still regarded as an important factor behind the demand for resources such as iron ore and copper even though restructuring of the economy in the past year or so has been changing the composition of China’s import requirements. The 7% GDP growth for Q1 2015 just announced is respectable in global terms but is suspected to represent part of a slowing trend. Indeed, the International Monetary Fund has just forecast that GDP growth for China will slip to 6.8% in 2015 and to 6.3% in 2016. In comparison, the IMF expects GDP growth in India to overtake that in China for the first time in 16 years by hitting 7.5% in both 2015 and 2016.
As for global growth, acknowledging help from low oil prices, low inflation and low interest rates, the IMF expects 3.5% for 2015 and 3.8% for 2016 compared with 3.4% in 2014. Certainly, this is an encouraging outlook, perhaps worthy of any party’s manifesto in the UK General Election but with, maybe, a little more credibility.
Within the context of its global trading links, the UK’s relationship with Europe remains significant. In the Eurozone, it is to be hoped that the combination of the European Central Bank‘s Quantitative Easing and individual national economic restructurings will stimulate growth among the members and push back the threat of deflation. Meanwhile, the concerns around Greece’s deteriorating financial position continue to grow as payment deadlines approach. Though the Eurozone member countries, especially Germany, may not wish to be seen as pushing Greece out of the union, even the estimated loss to the European Central Bank of €100 billion from a Greek default/exit may, despite domestic political opposition, have to be swallowed if Greece cannot put its house in order.
In a broader context, ‘Grexit’ carries with it the risk of reawakening contagion fears in the European banking system and the possibility of other struggling Eurozone countries moving towards the exit if only to negotiate concessions. It is looking increasingly as if the only way Greece can start to redeem itself is through another change in political direction towards a more conservative financial regime.
In the U.S., there has been endless speculation about when the Federal Reserve will decide to begin to raise interest rates to the extent that good economic data have been interpreted as meaning that interest rates may begin to rise as soon as June 2015, prompting a sell-off on Wall Street. Conversely, weaker-than-expected data has induced rallies on the inference by investors that rates may not rise until 2016.
The widely-held view that the US would be the first to increase rates has stimulated strong demand for the US Dollar. In turn, this has created a headwind for U.S. exporters as their earnings are reduced by translation from operations in weaker currency areas – all neatly self-regulating and emphasising the need for non-inflationary expansion and greater productivity for exporters to remain competitive in global markets.
In the United Kingdom, the timing of interest rate changes will also be extremely important for the economy, companies and individuals. Inevitably, the policies that emerge post-Election will be a factor in the rate of economic activity and what is regarded as the appropriate level for interest rates. As long as deflation does not become a serious threat, the odds probably point to the next move being up despite the recent comment from the Bank of England’s Andy Haldane that rates could be reduced if conditions justified it.
Bond and equity markets remain hooked on cheap finance from the Central Banks. This is sustaining the moves in equities to new index highs. Consequently, once interest rates begin to rise, albeit slowly, the mood should be expected to change. The IMF has highlighted the risk of a ‘taper tantrum’ and concerns for the Emerging Economies as cheap funds are repatriated to the U.S. possibly later this year.
At Beaufort Securities, our research team applies both fundamental and technical research principles to seek out relative value in the markets. This includes assessing Initial Public Offerings, small capital companies such as those quoted on the Alternative Investment Market (AIM), and large capital companies, particularly those comprising the FTSE 350 Index. Constant monitoring of global economic, political and social developments forms the basis for the Investment Strategy that Beaufort provides to its sales teams and, in turn, its clients as a framework for its investment recommendations. Consequently, we expect to be able to identify opportunities for our clients come, financially speaking, rain or shine.
Mike Franklin Chartered FCSI
Chief Investment Strategist
Beaufort Securities Ltd
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