Market commentary April 2009

Market commentary - for the period 6th October 2008 to 5th April 2009


UK Equities

(FTSE All Share Index -10%)

The collapse of Lehman Brothers in September 2008 caused significant distress to financial markets around the world as global stock markets fell to multi year lows by the end of the month. Some of the losses were recovered by December although risk measures signalling market volatility and risk aversion remained stubbornly high. The output of the UK economy contracted in the fourth quarter of 2008 by -1.6% which was the largest decline since 1974 and a slew of deteriorating economic data from around the world conspired to drive markets back towards the previous October lows during the first two months of 2009. Official data and business surveys has indicated that activity continued to fall sharply in the UK’s major trading partners in the first quarter of 2009 and the Organisation for Co-operation and Development (OECD) expect more than four fifths of it’s member countries to have been in recession (SOURCE: Quarterly Inflation Report, Bank of England).

The downward pressure on share prices was derived from a combination of sharply falling corporate profits, reductions in dividend payouts and contracting valuation ratios. In addition, there has been a significant increase in the number of companies raising additional equity through deeply discounted rights issues to either fund their investment plans, support working cash flow to enable them to survive the recession or to reduce the level of debt on their balance sheets.

On March 9th 2009, the UK market reached extreme oversold levels and began a ‘V shaped’ recovery of a magnitude that has surprised many market participants. Indeed, at the time of writing, the FTSE 100 has risen by over 25% from the March lows dissipating some of the extreme pessimism prevalent in the market at that time.

Looking forward, analysts are questioning if the recent recovery is sustainable and trying to determine what type of economic recovery we can expect. Government debt has increased substantially during the credit crisis and a combination of higher taxes and/or lower government spending is certain to place downward pressure on the trend rate of economic growth over the next decade. Unemployment levels continue to rise, personal debt levels remain elevated and a properly functioning banking system remains elusive. However, co-ordinated government actions does seem to have averted an outright depression, credit conditions have improved somewhat and some of the business indicators are turning up as companies restock their severely depleted inventory levels.

International Equities (FTSE World excl.UK Index -3.6%)

In the United States, the S&P 500 returned -20.95% during the period. The Federal Reserve set a near zero interest rate policy in an attempt to avoid a sustained period of deflation akin to ‘the Lost Decade’ that Japan suffered in the nineties. Having exhausted conventional monetary policy measures, President Obama’s Treasury team enacted a policy of ‘Quantitative Easing’ primarily through The Troubled Asset Relief Programme (TARP) which was established with $700 billion of funds and was designed to help troubled financial institutions and car makers. However, events have moved on and many other programmes including the Public Private Investment Plan (the PPIP) have since followed, pushing the overall cost of the fiscal stimulus above $1 trillion.

In Europe, the FTSE Eurotop 100 index fell by -22.2% during the period. The Euro area entered a deep recession as economic activity contracted in the fourth quarter of 2008 but has been projected by the OECD to pick up slowly in 2010. Germany in particular is suffering from the collapse in world trade affecting their export led economy and France is suffering to a lesser degree. Portugal, Ireland, Greece and Spain are suffering very severe recessions with a combination of economic contraction, high unemployment levels and poor government finances.

The collapse in global trade hit Japan’s economy hard as it reported both plummeting exports and business investment. It is likely that Japan will suffer it’s worst downturn in post-war history with economic contraction predicted to be around -6.5% for 2009. Household income is falling as unemployment is rising and pushing Japan back into deflation as the core inflation measure fell below zero. The Yen appreciated by 16.87% during the period providing a currency enhancement to Japanese investments.

In the Asia Pacific region, the benchmark MSCI Far East (excluding Japan) Index rose by 15.05% bucking the negative trends of the western industrialised economies. This index had previously suffered a peak to trough decline of -53.96% and therefore these numbers represent a welcome return to positive investment returns. The slowdown in Chinese growth was more limited as overall financial conditions have by no means tightened as much as in OECD countries. The banking sector is not significantly exposed to overseas high risk assets and household wealth has only been modestly affected by the fall in equity prices as less than one-third of the total value of shares is held by the private sector.

The MSCI Emerging Market Index produced a positive return of 14.01% as the weakening U.S. dollar provided support to commodity prices from the October market lows following the bursting of the commodity price bubble in 2008. The improving performance has been maintained since March as the appetite for assets considered with high risk and high reward characteristics is slowly returning.

Fixed Interest (FTSE British Govt All Stocks Index +5.2%)

The Monetary Policy Committee began a programme to purchase £125 billion of assets consisting of Government Gilts and high quality corporate bonds in a process known as ‘Quantitative Easing’ (QE). This process financed by Bank of England reserves was designed to push up asset prices and lower yields, boosting wealth and reducing the cost of borrowing for households and companies over the medium term. There is little precedent for this process of easing monetary conditions in the economy and there are risks of unintended consequences.

The UK economy is now experiencing deflationary conditions according to the recently announced Retail Price Index (RPI) figure which turned negative at -1.2%. However, the latest Bank of England Quarterly Inflation Report provides an insight to the likely profile of prices in the coming years. Quoting the same report; ‘it is more likely than not that Consumer Price Inflation (CPI) will be below the 2% inflation target in the medium term but there are significant risks to the inflation outlook in each direction’. The implication is that high levels of inflation are a distinct possibility in years to come and will become an increasingly important aspect of portfolio planning.

The performance of corporate bonds has been strong since the end of March and strong money flows into this asset class has provided some much needed liquidity for the market. Bonds issued by banks have generally continued to perform poorly in response to the credit crisis and many issues are valued at sub par valuations and are unlikely ever to be redeemed at their 100p issue price. It is these bonds which are destabilizing the capital structure of the banks which ultimately provide some of the security for the banks cash deposits. However, there are tentative signs of firming prices in this sector providing some of the data evidence which is starting to form the much maligned ‘green shoots of recovery’.

Commercial Property (FTSE All UK Property Index -20.2%)

Net asset values continue to be written down and the IPD indicators show a near 40% fall in values from the top of the market. Retail landlords are negotiating hard to reduce their service charge costs and voids are rising. The quoted property companies (REITS) have started raising cash through deeply discounted rights issues as many companies are severely indebted, although yields on these share classes are starting to look interesting and may present investment opportunities towards the end of the year.

Alternative Investments (FTSE Hedge Sterling Daily Index -11.2%)

Investors have continued to redeem their investments in hedge funds and fund managers have lost their ability to borrow at high levels and to maximize profits by short selling the banking stocks. We continue to favour UCITs III style funds for portfolio management purposes which are regulated by the FSA and contain prescriptive legislation on the use of borrowing in particular.

IFPC is authorised and regulated by the Financial Services Authority

FTSE Index performance: for period 6th October 2008 to 5th April 2009, total return with income reinvested

Source of statistics: Lipper Hindsight, Alpha Terminal

Disclaimer: this document represents investment commentary of a general nature and should not be used as a basis for making personal investment recommendations. It does not take into account personal investment objectives and you should contact an adviser at IFPC if you require further financial advice.

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