The room’s getting crowded, the party’s been going on a while but more people could arrive. Just beware fair weather friends and a sign it could be time to think about leaving…
As the Euro zone crisis intensifies and global markets reflect investor concerns, we ask ourselves, is a Greek exit from the euro on its way? Crucially, preparations have already begun to protect shareholder interest, companies are robust and policy in the US and China aims to maintain the upward momentum. To protect capital, proactively positioning portfolios has been key. International exposure and dividend yields offer attractive opportunities..
A ‘Grexit’ on its way?
All eyes once again are focused on Greece. An inability to form a government has led to a renewed fear that the country could exit the Euro and the wider European Union. Although only a small contributor to European economic output as a whole, contagion is the real risk. Concerns of further losses for external holders of Greek debt and a more widespread break-up of the euro have driven equity market weakness.
A self-perpetuating situation, investors are demanding more to lend to the likes of Spain and Portugal, driving their debt burdens to unsustainable levels. Furthermore, disappointing data from the US and China over the last few days have further added to the uncertainty.
…but preparations are underway
However, preparations have already begun to protect shareholder interest. German and French banks, which were the largest holders of Greek debt, have been aggressively reducing their positions. Some, for example, have cut periphery debt exposure by as much as half since 2010. Banks in the UK have been making provisions since at least November when the Financial Services Authority’s top regulator, Andrew Bailey, told banks: “We must not ignore the prospect of the disorderly departure of some countries from the eurozone.”
On the corporate side, interesting anecdotes have highlighted the proactive nature of company management in the face of this turmoil. Last year, for example, Tui, one of Europe’s largest travel companies, was reported to have requested to reserve the right to pay in a new Greek currency should the country exit from the euro. Corporate balance sheets are robust, holding more cash than long term averages, dividend yields and the potential for merger and acquisition activity once the macro outlook starts to improve can offer an attractive upside.
Finally, although wavering slightly, the US still successfully avoided falling back into recession. Keenly aware of both external and internal risks to growth, Chairman of the Federal Reserve, Ben Bernanke has made it clear he is not afraid to utilise further tools to protect economic growth. Especially with an election this year, policy is likely to remain accommodative. With respect to Emerging Markets, despite the recent wobble and an inevitable cooling of economic growth, with an estimated 1 billion of the population to join the consumer class by 2030, the long-term case remains strong.
Proactive portfolio positioning prudent
To protect capital, proactively positioning portfolios has been key. Reducing direct European exposure as Europe’s southern members showed severe signs of economic stress from an asset allocation perspective and via underlying fund managers has proved prudent. Fund managers have been able to maintain a zero weighting to Greece and a substantial underweight to the likes of Portugal and Spain relative to benchmark.
As equity markets reached new highs in the first quarter of this year, the substantial rally in share prices in the face of continued structural problems within the Euro zone, was a sign that the risk of a downward correction had increased in the short term. Caution was of course well-founded. A move to lock-in profits and redeploy capital to alternatives and property for a more attractive risk/return potential and hedge against inflation has been supported.
Assets which will help portfolio performance during these volatile market times are good quality companies with strong balance sheets paying an attractive level of dividends. Furthermore, in times of slow economic growth and persistent inflation, strong franchises with pricing power for protected market share and the ability to pass on increases in supply costs to the customer are very desirable attributes.
International exposure and dividend yields offer attractive opportunities
Looking forward, a resolution of key issues in Europe is required to gain confidence to add to equity exposure. Structural reform, greater fiscal consolidation, a focus on growth and long term support are required for stability in the region. At the same time, with a medium to long-term time horizon, it is more important to focus on the geographical location of a company’s revenue streams than where it is headquartered. Investor overreaction can offer buying opportunities with share price corrections providing attractive, cheaper entry points to high quality firms. Furthermore, the yield from dividends these companies pay out can provide a valuable income stream. With many investors holding back capital, the flow of money back into markets, buying into sell-offs at lower levels, could dampen these downward moves and provide a level of support. Therefore, although volatility could continue and market direction remains difficult to determine, it is possible to navigate the turmoil.
Billed as the “most pro-growth budget for a generation”, attacked with the claim the “hurting isn’t working”…
In a growth-starved environment, with inflation figures stoking fears, today’s budget was awaited in eager anticipation. Aiming to simplify our complex tax system, increase competitiveness and boost domestic industry, the politically astute rhetoric rang loud while bottom-line impacts remained mixed. Most crucially as an investor, how has the budget impacted the outlook for investment?
Growth Alone does not Drive Equity Returns
Much noise has been made over the downgrade of this year’s growth forecast (from 2.1% to 1.7%) but studies carried out to investigate a link between growth and equity returns have come back empty handed. Taking the recession during the early 1990s as an example, during its duration the UK All Share Index increased in value by more than 16%. Furthermore, as I write this article, the FTSE 100 is barely reacting.
Outlook for Stock Pickers Remains Buoyant
The government has picked certain sectors for penalty, others for promotion and the budget will impact companies in different ways. Investors and fund managers able to differentiate and exploit this will be well-placed. The following bullet points give a high level overview highlighting some of the discrepancies:
- TOBACCO duty to rise by 2% above inflation,
- BANKS to not benefit from corporate tax cuts,
- OIL companies to fund the ‘fair fuel stabiliser’,
- SMALL R&D heavy companies will benefit from a 200% tax credit this year,
- private AVIATION hit with a levy,
- home CONSTRUCTION firms to benefit from first-time buyer incentives focused on new builds
In addition, Illogical moves may reverse. Consumption remains under pressure (unemployment still near record high levels) but the outperformance of consumer discretionary over consumer staples has reached almost 50% – illogical since spend on luxury goods should be hit the most. Therefore, there are opportunities for high quality companies with pricing power and strong demand for their goods to play catch up.
Diversifying into Other Currencies Supported
In reference to the recent tsunami in Japan, the Chancellor mentioned the support the UK has provided and, in doing so, confirmed the UK’s aim of building foreign asset reserves. With countries artificially pushing the value of their currencies down (read: Brazil’s $40bn intervention last year and Chile’s $12bn this year) and others keeping theirs low (read: China’s RMB believed to be 40% undervalued), the upside potential when this eventually ends is great. Stan Fischer, the Governor of the Bank of Israel revealed they “are diversifying into currencies which (they) would never have put in the reserves before”, supported by the Governor of the Bank of Canada with his belief that we will see a “multi-polar” system. Watching sterling’s moves today, the currency is off slightly against the dollar but the real moves will be versus emerging market currencies and over the longer term. Following the lead of Central Banks ‘spreading their wealth’, this form of diversification may be prudent.
Promotion of Alternative Schemes
The tax relief on EIS (Enterprise Investment Schemes) and VCT (Venture Capital Trust) investment will be increased from 20% to 30% next year, offering a substantial opportunity for tax efficient investing. More interesting and less noted is the move to allow larger companies to be eligible for the scheme. This has been claimed to reduce risk. To this, a footnote should be added. Lower risk opportunities may be available but the same level of due diligence is required.
Finally, although not strictly an investment, giving to charity now has financial benefits in addition to goodwill. Those who donate may be granted a 10% discount in their inheritance tax bill. Looks like the government may be targeting not just our wallets but our souls.