After disappointing economic growth within the UK fed fears of a ‘triple-dip’ recession, housing market data has added fuel to the fire. Stability is needed for consumers to feel more confident and comfortable spending but instead contraction continues. Outside of London and within the prime real estate market, demand has been driven by a low level of supply and foreign investment. However, outside of this insulated area, property is struggling and banks still have assets to offload which could further maintain downward pressure on prices.
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.
“United we stand; divided we fall” Aesop (Ancient Greek Fabulist and Author of a collection of Greek fables. 620 BC-560 BC)
The problem with the “EU” banner is that it links together economies that are quite different from each other. Much press has been dedicated to the fate of the PIIGS – Portugal, Italy, Ireland, Greece and Spain but it is interesting to compare journalistic exposure with economic impact. Greece Ireland and Portugal account for less than 5% of EU GDP. To save you shifting through pages of research – here are the key pertinent points for each economy… The structure follows that of my earlier assessment of the futility of EU bailout mechanisms–
- FLAWED LOGIC – what are the real issues?
- NOT SOLVING THE PROBLEM – will the economy in question be able to grow enough / will the debt burden be manageable enough so that it will fall as a % of GDP?
- UNCERTAINTY – what are the political issues?
Portugal – A Disappointing Deficit, Dipping Back Into Recession
- DISAPPOINTING DEFICIT and FOREIGN PRESSURE – Disappointed the market with its deficit reduction plan for this year, amounting to a value for the first 10 months of 2010 which was than for the whole of 2009 and forecasted to exceed the EU limit until at least 2012. Exposed to more foreign pressure with around 70% of its debt is held abroad
- LOW GROWTH – estimated to only amount to 1.3% for 2010 for an economy expected to fall into recession next yr
- POTENTIAL SOCIAL UNREST – planning to reduce its public workforce
Italy – Saved by its Savings, Economic Exposure but Debt Isolation
- TOO BIG TO BAIL OUT – second largest debt burden after Greece (public debt equates to 120% of GDP)
- LOW GROWTH
- HOWEVER: High savings rate, exposure to German and Emerging Market economies, less dependant on foreign creditors and therefore more flexible
Ireland – The Public Prefers a Default
- HUGE BAILOUT – amounting to 60% of GDP vs. “only” 47% for Greece
- POTENTIAL FOR DEFAULT – 57% of the public believe the country will not be able to support the annual interest payments involved with this debt burden (€5bn over 9 years) and would prefer the government to DEFAULT on its commitments
- PROTEST and INTERNATIONAL IMPACT – 50,000 took to streets to protest against the Government’s plan to cut the budget deficit. The UK has £140bn exposure to Irish banks
Greece – Flirting with Insolvency
- STRUCTURAL LIMITATIONS – “overblown state sector”, “uncompetitive and relatively closed economy”
- SOLVENCY – It has been argued that the bailout package will only prevent Greece from insolvency for ~a year
- CIVIL UNREST – has been seen in response to social program cutbacks
Spain – Pulling a “Sickie”
- UNEMPLOYMENT and a potential for DEFAULT – the highest in the EU at around 20% of the population. A third of private sector debt (€0.6tn) was generated from the housing boom and liable to default.
- INTEREST PAYMENTS HAVE JUMPED – Since Oct, yields have jumped from 4% to 5% leading to a larger debt burden as a percentage of GDP
- SOCIAL UNREST – Just the other week we saw one of the largest “sickies” thrown by their air traffic workers
Hungary – The Government Can’t Win
Although not within the PIIGS acronym – it is important nonetheless to mention this economy at this point and a great example of the potential impacts to investment. It’s a case that highlights the Government can’t win – if it decides that instead of implementing austerity programs eliciting social unrest, it will instead employ more crowd-pleasing reforms, it will get punished nonetheless….
- DOWNGRADED – Moody’s has downgraded its debt to the lowest investment grade status. One more downgrade and it changes classification and those restricted to investing in Investment Grade debt only will be forced to sell, regardless of any other factors. Great opportunity to pick up dent at a discount (whilst watching the quality of the issuer!)
- REASON – Short term (less antagonistic) measures are not sustainable – special taxes and utilising private pension schemes to fill holes! The Government is relying on future growth to afford its pension liability in the future and anyone not transferring to a state pension by end Jan may lose 70% of their pension value.
Contrast with the Core
Just to contast these economies with the one seeming to be driving force behind the union – Germany’s deficit could potentially fall to the 3% EU limit next year
INVESTMENT INSIGHT: When investing in the EU – differentiate between countries!