Worldwide: Investment Outlook - October 2013

Last Updated: 11 October 2013
Article by Jonathan Davis and Christopher Bates

INVESTMENT REVIEW

Tiptoeing Away From a Taper

Both bonds and equities had a good month in September, helped by the Federal Reserve's announcement that it would not after all immediately begin tapering its asset purchase programme, as many investors had expected.

US

The surprising decision by the Federal Reserve to maintain the size and pace of its asset purchase programme at its September meeting remains a positive for both equity and bond markets in the longer term. The Fed's reasoning for the delay appears to be twofold. First, the extent of the surge in longer-term interest rates since tapering was first aired back in May has clearly taken policymakers by surprise. Any further increase in interest rates could derail the recovery in the housing market, which was already showing some signs of running out of steam. Secondly, the central bank will no doubt have had one eye on the imminent and potentially damaging showdown in Congress over the Government's debt ceiling, which can only be increased with legislators' approval. The prospect that parts of the Government would have to be shut down for the first time since the Clinton era, coupled with the risk that the debt ceiling could be breached as early as 17 October, has weighed more heavily on US markets since the tapering decision was announced. Political brinkmanship in an increasingly partisan Senate could well cause further market uncertainty in the near term.

After hitting new highs in mid-September, the US equity market is now looking for new direction and leadership. As we enter the final quarter of the year, a number of hurdles will need to be negotiated if US markets are to drive on further. The decision by Larry Summers to withdraw from the race to succeed Ben Bernanke as chairman of the Fed is likely to mean that President Obama announces a less controversial successor, one who is unlikely to deviate too far from Mr Bernanke's doveish policy prescriptions. In the medium term, however, US equity market valuations are beginning to look expensive relative to developed market peers. With monetary policy remaining supportive and economic growth continuing to trend upwards, some cyclical areas of the market whose valuations don't look too stretched, such as financial and material stocks, should still do well. In the fixed income market, bond yields rose sharply ahead of the Fed's announcement but have since traced some of that ground, with ten-year yields declining to around 2.65% at month end, after touching 3.0% earlier in the month.

UK

While investors remain unconvinced by Bank of England governor Mark Carney's efforts to downplay the recent rise in market interest rates, the economic backdrop in the UK continues to improve. Notable increases in manufacturing, construction and services PMIs suggest that a more balanced economic recovery is taking place. The most recent meeting of the Monetary Policy Committee showed little appetite for increasing the Bank of England's quantitative easing programme. Mr Carney's recent comments, implying that he sees no case for further QE at this stage, have prompted sterling to rise sharply against the dollar and euro. The committee did draw attention to the risks posed by recent developments in the housing market. The Government's decision to bring forward its Help to Buy scheme by three months to capitalise on the recent momentum in mortgage approvals has prompted talk of a new housing bubble. That looks premature at a time when lending by non-State-owned lenders remains subdued and demand is only recovering from historically low levels. The lack of growth in real wages in the UK remains a concern that will restrain consumer demand. While real wages rose by around 2.5% per annum in the decade leading up to 2008, they have fallen by 1.1% a year since then.

Sterling's recent strength is having an impact on earnings expectations. Earnings growth forecasts for this year, while comfortably above areas of the eurozone, have fallen into negative territory. The telecoms sector has been a standout performer year to date, but other more defensive sectors have begun to underperform. The makeup of the UK market means it could lag other developed markets if the economic outlook continues to improve, especially in mainland Europe. Nevertheless valuations for the market as a whole do not look stretched, and the UK trades at an attractive discount to the US and Japan. Gilt yields have fallen in recent weeks but have notably failed to 'decouple' from US Treasuries. Policy on the other side of the Atlantic will continue to play a big part in the future shape of bond market returns. For the moment, as long as the economy continues to gain traction and monetary policy remains supportive, we see little to derail the gradual upward trend of the UK market over the balance of the year.

Europe

While a gradually improving economic climate has provided a tailwind for European markets over the summer, the region's dysfunctional politics have resurfaced again to cast a shadow over investor confidence. Italy's five-month old coalition Government teetered on the edge of collapse after the former Prime Minister Silvio Berlusconi pulled five of his party's ministers from the Italian cabinet and called for a snap election. The news pulled Italian equities back from two-year highs and helped to push the ten-year bond yield back up towards 4.5%. The news from the German elections in mid-September has been more encouraging for investors, with the Chancellor Angela Merkel sweeping to a comprehensive victory. Her Conservative Party gained more than 41% of the vote, but fell just short of an absolute majority. With her former coalition partners the Free Democrats losing their representation in the Bundestag after a poor showing at the polls, Mrs Merkel will be forced into a new coalition government. Reaching a workable agreement with the main opposition party, the Social Democrats, will not be easy. It does however raise the prospect that Germany will now move more quickly towards an effective eurozone banking union. Despite the political uncertainties, signs of a revival in economic growth continue to make Europe's equity markets look increasingly attractive to institutional investors. The Eurostoxx index rose over 10% over the quarter. As in the US and UK, market interest rates in the eurozone have been moving higher since May. As elsewhere investor attention will continue to focus on how much more the European Central Bank can do to maintain supportive monetary policy. Another interest rate cut is not out of the question.

Asia

With markets in the developed world in limbo between a pick up growth and a tightening of liquidity, Chinese growth could once again become a positive area of focus. There seems little doubt that the economy is showing signs of stabilisation after nearly three years of slowing rates of growth. Leading indicators suggest that domestic, not external, demand is becoming the primary driver behind the recent improvement. The biggest threat to future Chinese growth remains the excessive build-up of debt. Chinese banking authorities have encouraged banks to securitize their bad loans and remove them from bank balance sheets. In November, the Communist Party's plenary meeting is set to approve a number of reforms, including privatisation of state-owned enterprises and further financial market liberalisation. Chinese equities have continued to perform well. The Hang Seng index was up around 10% over the third quarter, with technology and consumer stocks leading the way. Third-quarter GDP figures later this month are expected to show growth of around 7.7%, cooling to 7.5% by early next year.

In Japan the actions of recently elected Prime Minister Shinzo Abe continue to have a powerful impact on the Japanese economy. His aggressive reflationary policies are starting to bear fruit, although financial markets remain highly volatile. In the equity market daily moves of 3% or more have been commonplace over the summer. August's CPI inflation figures showed prices rising at their fastest pace for five years, suggesting that Mr Abe's plan to reverse Japan's deflationary spiral is having an impact. Stripping out energy costs, however, prices still fell 0.1% last month and without an increase in wages, it seems unlikely that consumer purchasing power can strengthen. Stimulating wages will be an important policy tool for the Abe regime once the long-planned increase in the rate of sales tax finally goes ahead next year. The rapid rise in Japanese equities since the end of last year means the market no longer looks particularly cheap. However with monetary policy remaining extremely supportive, earnings growth continuing to gather pace and the possibility of positive policy surprises, we still remain positive on the outlook for Japanese equities, despite the heightened volatility.

MARKET HIGHLIGHTS

Equity Markets

Equities generally rebounded in September after their poor performance in August. The best performing major stock market for a sterling investor was the German DAX, where Mrs Merkel's comfortable victory ensured a continuation of her cautious and pragmatic approach to policymaking. The emerging markets hit hardest over the summer, such as Brazil and India, also posted strong gains. The sharp rise in sterling against the dollar over the month offset the local currency gains in US markets. Although midcap UK companies (represented by the FTSE 250 index) have comfortably outperformed the FTSE 100 index over ten years, the strongest showing in the past 12 months has been seen in smaller capitalisation companies. The Footsie index has an attractive 3.7% dividend yield, but has lagged the other indices because of its heavy weighting in resource stocks during a period when commodity prices have been generally weak.

Fixed Income Markets

After a strong start to the year 2013 is proving to be a poor year for most bond markets, with the rise in US Treasury yields that began after the Fed first started talking about tapering its asset purchase programme in May gradually feeding through to other fixed income stocks. Government bonds in the UK and US are on course to produce their worst returns for several years, with index-linked securities particularly hardly hit in the post-tapering sell-off. Government bond yields have however started to fall again since the Fed deferred its decision on tapering in September. They may continue to soften until or unless there is renewed clarity about the Central Bank's policy intentions. UK gilts have closely tracked movements in the US market. Investors' search for yield has meanwhile led to further flows into higher yielding corporate bonds, raising concerns that the market for credit may be beginning to overheat.

Gold and Other Assets

Another consequence of the Fed's on-off approach to slowing the rate of QE can be seen in the performance of the dollar, which has weakened notably against almost all currencies since tapering was first announced. The US currency has fallen particularly strongly against the pound, sending the British currency to $1.62 at month end, close to its highest levels since the 2008 crisis. Unlike on many previous occasions, gold has moved in the same direction as the dollar, falling below $1300/ oz, its lowest level since June this year. With most speculators having abandoned gold, and no signs of any imminent surge in inflation, it is hard to make a positive case for gold in the short term.

MARKET RETURNS

INVESTMENT Q&A

Ireland's Road to Recovery

By Jonathan Sheahan

How is the Irish economy performing in 2013?

2013 has been a mostly positive year for the Irish economy. The latest data confirms that the economy is officially out of recession after three consecutive quarters of GDP contraction. The Irish economy grew by 0.4% in the second quarter. The main contributors were consumer spending (up 0.7%) and exports (up 4.5%). Although still above the European average, the Irish unemployment rate has meanwhile declined to 13.4% from a peak of 15.2% in February 2012. This is the lowest rate since July 2009 and the fourteenth monthly decrease in a row. Leading economic indicators are also ticking up. So it seems safe to say that the Irish economy is finally on the road to recovery.

Does that mean that Ireland is now in a position to exit its IMF bailout?

With any luck, yes. When the Irish property bubble burst in 2007, it plunged the Irish economy into an unprecedented financial crisis, as bad as that experienced by any country in Europe, other than perhaps Greece. Having guaranteed all the country's bank deposits, in November 2010 the Irish Government was forced to seek an €85bn bailout from the EU, the ECB and the IMF. The bailout funds were initially used to strengthen and restructure the dysfunctional banking system. These funds were conditional on Ireland agreeing to a raft of structural reforms and new budget measures to bring Ireland's deficit back to 3% of GDP. Three years on, both the Irish Government and the IMF appear to be broadly happy with the progress that has been made in administering this stern medicine. Ireland has certainly done more to put its house in order than a number of other eurozone countries. Having hit an an all-time high of 14% during the eurozone crisis, bond yields have fallen to under 4%. Earlier this year the Government was able to borrow from the private sector for the first time since the eurozone crisis erupted. As a result Ireland is expected to be able to exit the IMF bailout this year, or perhaps in early 2014, albeit with a number of transitional measures still in place.

What has been behind the turnaround in the Irish economy this year?

Confidence has probably been the biggest single factor. For the first time in five years genuine optimism has started to return to many parts of the economy. The willingness of the Irish to take tough austerity measures has been recognised both inside and outside the country. This increased confidence has helped to stimulate the economy. To take one example, international investors are once again investing in Irish property, both directly through the acquisition of large hotels and commercial buildings, and indirectly through the purchase of Irish loan portfolios. A number of multinational IT and fund management companies continue to see Ireland as a hub for their European operations and have invested accordingly.

Is the recovery sustainable – what can we expect for 2014?

The Government's annual Budget is usually announced in early December each year. This year, however, the Fine Gael/Labour Coalition Government has decided to bring the date forward to 15 October. Ireland's Finance Minister, Michael Noonan, is aiming for €3.1bn of budget cuts in 2014, meaning no early end to the austerity programme. The focus is on bringing in tax receipts ahead of forecast and avoiding cost overruns in social welfare and health programmes. The decision by the ECB to reduce its base rates to 0.5% should also help Irish homeowners with tracker mortgages. The risk of yet another recession, the third since the crisis, cannot be discounted however, as debt levels remain high.

What is the current state of the Irish property market?

After a peak to trough fall from 2007 to 2012 of over 50%, 2013 has seen some recovery in Irish property prices, particularly in the greater Dublin area. Anecdotal evidence suggests that cities such as Cork, Galway and Limerick are also seeing signs of stabilisation. National property prices rose on average by 2.3%, according to the latest annualised figures, even though this increase is from a low base. If Irish banks can find a way to lend more, the recovery in the property market should be sustainable.

But are the banks in Ireland anywhere near recovering?

There were six main Irish banks and building societies before the crisis: Allied Irish Bank, Bank of Ireland, EBS, Irish Life & Permanent, the Irish Nationwide Building Society and Anglo Irish Bank. Today all but one are still 100% owned by the State. Irish Nationwide and Anglo Irish Bank were both nationalised and merged into the Irish Bank Resolution Corporation (IBRC), which has since been put into liquidation. The loan books of EBS and AIB have also been merged while Irish Life & Permanent was forced to sell its life business to a Canadian insurance company.

Given how few write-offs have so far been made, the high level of mortgage repayment arrears remains the biggest concern. There is a risk that new insolvency legislation risks will crystallise more losses for the Irish banks. A second round of bank 'stress tests' is due to take place in 2014. Until the results are published, it is difficult to know how quickly the Irish banks can return to normality. Consumer and corporate credit conditions remain tight.

How has the Irish stock market been performing?

The ISEQ Index of Irish shares hit a high of almost 10,000 in June 2007. By March 2009 it had fallen to under 2,000 points, a decline of more than 80% – a classic tale of boom and bust. Since 2009 the Index has recovered in line with other stock markets and currently stands at around 4,200, having more than doubled from its low point. It still trades at less than half its peak. One worrying trend is that a number of larger Irish companies have opted to move the primary listing of their shares from Dublin to London, in order to increase liquidity and raise investor awareness. CRH was the first to move, joining the FTSE 100 Index in 2011. Grafton Group, United Drug and DCC are others to have made or be planning a move to the London exchange.

How important are low tax rates to Ireland's economic recovery?

The Irish Government has been adamant that it does not intend to abandon its low corporation tax rates, which are widely seen as one of the country's key competitive advantages. Its 12.5% corporation tax rate was instrumental in attracting large multinational corporations to Ireland before the crisis and its retention has helped to retain confidence. It should be noted that however while the low headline tax rate has attracted a lot of criticism, companies operating in Ireland do face a number of other taxes that offset some of the benefit. Nevertheless, given the country's heavy debt burden, income and capital taxes for individuals have risen quite sharply in the last few years. Higher-rate income tax is as high as 55% for some self-employed individuals with income of more than €100,000. Capital gains tax and capital acquisitions tax have been increased from 20% to 33%.

Will Ireland remain a fully paid up member of the eurozone?

Any concerns that Ireland will leave the eurozone have faded. The Irish Government sees itself as an integral part of the European Community and anti-euro public opinion has softened as the crisis has started to ease. Government bond yields are back to pre-crisis levels, reducing the risk of an enforced exit from the euro. The Irish Government remains committed however to negotiating better terms for the recapitalisation of the Irish banks in talks with Brussels in 2014, so a new political flare up is not impossible.

What is the outlook for Ireland now?

The Irish economy is still a long way from being out of the woods. It needs to make deeper inroads into its debt and deficit as a percentage of GDP. There are concerns that too many talented people are choosing to emigrate. The encouraging news is that GDP, unemployment, house prices and consumer confidence have all started to improve and the hope is that current trends will continue, bringing to an end a painful episode in the country's history.

CHRONOLOGY OF MARKET EVENTS

We have taken great care to ensure the accuracy of this newsletter. However, the newsletter is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication.
© Smith & Williamson Holdings Limited 2013. code 1137/2013/db

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.