Market Watch from Redmayne Bentley Leeds Financial

 

The official starting gun has been fired for the general election and, as widely predicted, the 6th May for most of us cannot come soon enough, for what has been billed as the most important general election in a generation and one that saw campaigning start many, many months ago. We are now in for four weeks of campaigning on just about everything but the central issue and that is public spending. This year it is expected to reach £704bn, with nearly one in every four pounds being spent borrowed.  All the main political parties have so far given this debate a wide berth for fear of losing votes from fearful public sector employees. Ultimately, the UK’s productive capacity is inadequate against the scale of our debts. Therefore voter expectations remain set for huge disappointment, as politicians do nothing but offer overly optimistic promises about the years ahead in order to secure votes from an electorate who overall prefer to live in denial, about the difficulties that will have to be addressed. So whilst everyone blames Politian’s constantly, in fairness we elect them and so therefore society gets what it deserves - a stream of unrealistic commitments and future broken promises. This will only alienate the electorate and already discredited politicians further, as central issues remain a side show. Even under Margaret Thatcher public spending was never cut and yet we already know that cuts are coming. All the talk is about the size of deficit reduction, not how to cut the countries huge and growing debt mountain. In the future voters are going to feel let down when the full extent of the cuts become inevitably known and this applies to whoever forms the next government. So far the parties are dwelling on the small details in order to avoid addressing the grand problems

 

In the UK the top 1% of earners pay 24.1% of the income tax and the top 10% pay 53.5% according to George Magnus in the telegraph at the weekend. If the top 10% or even just a few of the top 1%, in an ever more so globalised world, decide to move abroad then the tax burden for the rest will have to increase significantly. Whilst the wealthy must contribute and accept they have a civic duty to pay a higher percentage of the overall tax take. If they are squeezed too much and leave, we will all pay a high price via increased taxes. There is no doubt that the taxes of these higher rate tax payers, should they leave, will be warmly welcomed by other nations, keen for every piece of revenue they can seize and which in many cases only reduces there own borrowing requirements. We should all be aware that a smaller deficit reduces the need to borrow from the few global creditors. These lenders generally do not have the borrowing nations overall well being as a high priority. In an increasingly competitive world for jobs, we may well see sovereign wealth funds like those of china being used as a weapon to undermine the economies of rival trading partners, as they pursuit of a purely domestic agenda. The communist party that rules China with an iron hand knows that for it to remain in power it must create jobs. These will be at the expense of jobs elsewhere in the world, probably in Europe and the US where economies are too unbalanced to generate the home-grown jobs that are needed without radical reform. This radical reform is not even being aired. Never mind being debated currently.

 

During the week the Bank of England voted to keep UK interest rates at their current record low of 0.5 per cent and refrained from any further quantitative easing, as further evidence has emerged of an economy gaining traction, something I do not believe will continue. On the same day the European Central Bank also kept European rates for the sixteen-nation zone at 1 per cent, for the eleventh month in a row.  The bank of England’s next interest rate decision meeting, which was scheduled for 6th May, will now be moved to the 10th May, with the meeting being held on Friday 7th May and Monday 10th May.  An auction of government bonds set for 5th May has also been affected, with the debt management office saying it would bring forward the auction of a 4.5 per cent three year gilt to 28th April.  During the week the Bank of International Settlements, often referred to as the bankers’ bank, issued a report saying that Britain would need drastic austerity measures to prevent public debt exploding out of control and that interest payments on the UK’s public debt will double from 5 per cent of GDP to 10 per cent within a decade under the bank’s base scenario, before spiralling upwards to 27 per cent by 2040.  It also stated that Labour’s plan to consolidate the budget deficit by 1.3 per cent GDP annually for the next three years did not go far enough. Next months salary slips will make poor reading for hundreds of thousands of taxpayers as frozen allowances and the withdrawal of the personal allowance of £6,475 a year for anyone earning above £100,000 take effect.  This means that anyone earning above £113,000 will, in effect, lose their full personal allowance.  Anyone earning between these two figures is paying nearly £2 to the taxman for every £1 they earn and this is the highest rate of tax since 1988, when the top rate of income tax was cut to 40 per cent.  Taxpayers in this band will be paying a new marginal rate of 61.5 per cent and this is a clear breach of the Labour Party’s manifesto pledge, not to raise income tax above 40 per cent in the life of the current Parliament. 

 

The Organisation for Economic Co-operation and Development gave the government a boost by reporting that the UK economy is set to grow faster than all but one of its G7 peers in the second quarter.  It is forecasting that the UK economy will grow at an annualised rate of 3.1 per cent in the second quarter, in line with the government’s own projections announced in the recent budget.  According to them, only Canada, of the G7 nations, will grow faster than the UK in the second quarter.  It also believes that the UK economy grew by around 2 per cent annualised in the first three months of 2010, behind Canada, US, France, but ahead of Germany, Japan Italy.  Whilst the major political parties talk about efficiency gains and tweaking to the tax system, in reality efficiency gains mean cuts and job losses in the public sector, as the country runs out of money and is unable to continue to live so lavishly beyond its means.  According to the OECD, the most efficient way to consolidate excessive public debt positions whilst mineralising the hit to overall aggregate demand in an economy is done by an 80/20 mix of cuts in spending and increases in taxes.  I continue to argue that the next incoming government will increase VAT up to 20 per cent, taking it into line with the rest of Europe and bring in much needed tax revenue.  Whilst both parties have studiously avoided ruling out such a move, Stuart Rose the outgoing Executive Chairman of Marks & Spencer in the week confirmed that he would not be surprised to see such an increase.  Recently speaking to the Treasury Select Committee Simon Hayes, Chief UK Economist at Barclays Capital said he thought the market would welcome such a move. A VAT commitment has also been left out of the Labour Party’s manifesto.

 

During the week there was further positive news on the UK economic front from the British Chamber of Commerce in its economic survey.  The BCC survey of more than 5,500 businesses indicated that the service sector health is improving, though risks of a relapse remain.  The report was less bullish for the manufacturing sector, with key measures still deteriorating.  Investment in plant and machinery remained negative in both manufacturing and the service sector and whilst in manufacturing first quarter sales moved into positive territory, new orders remained negative. Government measures of flexible employment policies and low borrowing costs has made the extent of business failures much milder than in previous recessions according to the latest report from accountants and management advisors BDO.  The total number of businesses failing last year rose to 26,165, which translates into 1 in 74 companies going under, 16 per cent more than the year before and a 59 per cent rise on the 2007 pre-recession level.  Whilst still predicting a high number of business failures in the coming years, the report forecasts a declining rate of insolvencies, with 1 in 86 this year and 1 in 100 in 2011. In the last major recession in 1991/1992, 27,300 businesses went into liquidation. 

 

According to forecasts from the National Institute of Economic and Social Research, the UK economy grew by 0.4 per cent in the first quarter of 2010, easing fears of a double-dip recession.  The report suggests that the inclement weather in January did not de-rail the recovery as much as had been anticipated. On these numbers the economy has now grown by 1.1 per cent since it bottomed last September.  Britain’s output is still 5.4 per cent lower than it was in 2008 due to the recession. The official numbers on first quarter GDP growth will be released on April 23rd, little more than a week before the general election. The NEISR prediction was released on the same day that we saw further evidence of the manufacturing sector bouncing back in February.  According to the Office of National Statistics, UK manufacturing posted its biggest annual gain in two years in February, when output rose 1.4 per cent on the year, showing gains in 11 out of 13 sectors.  The ONS, however, cautioned that February’s gain could have been boosted by a particularly poor performance in January, due to the inclement weather. 

 

The CIPS/MARKIT Report on Manufacturing released in the week suggests that manufacturing activity is rising in March.  The activity reading rose to 57.2 from 56.5 in February compared with economics forecasts of 56.8.  This was the highest reading since October 1994.  A reading above 50 denotes growth, whilst below signals contraction.  The Factory Output Index rose to its highest in more than 15 years, hitting 61.9 from 59.8 in February.  Other numbers, however, revealed that 15 per cent of firms reported job losses, increasing fears that Britain’s labour market will be slow to recovery from the recession, particularly when economists are hoping that a pick-up in manufacturing and private sector jobs will help offset what will be inevitable job losses within the public sector, as spending cuts take hold next year.  The UK Purchasing Managers Index for the service sector eased to 56.5 in March from its three year high of 58.4 in February.  Although the numbers indicate expansion, the figure was slightly below market expectations of 58.  After having contracted for two years, there was encouraging news on the construction sector when the monthly CIPS/MARKIT Construction Purchasing Managers Index, which tracks activity in the sector, rose strongly to 53.1 last month, from 48.5 in February.  This is the first month since February 2008 in which the construction PMI has recorded a level above 50. 

 

According to the Bank of England’s latest Credit Conditions Survey, credit availability for businesses increased in the first quarter of the year andBritain’s lenders expect to make more available over the next three months.  The report highlighted that demand for credit amongst small and medium sized business increased more than anticipated, but remained unchanged for larger companies.  Demand is also expected to rise again in the second quarter.  For the first time since the crisis began, lenders reported an unexpected fall in loan default rates amongst medium and large sized businesses, although amongst small companies default rates were unchanged.  Whilst the survey is encouraging, it does little to alter my view that a long period of sluggish credit growth lies ahead, as the positive tone of this survey and those of the last few months have not fed through to a pick-up in net lending, largely because firms are continuing to repay debt as they de-leverage their balance sheets. Individuals also continue to pay down high debt levels. Whilst the supply of secured credit to households was broadly unchanged in the first quarter, demand actually fell.  This has largely been blamed on the poor weather at the start of the year and the ending of the Stamp Duty holiday.  According to the Bank of England, Britons paid down £4 billion of mortgage debt between October and December last year.  In the fourth quarter of last year £4.038 billion was repaid from mortgages, taking the total to £29 billion since the credit crisis began.  The quarterly number is 43 per cent less than at the height of the crisis in the fourth quarter of 2008, when Britons cut their mortgage debt by £7.1 billion.  It is also less than the third and second quarters of last year, when £5.059 billion and £6.126 billion were respectively paid back.  This was therefore the fifth quarter in which homeowners have put money into their homes and a reversal of the dominant trend of the past decade, when home owners largely used their properties as cash machines by re-mortgaging and then using the money to fund spending on holidays and new cars.  UK house prices bounced back in March, rising by 1.1 per cent, having fallen in February, according to the Halifax.  The latest increase pushed the annual rate of house price inflation up to 4.2 per cent from 4.5 per cent in February.  This rise means that the average home in the UK now costs £168,521, nearly £11,000 higher than a year ago. 

 

The final months of the government scrapage scheme saw an increase of 26.6 per cent in sales of new cars during March, although new registrations remain down on long-term comparisons.  The Society of Motor Manufacturers and Traders reported that 397,383 cars were registered last month, down on average sales for the month over the past decade of 418,404.  The SMMT also warned that with the scrapage scheme now ended, total sales for the year are expected to drop by about 9 per cent to 1.82 million.  The manufacturer that has gained the most from the car scrapage scheme was Hyundai, where sales rose 145 per cent year on year on the back of the success of its i10.  During the ten-month scrapage scheme its total sales were 43,992, just ahead of Ford who recorded 43,874. Neither of these two companies manufactures cars in the UK. And if all these cars had been manufactured within theUK it would have given a much more significant and lasting boost to the economy.

 

Retail sales in the euro zone fell again in February, underlining the fragility of its economic recovery. Sales were down 0.6% compared with January, more than had been expected by analysts and were down 1.1% compared with the same time last year. A lack of confidence among consumers was blamed for the fall, as the rate of unemployment in the euro zone hit 10%. Revised figures last week also showed that the euro zone’s economy failed to grow at all in the last three months of 2009. The European Union's statistics office announced that the quarter-on-quarter growth in the three months to December was zero. This was revised down from a previously reported 0.1%, according to Euro stat. Year-on-year, the economy of the 16 countries using the euro contracted by 2.2%, more than the previously estimated 2.1%. The chief economist of the Organisation for Economic Co-operation and Development (OECD), Pier Carlo Padoan, said Europe’s urgent priority was to reduce levels of government debt that had climbed during the financial crisis. This should happen before interest rates started to rise, he added. "We would not recommend that countries wait for market pressures to take action. If that happens, it means they're too late," he added. The group also said that an impediment to global growth was the high valuation of the Chinese currency. "We all know one key currency that should move from its current level and appreciate," said Mr Padoan, referring to China. 

 

China over the weekend announced a rare deficit for March, the first in six years, strengthening Beijing’s argument that the value of its currency has only a limited impact on international trade flows. If one looks at the numbers however its deficit with the USremains at very high levels and is expected to remain so. According to Societe Generale the Chinese trade gap will reach $100 billion in 2010, driven by a 45 percent climb in imports (largely of commodities) as China’s demand growth outpaces that of other major economies. This may curb purchases of U.S. Treasuries this year as its first trade deficit in 17 years leaves it with fewer dollars to invest, causing US yields to climb.  The news about the $7.2bn deficit comes at a fortuitous time forBeijing, which is under pressure particularly from the US to allow the Renminbi to appreciate a move, which would make American exports to China relatively cheaper. Timothy Geithner, US Treasury secretary, last week made an unscheduled visit to Beijingfor talks with Wang Qishan, the Chinese vice-premier responsible for economic affairs, as the US Congress has been putting pressure on the White House to force a change in China’s currency regime. Both sides have made conciliatory gestures following months of strained relations, with the US delaying a decision on China as a currency manipulator and Beijingmoving diplomatically in tandem with Washington on Iran and nuclear security. Hu Jintao, the Chinese president, is likely to discuss the Renminbi with Barack Obama when he flies to Washington for nuclear talks on Monday. China begun to prepare the ground publicly for a shift in exchange rate policy; days after the US Treasury said it would postpone a decision on whether to name China a currency manipulator.  A senior government economist told reporters in Beijing that China could widen the daily trading band for the Renminbi and allows it to resume the gradual appreciation it halted in July 2008 in response to the global credit crisis. Speaking at a press briefing organised by the Foreign Ministry, Mr Ba said the current peg was a temporary emergency measure that would be abolished at some point. In recent months, Wen Jiabao, China’s premier, and other senior officials have repeatedly said the Renminbi was not undervalued and China would not bow to foreign pressure over its value.

 

US Consumer borrowing dropped in February, after increasing for the first time in a year during the previous month, according to a government report released on Wednesday. Total consumer credit fell a seasonally adjusted $11.5 billion, an annual rate of 5.6%, to $2.448 trillion in February, the Federal Reserve reported. January's figure was upwardly revised to show an increase of $10.6 billion in total consumer borrowing from December. The Fed had previously reported a $5 billion rise in January, the first increase in a year. Economists predicted   a decline in total borrowing of $0.7 billion in February.

 

Investors selling Greek bonds pushed the yield on a two year Greek government bond nearly double that of the comparable German bond in the week as the poker game between the EU and the market suggests that we may be getting close to the point when the market asks to see the EU’s hand, as investors becoming increasingly worried about the lack of detail in the European plan to help Greece. News that Greece's industrial output fell 9.2% year on year in February while inflation jumped to 3.9% in March did not help things as did data from the Bank of Greece showing its banking system lost 8.4 billion Euros of deposits in the first two months of 2010, a 3.6 percent decline. This supports anecdotal evidence of savers moving money to foreign banks. This has meant that many leading banks have seen their liquidity ratios fall worryingly low, increasing the possibility that the banks themselves will need to borrow further funds from the government, which is itself already desperately short of capital and facing a credit crunch in the next few months as markets increasingly want higher interest payments for the increased risk of lending to them. The Greek economy is forecast to contract by 2% this year after a similar fall in 2009, but some economists now expect the decline to be sharper. On Friday Greece was downgraded by the credit ratings agency Fitch as the country's financial crisis threatened to spiral out of control. Fitch, one of the world's big three ratings agencies, lowered Greece's rating by two notches to BBB- and said the outlook on the country remains negative. Fitch's downgrade means the Greek government could have to pay even more money to fund the huge hole in its public finances. Greece needs to raise €35bn (£30bn) this year to refinance its debt, including €10bn by the end of May. The assessment by Fitch admits Greece is likely to get outside help but adds the financial backstop promised last month by the euro zone and International Monetary Fund requires more clarity. The rescue plan for Greece announced last month by the EU and the IMF was never going to reassure international money markets. It lacked crucial detail and failed to address the key issue – how to drive down Greek costs of borrowing so that the country can cut its public deficit and limit economic contraction which would raise the real value of national debt and push the country towards bankruptcy. Last week's hike in interest rates on Greek bonds from about 6.3% to 8% (before falling back to 7.35%) – the highest since the euro was introduced in 2002 – shows that investors' confidence in the current strategy is draining fast. With it is Greece's ability to refinance its maturing debt. Thursday saw another sad record, the spread or difference between Greek and German 10-year bonds increased by over half a point to 4.63%. If Athens can't raise €10.5bn by the end of May (including $5bn on the US market for "sovereign debt") then some form of bailout will become necessary. If Greece collapses and drags down the rest of the euro zone, the social costs and the political fallout will threaten the entire European experiment and that would immediately kill the tentative signs of recovery and plunge the EU into a double-dip recession. 

 

Tuesday’s UK Trade Figures are likely to show a rebound narrowing in the deficit, largely because the previous month’s numbers saw exports delayed due to the poor weather.  The overall trend is likely to confirm that exports are on the whole rising at a slower pace than imports, which, considering the weakness of the pound remains a worrying trend. The market consensus is for a deficit of £7.3bn compared to a deficit of £7.98bn in January. The non-EU trade deficit is forecast to narrow to £3.80bn from £4.83bn in January. The British Retail Consortium (BRC) sales monitor for March is also released on Tuesday and is expected to show a fall in spending after recent rises. Analysts expect an easing in sales growth from 2.2% to about 1.8%.

 

In the US, first quarter profit reports will start pouring in this week, and results are expected to be very strong. Cost-cutting and easy comparisons against an abysmal first quarter of 2009 are expected to boost matters, but investors will be watching closely to see if revenues are growing. Company outlooks will also be critical bearing on mind that stock valuations already look to be pricing in a flawless recovery. Earnings are currently expected to have risen almost 37% versus the first quarter of 2009,according to Thomson Reuters, while revenues are expected to have risen 10%, indicating the importance of cost cutting in boosting earnings. Alcoa begins the quarterly reporting period, as is traditional, when it reports results after the start of trading on Monday. March retail sales on Wednesday are expected to have risen 1.1% after growing 0.3% in February. On the same day The Consumer Price Index (CPI), a measure of consumer inflation, is expected to have risen 0.1% in March versus a flat reading in February. Core CPI which excludes volatile food and energy prices is expected to have risen 0.1%, after moving up 0.1% in February. On Friday, Housing starts and building permits are due with housing starts forecast to have risen to 610,000 in March from a 575,000 annual rate. Building permits, a measure of builder confidence, are expected to have fallen to an annualised rate of 626,000 units from a 637,000 rate of units in the previous month. The April Consumer Sentiment index from the University ofMichigan on Friday is expected to have improved to 75.0 from 73.6 in March. 

 

On Wednesday OECD chief economist Pier Carlo Padoan warned the Bank of England that it may be forced to raise rates 'a little earlier than elsewhere because of inflation and on Friday U.K. factory-gate prices increased to their highest monthly rate in almost two years in March as commodity prices soared. Output producer prices moved up 0.9% on the month in March, much stronger than a 0.3% gain in February taking them to their largest monthly increase since May 2008. In annual terms, output prices increased 5.0%, sharply higher than 4.2% in February and the joint-highest rate of inflation since October 2008. The gains in producer prices were significantly stronger than expected with output prices forecast to rise 0.3% on the month and 4.3% on the year. The main drivers behind the gains were increases in the prices of petroleum products, scrap metals and chemical products.  Equity markets over the week have been moving higher on rising commodity prices, with the oil price hitting $87 a barrel, an increase of nearly 70 per cent on a year ago.  One poorer piece of news in the week that also reflects the decline in sterling and the rise in the oil price was the fact that the average price for a litre of petrol moved above £1.20, breaching its previous peak of July 2008.  With oil prices forecast to increase to $100 a barrel in the next couple of years (possibly sooner if global recovery really takes off in the coming year) and sterling likely to continue to remain weak, the prospects of another 20p on a litre looks an almost certain.  Not only are oil prices going to push up the price of petrol but inflationary pressures around the world are rising strongly.  An agreement reached by Asian steel mills in recent weeks has seen an almost 90 per cent increase in the price of iron ore for the next quarter.  Annual thermal coal contract prices have also increased by 40 per cent following settlements recently between many leading extractors and users.  The surge in annual coal contract prices comes, as China has become an importer of thermal coal for the first time.  Beijing bought 80 million tonnes of thermal coal last year, a large turnaround from net exports of 70 million tonnes in 2005.  India’s strong consumption is also helping to squeeze the market, with the nation importing about 70 million tonnes of thermal coal this year, double the amount it bought overseas in 2007. 

In the week Guy Hands, Chairman of firm Terra Firma and one of Britain’s most successful private equity bosses, warned that Britain can look forward to a painful decade of unemployment, inflation and social unrest as the country unwinds from its huge debts incurred during the boom.  He believes the entrepreneurs of his generation who grew rich in the boom years will have to get used to the new environment, saying “Many of the familiar relationships of the past 30 years have been wiped clean by the financial collapse”.  Hands himself, has suffered in the credit crunch.  The Debt loaded EMI acquisition of 2007 has already breached banking covenants and is desperately seeking further finance. If this is not solved in the next few weeks then its lenders, led by Citibank, may take control of EMI. With the more positive UK economic backdrop, sceptics may well argue that it is no coincidence that a general election starting pistol has been fired and that the uplifting, feel good factor has been engineered ahead of what is likely to be a much more austere period later on as the new incoming government tries to address excessive public spending, which is simply un-maintainable at its current levels. Inflationary pressures are not just growing in the UK, but globally, and whilst I believe a period of weaker prices is likely, ultimately, the Western world will want to inflate its way out of the current debt mountain and this should be a significant factor in everybody’s financial planning. Whilst politicians’ rhetoric continues to be upbeat, a more downbeat economic backdrop I believe is likely to emerge after the election, when reality takes over from fiction. A country can support very high levels of dept as a percentage of GDP for many years, but the equilibrium is fragile. It relies on growth staying strong and interest rates stay low.  As Greece is learning, a recession that leads to a loss of investor confidence can very quickly lead to a downward vortex of despair. Whoever the next government are, faced with the immensity of the fiscal challenges ahead they will be forced to slaughter at least some sacred cows which, on the electoral trail, they have sworn to retain.