Where to turn next?

In my last Blog entry on 4th November, I warned that (aside from the Eurozone issues) weak prospects for economic growth would keep any Equities rally in check. In the last three weeks, the FTSE has fallen by 6%, the Dow Jones Industrials has dropped by 4% and the Nikkei has retraced 5.5%.

The main catalysts behind the poor month are the usual suspects. The Eurozone debt problem lurches from one flashpoint to another, with Spain now in the spotlight. In the US, the bi-partisan "super committee" convened to tackle the massive US deficit had failed to reach an agreement, which will now lead to automatic cutbacks in budget cuts, due to start in 2013. Indeed, US growth for Q3 2011 has been downgraded from 2.5% to 2%, with similar downwards revisions expected for Q4. Even China has seen its manufacturing fall to a 32 month low.

In short, it feels like August all over again. With most asset classes (with the notable exception of UK Gilts, German Bunds and US Treasuries plus a handful of others) moving lower, what should investors do in conditions such as these?

Firstly, investors should remain calm, and remember that all investment is a medium or long term process.

Markets will inevitably fluctuate over the course of an investment cycle, and staying the course with a chosen strategy is arguably one of the safest bets. However, an added element to consider is that "risk free" returns - i.e. cash - are so poor, running for the relatively safety of cash is not really an option either. Certainly in the UK, there are very few if any deposit accounts that will pay a return to keep up with Retail Price Inflation (currently 5%), therefore cash returns are (by and large) condemned to loose value in "real" terms.

In these conditions, I continue to favour quality Corporate Bonds, selected sovereigns (particularly UK Index Linked Gilts) and Gold. However, should Equities fall much further from here, say by 10% or more, then on a fundamental basis,  selected positions will begin to look attractive, particularly defensive industries such as food retail and utilities.

As ever, seek professional advice from a suitably qualified person before taking any investment decisions.

Buying time or a real solution?

The announcement of a comprehensive list of actions at the EU summit on 26^th October has been warmly greeted by the market, with a real sense of optimism that the announcement could find a solution to the European sovereign debt crisis that has dogged markets for the best part of eighteen months.

The mere fact that the EU leaders appear to have reached a consensus does provide some cheer, as for many months it did not appear that a common view was shared. However, as ever, the devil is in the detail. The first measure announced was the size of the European Financial Stability Fund (a special vehicle financed by EU members and designed to provide assistance to its members as necessary) is to be increased to €1tn. This should allow sufficient capital to reduce lending costs and provide liquidity, but would fall short in the event that both Italy and Spain were about to default.  Secondly, bondholders in Greek Government debt (mainly other European banks) are to take a 50% “haircut” (loss) on the value of their Bonds. This will ease the immediate pressure on Greece a little and potentially could reduce their debt levels to 120% of GDP by 2020. However, the country still has a long road ahead, with austerity measures likely to continue for many years, and will also involve the privatisation of some Greek institutions.  Any deviation could still ultimately lead to Greece defaulting on its’ debts.

Additional measures announced include a requirement for European banks to bolster their cash reserves by mid 2012, with initial estimates suggesting a total of €106bn will need to be raised. The European Banking Authority has recommended that Banks unable to meet the criteria withhold bonuses and do not declare dividends, before seeking fresh capital from Governments. Any further bank bailouts would, of course, prove unpopular, but may be necessary.

However, the deal is not done, as the Greek Government had announced that it intended to hold a referendum on the bailout package in January. Given the unpopularity of the austerity measures, it is quite possible that any vote would go against the package, sending the crisis back to square one. However, it now appears that the referendum has been shelved for the time being, as a compromise between the two main Greek political parties. 

Whilst providing a short term fix, the deal still does not tackle the fundamental issue that Eurozone growth is negligible at present, and unless the prospects for growth improve rapidly, other Eurozone nations (other than Greece) with large debt to GDP ratios, such as Italy, Spain and Portugal, will continue to face the same issues. In short, debt levels in these nations are increasing still, and until this reverses, the problem will not go away. Indeed, market attention is likely to refocus on the likes of Italy and Spain, which are much larger economies than Greece, and in that respect, a bigger problem.

The debt crisis has also provided something of a “smoke screen” to cover the other crucial factor, that the US, UK and Eurozone economies are perilously close to fall back into recession. Whilst initial market reaction has been positive, and I do expect Equities to be more positive than of late, weak economic data flowing through for the final quarter of 2011 should keep any substantial Equities rally in check.

The Quest for Income

Since March 2009, the Bank of England has anchored the minimum Lending (or “Base”) Rate at just 0.5%, which is unprecedented in two ways. Firstly, it is first time in 300 years that the Base Rate has been set at such an ultra-low level. Secondly, it is highly unusual for Base Rates to stay at the same level for such an extended period. Furthermore, the Base Rate is set to stay where it is for some time to come.

Aside from the historic perspective, the knock-on effect on cash deposit interest rates has dealt a vicious blow to anyone who relies on income from savings to supplement other income, such as Pensions. In a double whammy, Retail Price Inflation nudged past 5% last month, meaning that the real value of savings is being eroded. The average branch based instant access account now pays less than 1% per annum gross interest, and whilst this rate can be improved upon by using internet or phone accounts, you will be hard pressed to find any instant access account that pays more than 3% per annum. Indeed, due to the fact that Banks and Building Societies have had to pay more to borrow money over recent weeks (as a result of the Eurozone debt crisis) deposit interest rates have been steadily falling even further since the Summer.

But what can investors do to increase their income? Firstly, using Cash Individual Savings Accounts (or ISAs) will increase the income stream for basic and higher rate taxpayers, as then interest will be paid without deduction of income tax at source (non taxpayers will see no advantage as they should not pay any income tax on their savings in any event). But Cash ISA rates are little better than ordinary deposit rates, and the annual allowance limit, currently £5,340 in the 2011-12 Tax Year, is restrictive

Beyond the Cash ISA, for all but the most risk averse of investors, there remains value in Fixed Interest Securities as a way of achieving an improved income stream from a capital sum. Fixed Interest securities are debt issued by either Governments or Companies as a way of them raising finance through the markets. They come in many different guises, but the most common for domestic investors are Corporate Bonds (debt issued by Companies) and Gilts (debt issued by the UK Government).  Fixed Interest Securities (as the name suggests) tend to pay a fixed income for a fixed period, when the issue is redeemed at a pre-determined price (usually 100p), subject to the financial ability of the company to repay. In the unusual event that a Bond issuer cannot repay, this is known as a “default”, which could lead to a percentage loss on the capital value (colloquially known as a “haircut”). In the event of a default occurring, Bond holders rank ahead of ordinary shareholders in the queue to receive their capital.

There is a wide range of Corporate Bonds in circulation, issued by a vast array of different companies. Lending money to the most financially secure will tend to yield a lower income than lending to a less secure company. This is the trade-off between risk and reward, as investors in lower graded debt, with a higher chance of default, demand a higher rate of interest to compensate for the risk.

Despite the economic conditions, default rates remain at very low levels, particularly in the higher graded Bonds. According to research carried out by M&G, default rates on investment grade debt (i.e. BBB+ or better) stands at between 1% and 3%, and Higher yielding debt (i.e. BB) at 9.6%. Default rates can be minimised further by investing in a collective investment, which holds a range of Bond investments, so as to obtain an adequate spread and diversification across a range of issuers.

At the lower end of the risk scale, UK Gilts (issued by the UK Government) yield between 2% and 3% gross per annum. Slightly more risky than Gilts, Investment Grade Corporate Bonds (i.e. those rated BBB+ or better) yield between 4% and 5% gross per annum (and in my opinion represent the “sweet spot” at present between risk and reward). Higher Yield issues yield 6% gross per annum or better. These compare favourably to cash interest rates at present, but it is important to bear in mind the default risk; in addition, a further risk inherent with fixed interest investments is that they tend to become less attractive in periods when interest rates rise rapidly. However, in the current climate, this appears a remote possibility – our current estimate is for the Base Rate to stay on hold until the end of 2012 - but in the longer term, this factor should be borne in mind.

Corporate Bond prices did suffer a little during the late Summer market malaise, but have begun to rebound over the last few weeks. They remain an attractive investment proposition in the medium term, and certainly give an option to boost income in this unusual period when cash returns are so unattractive.

As ever, before committing to any investment strategy, you should seek impartial advice from a qualified investment professional, and any decision should take into account your personal circumstances and tolerance to risk.

A bolt out of the blue?

With Equities falling once again today (Tuesday) and the FTSE close to breaching new lows for the year, you don't have to look very far to find out the reason why. As has been the norm for the best part of the last eighteen months, worries over Eurozone sovereign debt continue to dominate proceedings. Greece has (unsurprisingly) admitted it is unlikely to be able to meet the strict austerity criteria ordered by the other EU states, and politicians and central bankers seem unable to find a consensus from where we can move forward.

To quote William Hague, "the Euro is a burning building with no exits".

It is going to take some momentus policy decisions between now and November to try and stem the tide, as falling stock markets will do nothing to help the battle to save the single currency.

One such decision could be that the Bank of England cut base rates once again - to just 0.25% - and rumours have been circulating the market that this could be on the table when the MPC (chaired by Mervyn King) announce rates this Thursday.  It has been suggested that this could be used either in conjunction with, or instead of, an increase in the BoE's Quantitative Easing programme. Interestingly, a number of leading banks and building societies have been cutting the already meagre deposit rates over recent weeks....maybe there is something in this rumour after all?

It is important to note that this would, once again, be an unprecedented move by the BoE. And this cut would leave no room for any further easing. It would certainly be a bold move, and one that could quite easily add to the panic rather than calm market nerves. 

The European Central Bank also meet on Thursday. An overdue reverse of the rather bizarre hikes in the ECB rate earlier this year could well be on the cards. Some ECB hawks will certainly be pointing to above target inflation numbers as justification for leaving rates on hold. But this is of secondary importance. Markets need some positive news, and failure by the ECB to cut rates would heap more adverse sentiment on an already edgy and depressed market.

Thursday is yet another crucial day in how the rest of the year will pan out.

Between a rock and a hard place

"Significant Downside Risks"  were the three key words from last night's Federal Reserve Open Market Committee statement that investors appear to focusing on, despite the headline announcement that Federal Reserve announcing a purchase programme of longer dated Treasury securities, with a corresponding sale of shorter date securities. Dubbed "The Twist", this manoeuvre is designed to reduce the cost of longer term borrowing, with the hope of stimulating demand in the housing market by reducing the burden on mortgage payers.

The Fed's action was expected by the market; however, whether it will have any impact remains to be seen. The decision was carried on a majority vote only, and three dissenters within the ten member committee indicates that both on Capitol Hill and within the Federal Reserve itself, there remains indecision as to the best course of action to stimulate demand, reduce unemployment and boost the flagging housing market.

But the Fed's statement, in particular the language used, was deeply negative. There does seem to be little light at the end of tunnel right now, with the Fed's statement coming on top of the International Monetary Fund's downgrading of growth expectations for the US, UK and Eurozone on Tuesday.

I have been expecting a further weak patch for most Western economies for some time, and in my view, policymakers now have a real fight on their hands to keep the US, UK, Eurozone from plunging into a double dip recession. Equities markets remain nervous and I believe that a Greek default and the potential fallout is far from priced in. If Equities markets fall further this will only exacerbate the problem facing Central Banks.

The Federal Reserve and Bank of England face a difficult dilemna. They have both eased policy by reducing interest rates as far as they can go, and embarked on asset purchase programmes to promote lending and stabilise the monetary system. These were put in place in 2008/9 and staved off a potentially crippling seizure in the banking system. Fast forward two years, and banks again face a liquidity crisis, amdist a sea of downgrades from credit rating agencies. Should the Fed and BoE act again, and invoke another round of Quantitative Easing? It is a difficult call. They are both fast running out of ammo, and the move could spark panic rather than calm fears. Who would be a central banker? In my view, they are stuck between a rock and a hard place.

How not to trade....

In this blog, I try very hard to stay politically neutral, and I endeavour to report the facts rather than opinion clouded by any political leaning. Of course, Government policies affect the economic backdrop in which investment markets operate, and politics and markets are intrinsically linked.

However, at the M&G "Meet the Managers" Conference, speaker Steven Andrew presented a slide showing a graph of the price of Gold and overlayed a marker as to when Gordon Brown - then Chancellor of the Exchequer - decided to sell 1/2 of the UK's Gold reserves. Cue much derision from the massed audience.

I decided to dig a bit deeper, and discovered that Brown sold the Gold in a series of auctions between 1999 and 2002 - the sheer quantity sold meant that the sales had to be "drip fed" through the market to avoid destabilising the price of Gold too much. The average price obtained was $280 an ounce. The monies raised were used to diversify into foreign exchange, particularly the Euro.

The spot price of Gold closed yesterday at $1833 an ounce some 654% higher than the average price achieved between 1999 and 2002. If Brown had of hung on, and sold now, the UK would be £13 billion richer.

And the trade could look even worse, as the fundamentals look in place for Gold to move towards the $2000 an ounce mark in the next few months. There is always the risk that Gold could retrace given its' stellar run since 2008, but market momentum is certainly in its' favour at present.

Bonds set to outperform once again

Over the past two years, Corporate Bonds - debt issued by companies - have been one of the best performing asset classes, and one that I have used extensively in client investment portfolios since 2008. They are naturally defensive investments, that have become increasingly attractive as the Base Rate freeze at 0.5% becomes ever longer.

I attended the M&G "Meet the Managers" Conference in London yesterday, and after listening to the conference, I managed to grab a quick chat with Richard Woolnough, manager of the M&G Corporate and Strategic Corporate Bond funds, and one of the most respected managers in the industry. I asked Richard what the prospects for the next twelve months were, particularly in terms of credit risk and rising default rates that could occur if we returned to recessionary conditions.

Richard's contention is that default rates - that is to say those companies that fail to repay their debt - will remain low, as many of the weakest companies have already fallen by the wayside during the 2008/9 recession, and he believes that Corporate Bond holders are being compensated well for the risk. I agree, and as Base Rates are unlikely to increase before 2013 and corporate profits remain relatively stable, I expect Corporate Bonds to continue to be an attractive investment.

Another factor to consider is that research indicates that companies are not looking to raise capital at this time, so issuance of new Bond issues is low. This could well increase the "scarcity" factor, which may further support Bond prices.

As ever, before taking any investment decision, always take independent professional advice tailored to your circumstances.

Hole lotta trouble if Ben doesn't deliver

Global Equities markets have been more bouyant over the past trading sessions as attention switches to Fed Chairman Ben Bernanke and other Central Bankers' annual get together at Jackson Hole in Wyoming. The reason that this conference is so important is that last year set a precedent, in that QE2 - round two of the Fed's Quantitative Easing programme - was announced, and markets are clinging to the hope that more stimulus will be signalled this year.

In simple terms, Quantitative Easing (or QE for short) is a monetary policy tool which is used when all usual stimulus measures, such as lowering of interest rates, have been exhausted. It involves the printing of money which is then used to purchase assets (in the case of the US QE programme, US Treasury Bonds). The effect is to reduce the yield on these Bonds, and as these are often held by banks, to increase banks' liquidity to lend to business and consumers. The first wave of QE was introduced shortly after the Lehman Brothers collapse in 2008 and the second round was put into action last year.

A major talking point is whether QE3 is necessary or even welcome. The previous rounds of QE1 and QE2 lowered the yield on Treasury Bonds, so much so that the yield on the 10 year note briefly touched 2% last week.  In other words, lend the US Government your money for 10 years and they will pay you 2% per annum until 2021. Banks certainly do not need more liquidity at this time - they are simply hoarding it as households and businesses are in a mood to deleverage and pay back existing debts rather than take on new loans. It also failed to stimulate any response in the limp US housing market. QE also introduces inflation, which continues to sit above the Fed's target, and reduces the spending power of household income.

That said, Bernanke will not want to disappoint a febrile market and investors expect that  "Helicopter Ben" (as Bernanke has been a little unfairly labelled) to come to the rescue once again and give markets another shot of adrenaline. The absence of any meaningful announcement at Jackson Hole will be seen as a failure, and may send markets lower once again. Any respite in the markets may be short-lived as QE at this time would, in my opinion, be ineffective at bolstering economic growth or creating jobs, which the US needs to build a firm foundation for recovery.

The search for growth

Markets have lurched from one crisis to the next over the last few weeks, and the unexpectedly weak German GDP data on Tuesday did leave to alleviate the unease.

For a country that has posted impressive growth data over the last two years, bucking the global downturn, growth of just 0.1% between April and June is something of a major shock.

Germany is not alone in declaring that the second quarter of 2011 was tough going. French GDP was flat and for the two countries that are seen as being the main protagonists in ensuring the continuation of the Eurozone project, it is more than a little disconcerting.

What it does, however, do is paint the UK's GDP growth of 0.2% for the same period in a better light. That said, 0.2% growth remains painfully anaemic and perilously close to sliding back towards recession once again. And it appears that the UK consumer is not willing to play their part. UK retail sales nudged forward by 0.2% in July, with spending on big ticket items down over 4% year on year. It is hardly surprising given the pressure household incomes are under, plus the appetite for consumers splurging on the credit cards continues to abate

Just to compound a bleak few days on the economic data front, US weekly unemployment data showed an increase in claimants, and US inflation numbers surprised to the upside.

At the time of writing, the FTSE is down nearly 4% and has given back one half of the gains made since the market dive bombed almost 1000 points in the beginning of August. Where does one head in markets like this? Well, Gold is up over $20 an ounce on the day and money continues to flood to UK Gilts, with the 10 year yield now down to just 2.4%.

It appears we will be staying in "risk off" mode for some time to come.

The Bear returns in Au-gust

With the FTSE 100 touching 4800 during early trade on Tuesday, a new bear market was confirmed, as the leading index of shares had fallen over 20% from the recent highs. Stocks around the globe had been pummelled over concerns that US growth would falter, the S&P downgrade of the US to AA+, lingering worries over Italian and Spanish debt, and to add the icing on the cake, rumours abound that France is also to lose its' AAA rating. The French Government have been quick to denounce the rumours, and indeed S&P and Moodys have confirmed the French economy remains AAA. However, the damage is apparent as leading European bank shares crumbled to their lowest level since 2008.

Even the Federal Reserve's extraordinary act of clairvoyance on Tuesday night , where they stated that the Fed Funds rate will remain at 0.25% for at least until Mid 2013, was not sufficient to calm the market's fears.

Through all the volatility and pessimism, the key to remember is that we are in August, a time when many traders are away from their desks. Whilst trading volumes have been modest, many commentators are speculating that much of the volatility is being driven by computerised programme orders and stop losses. This can perhaps explain some of the wild intra-day swings we have been experiencing, but one certainly cannot deny that the risks in the market have increased substantially over the past week. It is possible that markets will find a floor at around current levels stage a modest rebound, as technical indicators suggest most global indices have moved into "oversold" positions. However, until the negative newsflow abates, any respite may be short lived.

Meanwhile, Gold continues its' stellar run, turning August into Au-gust. Gold burst through $1800 an ounce yesterday, and is homing in on our long term target of $2000 an ounce.

No need to panic....just yet

Whilst its' timing was questionable, Standard & Poors bloodied the nose of the Obama Administration at 8.00pm Eastern time on Friday night, by stripping the USA of its' coveted AAA rating. Citing the political wrangling before the increase to the debt ceiling Tuesday last, and the lack of credible debt reduction measures.

To continue the boxing metaphors, the move is akin to a standing eight count. Both Moody's and Fitch have retained the highest grade for US government debt, and S&P were at pains to point out that short dated US debt continues to be rated at AAA.

But what effect will this have? Well, in practice, very little at this stage. Although China were quick to chastise America's "addiction to debt", they remain the largest holders of US Treasury Bonds. Indeed, during trade in the Far East overnight, T-Bond yields moved lower (prices rose). 

S&P now only rates 15 countries at AAA, including the UK and the Isle of Man. The UK have avoided any such downgrade by taking the rather uncomfortable but necessary austerity measures since the Coalition took power in 2010. But we are not out of the woods by any means and our efforts at defecit reduction will be closely monitored.

On top of the S&P downgrade, the surge in Italian Bond yields caused fresh concern over the weekend, sufficient for the G7 nations to put forward a statement effectively saying that they stand ready to support the global economy. Heady stuff. The ECB will begin a programme of buying Italian and Spanish Bonds today in an attempt to reduce the yield on both from 6% to a more liveable 5%.

Equities markets reaction has been fairly muted although they are still reeling from the large slides in the last five trading days. Some commentators have been quick to declare that the bad news is "in the price", although this is not a view that I share. The loss of the AAA rating for the US will certainly deal a psychological blow, and a "double dip" recession is becoming more likely by the day. Meanwhile, we may well be seeing the twilight days of the Euro in its' present form.

The safe haven that is Gold marches onwards towards $2000 an ounce, bursting through the $1700 barrier in Asian trade. A useful insurance in any investment strategy, it is proving' its worth as such once again.

So whilst I would certainly counsel anyone not to panic, the global economic picture is changing rapidly. Central Bankers and Governments will undoubtedly face some tough decisions over the coming weeks, and the price of getting it wrong could well be severe.

What a difference a week makes...

Following the agreement reached by Democrats and Republicans to raise the debt ceiling by up to $2tn on Tuesday, global stock markets have gone into a tailspin. At the time of writing, both the FTSE100 and S&P500 have lost over 7% during the last week, which is quite a correction.

I am not at all surprised by the markets' reaction. The wranglings over the debt ceiling were simply distracting investors away from a suite of very poor economic prints coming out of the US over the last month. Growth has stalled, consumers are keeping their dollar bills in their pockets, manufacturing has weakened and unemployment has increased. Indeed, jobs will be in the spotlight today as Non Farm Payroll data should prove disappointing. With the debt ceiling problem put aside for another day, investors have been compelled to accept that the US economic recovery is going to be weak for some time to come, and may even lurch back into recession.

If that wasn't enough, Italian and Spanish Bond yields continue to climb as bondholders demand higher compensation for holding sovereign debt. A default of either or both would be an event of seismic proportions and I currently sit in the camp that believes that both are "too big to fail" -however, remember that was also said about Lehman Brothers.

Safe havens during this turbulence have been UK Gilts, US Treasuries, quality Corporate Bonds and Gold. Advisory Client portfolios have been positioned in these areas for some time, and have been mostly unchanged during the last week. With this shakeout set to rumble on for a little while yet, caution remains the watchword.

Down to the Wire

With the deadline of August 2nd fast approaching, a deal to increase the US debt ceiling appears a long way off, with Democrats and Republicans lawmakers still arguing over the size of speeds of spending cuts and tax increases.

Under congressional rules, the upper debt limit of $14.3tn will be breached by August 2nd, and without an increase, the US could potentially default on debt repayments. The repercussions of such a move would be catastrophic, leading to widespread panic across Equities and Bond markets and probably triggering a second global recession in four years.

Democrats are arguing for a larger increase in the debt ceiling, which will give more time for the economy to recover, whilst protecting social support programmes, and increase in taxation. Republicans are, by and large, also willing to allow the debt ceiling to increase but only by a small amount, which will only alleviate the problem for a few months. In exchange, Republicans would like to see a hefty reduction in public spending and fewer tax increases. A small number of hardline "Tea Party" members are taking the stance that they will not vote for any increase in the ceiling whatsoever.

Without the ability to increase their borrowing beyond 2nd August, the US would quickly be unable to meet interest and principal on its Treasury Bonds, which would trigger a default, quickly followed by the reduction or cessation of social security payments, which would cause widespread panic. The debt rating agencies, S&P and Moody's, are content to maintain the coveted "AAA" rating on US debt for the time being - however, should a deal not be reached, this will quickly be lost.

I take the stance that a deal WILL be reached, and that the current wrangling is little more than political point scoring. However, the deal will be something akin to a sticking plaster over a gaping wound, merely pushing the problem into next year when tough decisions will need to be made once again.

In the meantime, the safe haven that is Gold continues to march northward, pushing through $1625 an ounce on Wednesday.

A Greek Tragedy

Since 2010, the ongoing problem of Greece’s sovereign debt has cast a cloud over the Eurozone. Following the global financial crisis of 2008, Greece’s debt levels began to grow at an alarming rate (as seen in the chart opposite) which cumulated in Greece formally asking the EU/IMF for assistance in April 2010, via an instalment of €45bn and a repayment of €8.5bn in respect of Greek Government debt which was due for repayment. This caused Greece’s credit rating to be cut to “junk” status by Standard & Poors, citing increased fears that the Greek Government may default. This, of course, exacerbated the problem, as Greek Bond yields rose substantially.

In exchange for the bailout funds, the Greek authorities imposed austerity measures which, understandably, did not go down well with the Greek population. These includes large increases in direct taxation, and public sector pay cuts. Following a damning EU-IMF audit earlier this year, which showed that the austerity measures, where implemented, had done very little to improve the situation, S&P lowered the Greek credit rating further to “CCC”, which is the lowest of any global sovereign debt. The latest bailout request came after the dissolution of the Greek Parliament, and concerns that Greece would not be able to meet its’ obligations for payment due on 15^th July. A Bill bringing in additional austerity measures passed narrowly though the Greek Parliament on 29^th June, and as a result, the EU and IMF will forward the next instalment of a £98bn loan.

What is clear that this is simply a “stop gap” aimed at avoiding an immediate crisis. Until Greece can show real prospects of economic growth and also show that the austerity measures – including a freeze on public sector pay, rapid increase in the pension age, a rise in VAT, and most importantly a clampdown on tax evasion – are having a meaningful effect, all the EU have done is kick the can down the road until the next crisis point. At least a default – where Greece fails to repay its’ interest or capital on its’ sovereign debt – has been avoided for now, but many analysts view the EU monies propping up the Greek economy as a default in all but name.

Indeed, the fact that Greece has been given another shot of adrenaline has also switched investors’ attention to other EU states in poor financial health. This week, all eyes are on Italy, where 10 year Bond yields have surged to 5.4%, over concerns that a number of Italian banks would fail impending stress tests. In the past six months, both Ireland and Portugal have received bailouts, after suffering dramatic increases in their Government Bond yields, which leads to the interest payments on sovereign debt to become unsustainable.

This “contagion” to other EU states is unlikely to stop any time soon. And whilst it is possible to delay a default and buy time for countries such as Greece, Ireland and Portugal, Spain and Italy are a whole different proposition. A default – either actual or technical – of either of these two giants would almost certainly bring the whole Euro zone project into question. And don’t forget the USA has its’ own issues, as they have hit their technical debt ceiling of $14.3 trillion, and without the approval of Congress by 2^nd August, the US would face an economic catastrophe. I do not doubt that a fresh law will be passed in time to increase the limit before this date; however, the sheer scale of US Sovereign debt is truly frightening. Whilst Equities markets have been running along their own agenda over the past twelve months, it is only a matter of time before markets will be severely jolted by the reality of the debt crisis facing EU nations and the US. I continue to recommend to clients that they adopt a cautious approach and keep a limit on exposure to risk assets, including Equities.

A Crisis of Confidence, or something bigger?

You may have caught the recent news headlines that a number of leading retailers have either gone into administration or embarked in radical restructuring. Firstly, wine merchants Oddbins moved into administration in March, shortly followed by Focus DIY. During June, long standing furniture retailer Habitat, home improvement firm HomeForm (whose brands include Möben Kitchens,  Sharps Bedrooms and Dolphin Bathrooms) and fashion house Jane Norman and department store T J Hughes have all entered administration. More recently, chocolatier Thorntons and Carpetright have announced a radical plan of store closures. This week, Thomas Cook has warned of weak domestic demand for overseas holidays.

Each company has told of the same story – shoppers simply aren’t spending as much as they used to, and overheads (in terms of fixed costs) are increasing. In the case of HomeForm, Focus DIY and Carpetright, the weak housing market has led to a reduction in volume of sales.

A key measure of Consumer Confidence is published by Nationwide each month, and recent data has indicated that confidence amongst consumers remain low. Indeed, the survey for May 2011 showed confidence levels about the same as they were in the midst of the credit crunch in 2008.

As we have mentioned previously, consumers have been squeezed from all sides over the last three years. Unemployment has risen sharply together with a decrease in job security generally. For those in employment, wage inflation has been minimal. Against this backdrop of static incomes, large increases in the costs of petrol and diesel, gas and electricity bills, higher food prices, more expensive clothing and hikes in car insurance and public transport have all combined to reduce the discretionary spending power of consumers. Undoubtedly, the VAT increase from 17.5% to 20% on January 4^th has not helped either. Even the reduction of base rates to 300 year lows, which has led to cheaper mortgages for many on variable or tracker rates, has done little to help ailing retail sales and consumer confidence.

A further consideration is the consumer’s ability – and willingness – to borrow to fund major purchases.  Much of the spending on big ticket items over the last ten years has been driven by borrowing, particularly through Mortgage Equity Withdrawal (MEW), where homeowners used their house like a “cash machine”. This was fine all the time house prices were rising, however with prices gently falling recently, this is no longer an option for many, together with the stricter lending criteria from banks and other lenders, whose fingers are still smouldering following the much talked about credit crunch of three years ago.

One could argue that once the economic outlook improves (which is the most likely scenario in the next two to three years although growth is likely to remain subdued) consumer confidence will rise along with shoppers’ spending power. However, I wonder whether a bigger change is occurring in the nation’s psyche?  Following the binge during the “Noughties”, shoppers have become far more price-conscious, and this has been witnessed by the rise of discount retailers such as Primark, Matalan, Aldi and Lidl. This is a trend I see continuing. Similarly, top end retailers, such as John Lewis, continue to post impressive results, as the mass affluent are least affected by the weak economic conditions. But for those retailers caught in the overcrowded middle, the prospects are not great.

The announcements of T J Hughes, HomeForm, Jane Norman and Habitat come at the end of a quarter, when rental payments typically become due. One has to wonder how many other retailers will come find themselves in the same situation at the end of September?

More retailers hit the wall

Following my last journal entry, three more high profile retailers have entered administration. Furniture store Habitat, Homeform (the owners of Moben Kitchens, Sharps Bedrooms and Dolphin Bathrooms) and fashion house Jane Norman have all fallen during the past week, with all citing poor sales and weak consumer demand as the culprit.

All three worked in challenging and competitive markets, and one could conceivably argue that the malaise on the High Street is simply weeding out some of the weaker retailers, whose long term prospects were not that great, whilst the stronger retailers just get stronger.

However, one only needs to look at recent sales figures from Argos / Homebase, and announcements today by Carpetright and Thorntons  - who are both closing stores -  to see that the poor sales and weak growth is spread right across a wide range of retailers - even giant Tesco's UK like-for-like sales were flat for the first quarter of 2011.

The prospects for the remainder of 2011 remain bleak - hard pressed consumers, hit by rising fuel, energy and food prices and poor job security - are putting major purchases on hold, and judging by recent trends, also paring back on the little luxuries and concentrating on the essentials. Until confidence improves, one has to wonder how many more retailers will soon follow this week's casualties

Dark Clouds gathering once again?

I have been gently warning clients over the past year or so that we may well see a return to recession, both in the UK and US. Whilst both economies have managed, thus far, to avoid the so-called "Double Dip", growth seen in the first quarter of 2011 has been anaemic at best.  But it was growth none the less and had given comfort to investors that the worst was behind us.

However, recent data from both sides of the pond have suggested that we may yet be sucked back into the recessionary abyss.

US unemployment had been showing healthy signs of improvement over the first few months of 2011, but May's print fell far short of expectation, and the unemployment rate, which had been falling, nudged back up to 9.1%.

Closer to home, this morning's British Retail Consortium data for May showed UK retail sales falling 2.1% from the same month a year ago. This is clearly worrying data, and shows the fragile position the UK economy is in. Consumers, battered from inflation, weak wage growth or fears of redundancy, are simply not prepared to splash out on the big ticket items. We expect retail sales to remain poor through the rest of 2011, and one wonders how many of the straggling retailers will follow Focus DIY and Oddbins and fall by the wayside.

Actions speak louder than words

The Bank of England inflation report announced Wednesday made for uncomfortable reading, as prospects for economic growth have again been downgraded, and inflation is expected to remain elevated for longer.

In the report, the Bank indicates that inflation will sail past 5% later this year, citing energy costs as being a major contributor. One could be forgiven for not remembering that the Bank has a mandate to keep inflation at or around 2%, and in ordinary course of events, interest rates would have risen substantially to head off this threat. But these are far from ordinary conditions.

One could construe Mr King's comments as being moderately hawkish. But actions speak louder than words. Hinting that interest rates will increase is one thing, actually raising them is another. With growth faltering once again, weak consumer confidence and a stagnating housing market, it would be brave call by the Bank to raise interest rates any time this year 

Bootle says no rate rise before 2013

Noted Economist Roger Bootle has an enviable track record of getting the big calls right. In his latest Quarterly review Link Bootle has predicted that UK base rates will not rise before 2013, citing a weak recovery and squeezed household incomes as two reasons why the Bank of England will be in rush to raise interest rates from the current historic low of 1%.

I tend to agree with Mr Bootle that the Bank of England would be unwise to increase Base Rates until the recovery is based on more secure footings, and unemployment has levelled off. The price increases in Oil, food and other raw materials will themselves dampen demand, and wage inflation remains benign.

However, it is unclear whether the Bank of England's credibility in keeping a lid on inflation can last out for another 18 months. With CPI running at almost twice the BoE target, the pressure for them to "do something" is mounting. My own suspicion is that the Base Rate will be held for this year, but will rise, albeit very gently, during 2012. It will, however, be some years before Base Rates return to "normal" levels.

Gold marches higher as S&P downgrades the US

The price of an ounce of Gold has hit yet another record high today, breaking the $1500 an ounce barrier. Concerns over the global economic recovery and the ongoing Middle East unrest have contributed of Gold's performance of late, but market commentators are atrributing the very latest surge to S&P's downgrade of US sovereign debt on Monday. S&P, whilst re-affirming the AAA (highest) rating for the US did reduce their outlook from 'Stable' to 'Negative', which prompted a sharp slide in global markets. I expect Gold to continue to move higher over the course of this year, although the price may take a pause for breath after the latest upward movement.

Any respite for savers?

With low interest rates on the cards for some time to come, returns on cash deposit are likely to remain deeply unattractive, particularly given that the spending power of cash is being eroded at a faster rate than for some time. In reality savers are actually losing money by depositing funds in most if not all bank and building society accounts, as the net rate of interest paid is below CPI inflation. If you are going to keep substantial funds as cash, make sure you hunt around for the best rates offered by internet and telephone banks, or new accounts, which often offer incentives for a fixed period of time. Also make full use of any existing or new Cash ISA allowances (see more below). It is also worth bearing in mind that the FSCS compensation limits increased on 31^st December 2010 to £85,000 per person, per authorised Firm. (up from £50,000 per person, per authorised firm previously). For joint account holders, the limit is £170,000. The key point to remember is that this limit is per authorised firm not per account. Also watch for banks which are subsidiaries of others, or trade as a different entity – they may still come under the same authorised firm. If in doubt, check with the deposit taker.

Central Bank Conundrum

The nine member Monetary Policy Committee appear to be divided over the future direction of UK interest rates. Minutes for the February meeting showed three voted to increase rates, with Andrew Sentence recommending a 0.50% increase. Six members voted for no change, and Andrew Posen voted to add additional stimulus into the economy. On the face of things, with Consumer Price Inflation (CPI) running at 4% - double the Bank’s target – the natural reaction would be for the MPC to start increasing rates to bring inflation under control. However, the key fact to consider is that the increasing inflation is due to overseas and external factors that are beyond the Bank of England’s control. Increases in prices within the basket of goods and services that comprise the CPI index have largely been caused by hikes in the cost of raw materials (such as oil, cotton and grains) and increases in taxation (i.e. the recent VAT increase). Companies appear to have, by and large, passed on these increases to consumers. There is very little sign, if any, of wage inflation, which would be far more of a worry to policymakers.

The remit of the Monetary Policy Committee is two-fold – firstly, to aim to keep close to the CPI target of 2%. But secondly, and more importantly, to support Government policy and help meet targets for economic stability and growth. Given the fragile state of the UK economy (as seen by the contraction in the revised 4^th Quarter UK GDP data), I believe that any increase in Base Rates would serve to dampen demand and consumer confidence. However, the inflation hawks will point to the turmoil in the Middle East and the increasing oil price which may well cause inflation to climb even further above the Bank’s target. This may be enough to swing one or two Base Rate increases during the course of this year. However this will only bring the Base Rate back to 0.75% or 1% which is still very low in historic terms.

A Crude Awakening?

I mentioned in my January newsletter that rising oil prices may throw the global economic recovery off course. These comments were written before the tumultuous recent events in Tunisia, Egypt, Bahrain and Libya, which have caused Brent and West Texas Crude prices to spike higher over recent weeks, with West Texas Intermediate Crude rising from $90 a barrel to $101. Speculation that OPEC could not increase production significantly to offset a suspension or severe disruption of Libyan oil production, coupled with fears that uprisings may be felt in neighbouring countries, notably Saudi Arabia or Bahrain, have driven prices higher. Libya is Africa’s third largest oil producer and reports from the International Energy Agency suggest that Libya produced 200,000 barrels of oil less than their usual quota last month.

The surge in oil price has been clearly visible at petrol stations and has led to concern that even higher petrol prices could be on the cards if the turmoil escalates. Chancellor George Osborne has hinted that the 1p rise in fuel duty pencilled in for 1^st April will be suspended, but this will do little to aid motorists who have been hit with three increases in tax (VAT and fuel duty) so far this year.

Whilst the immediate impact on individuals and families who need to spend more at the pumps to fill up is very clear, it is important to consider that the cost of transporting goods to their final destination or point of sale will also increase. The travel industry will also be hit, with some airlines already introducing fare surcharges (although this may have a small silver lining as more people choose to take holidays in the UK, thus boosting our own tourism).

The cumulative effect may well damage the fragile economic recovery and raise inflation higher still, putting further pressure on the Bank of England to raise interest rates (of which more below). Both the British Chamber of Commerce and National Institute for Economic Research have recently reduced their GDP growth forecast for 2011, although both fall short of suggesting the UK economy could be plunged back into recession. I would tend to agree that sluggish growth remains just the most likely scenario for 2011, but the chance of a double dip recession is certainly increasing. And if the price of Brent Crude oil sticks well above the $120 a barrel level for most of the year, the downside risks to growth will only increase.