Article by Henderson Global Investors

Article by Henderson Global Investors —

Market update

By Bill McQuaker- Head of Equities

1st November 2011

It takes a lot of money to look this cheap.”
— Dolly Parton


Germany may have approved the expansion of the European Financial Stability Facility to €440 billion but equity markets remained unimpressed. The ink had barely dried on the ratification and commentators were already suggesting it was insufficient and needed to be leveraged up to €2 trillion; this before more recalcitrant countries such as Slovakia had even voted on the smaller figure. The MSCI World index fell 4.5% in September. Weighing on investors’ minds was not just the crisis in the eurozone but also the creeping deterioration in economic data. Talk of double-dip resurfaced, and, as a result, core government bonds and the US dollar benefited from a ‘flight to safety’.

Investors hoping that the US Federal Reserve would embark on a third round of quantitative easing were left disappointed that there was no outright balance sheet expansion. Instead, it opted for “Operation Twist” in which it buys longer-dated Treasuries with the proceeds of shorter-dated Treasuries to help anchor lower yields further along the maturity curve using $400 billion of its existing portfolio. Whilst helpful for the mortgage market it did not excite equity markets left bruised by the weak non-farm payrolls figure, in which zero new jobs had been created. Slightly better news came in the form of the Institute for Supply Management reporting that the non-manufacturing index had risen to 53.3 in August from 52.7 in July. The FTSE World United States index fell 2.9% in sterling terms (the fall softened by the stronger dollar, in US dollar terms the decline was 7.1%).

Economic data in Europe continued to soften, with the September composite Purchasing Managers Index (PMI) sliding from 51.5 to 49.1, the first time it had been in contraction territory since July 2009. The European Central Bank (ECB), perhaps conscious it had only raised interest rates in July, refused to cut them in September. Offering some justification for the bank’s position was news that consumer prices had risen 3.0% year-on-year, up from 2.5% the month earlier. More helpful was the additional liquidity that the ECB extended to ease funding pressures for European banks. The FTSE World Europe ex UK index fell 8.5% in sterling terms (-6.0% in euro terms).

In stark contrast to the ECB, the Bank of England appeared to be setting the stage for a resumption of quantitative easing as its minutes revealed a very dovish tone. This was despite the consumer price index edging up to 4.5% year-on-year in August. Lower PMI readings — the August manufacturing moved down to 49.0 whilst services slid to 51.1 — were among datasets that suggested the UK economy was stalling. The FTSE All-Share index fell 5.0%, with medium sized companies among the laggards.

Within Asia, Japan’s retail trade figures declined in August, down 1.7% month-on-month, but this was offset by a brighter reading in the unemployment rate, with the figure falling to 4.3% in August, the lowest since January 2009. Second quarter GDP growth was revised down to -2.1% annualised, from an earlier estimate of -1.3%. The FTSE Japan rose 3.1% in sterling terms, although was down 0.6% in yen terms. In China, the moderation in CPI annual inflation from 6.2% in August, down from 6.5% in July, gave some hope that monetary tightening would be less aggressive. The non-manufacturing PMI grew at a slower pace in August and the trade surplus narrowed to US$17.8 billion. In Australia, there was a dichotomy between Westpac consumer confidence, which rose 8.1% to 96.9%, and the NAB business confidence, which dipped to -8 in August after a +2 reading in July. The FTSE World Asia Pacific ex Japan index fell 10.0% in sterling terms.

Core government bond markets performed well over the month as the yields on the 10-year government bond fell below 2% in both the US and Germany. In the UK, the yield dipped to 2.4% and prices gained, with the FTSE Brit. Govt. All Stocks index up 3.3%. Greek government bonds suffered as investors feared a default, with the yield on the 10-year climbing to 22.4%, up from 17.6% at the start of the month, whilst the yield on the 10-year Italian bond climbed to 5.5%. Among corporate bonds, high yield bonds continued to struggle, although higher-rated investment grade tended to ride the coat tails of lower government bond yields (IBOXX £ Non-Gilts All Maturities +0.3%).

From a price/earnings ratio perspective equities look cheap, although this is predicated on the denominator (earnings) remaining robust. For that to occur business and consumer confidence cannot afford to fall much lower. Once more, it remains to the authorities to create the necessary conditions in which the economy can flourish — the most pressing of which is to engender a sense of stability in the eurozone. President Sarkozy of France and Chancellor Merkel of Germany have pledged to provide details of a plan before the end of October to recapitalise Europe’s banks and bolster the fragile union. They may have to work more than “9 to 5” to ensure it is sufficiently comprehensive to appease the markets.

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