06 - 02 - 08

If you have read enough doom and gloom about stockmarkets and interest rates, then stay with us this month. Because despite news that interest rates may not fall very much in the UK for some time there are sufficient indicators to suggest ...

... that things simply are not as bad as some journalists are saying. But then good news never did sell newspapers.

To be fair, there are some poor indicators such as slowdown in the housing market, criticism from the European Commission that our budget deficit is well in excess of the 3% of Gross Domestic Product (GDP) that is allowed under the Maastricht Stability and Growth Pact and the economy is rapidly slowing down.

Some sticky things are good

But if you listen to the experts, there is plenty of cheer to be had; if not euphoria. As a starting point Graeme Leach the Chief Economist at the Institute of Directors has predicted what he has called “stickyflation” which is infinitely preferable to either stagflation (aggressive inflation out of control) or deflation (falling prices). 

Stickyflation, Leach says is where inflation slows, but in a “sticky” fashion, in other words, not fast enough to enable the Bank of England’s Monetary Policy Committee to cut interest rates by very much, very early. This is certainly reinforced by the 8:1 vote against cutting rates at the start of this year.

Indicators of hope
Many other economists argue that the underlying factors are positive. For example David Smith, who writes regularly in the Sunday Times, points to the labour force survey which shows that employment has been steadily rising, while unemployment remains relatively low. 
 

More opportunities for UK workers

Employment is expected to rise by 0.4% next year, about 120,000, but there is also reason to believe that the slack will not be taken up (at least to the same extend as recently) by overseas workers. There are two reasons for this; first, the strength of the Euro, comparative to Sterling and secondly, because the economies of the accession states, from which so may immigrant workers come are growing faster than ours; albeit from a lower base.

In fact, high levels of employment may well mean that even with relatively high interest rates (compared with recent years) the housing market will do no more than slow, rather than crash. This could allow wage inflation to help young people back onto the bottom rung of the housing ladder, without the trauma associated with a house price crash.

The CBI is predicting a “soft landing for the economy, Ernst and Young’s ITEM Club predicts “rebalancing” within the economy, rather than recession and the Engineering Employers Federation has recently reported a “renaissance” in manufacturing, with factory gate prices up 5% year–on-year; the largest rise for 17 years. While this might set some alarm bells ringing about inflation, it demonstrates a level of confidence amongst manufacturers that, if sustained, could lead to a reduction in the worryingly high proportion of the current account (or balance of payments as we used to call it) accounted for by invisible such as banking and insurance. Not a moment too soon, some might argue.

Markets (Data compiled by the Insurance Marketing Department Ltd.)
The fact that equity markets have continued to slide should not be a surprise to anyone; markets go down as well as up and the fact that the FTSE100 has bounced back from its lowest January level by more than five percent to end the month -8.94% tends to reinforce this. If you consider the long term trend – say five years - the same index is actually almost 65% up, representing an annualised growth rate of about 11%. Further to put volatility into context, the FTSE 100 has risen by 1.5% during the time this paragraph has been written, on 1st February. The FTSE250 fared slightly better, this month, falling by -7.28%; it has now lost 11.22% over a year.

Motorists will not be pleased with record Shell profits

In the US, the Dow Jones lost -4.63%, but is still very slightly ahead over a year, experiencing a far less deep “trough” during the month than the FTSE100. Worst performer of the month was the Eurostoxx50, with a loss of -13.79%, bringing its dismal 12 month performance to a loss of 9.23%, closely followed by Japan’s Nikkei225, which fell by -11.83%.

One good point is that the price for Brent 1-month crude oil fell back by -1.78% during January, which will do little to stem criticism of the record £13.9 billion profits announced by Shell. House prices fell by -0.3% during January, according to Nationwide, reducing the annual rate of change to 4.2% from 4.8%.
 
A change of pace in CGT, or a partial U-turn?
After the furore resulting from the Pre-Budget Report last October, the Chancellor has finally published his revised proposal that business owners will have a lifetime allowance of £1 million taxed at 10%, before the 18% rate cuts in.

What is not clear is how this will apply to members of share based profit share schemes. It is also likely to create a false market on AIM, as investors offload their shares before the end of the tax year. This market, which has been languishing for some time, has deteriorated compared with the FTSE100 and FTSE250 even more since the announcement of the CGT change.

Interest rates
An interesting survey by the Office for National Statistics reveals how spending habits have changed over the past half century. Apparently, we spend half as much of our weekly household budgets on fuel and power as was the case in 1957, half as much on clothing, a sixth on tobacco and the same proportion on alcohol.

But housing still accounts for a massive proportion of spending, although with a greater emphasis on home ownership.

What effect changing interest rates will have on the next 50 years is anyone’s guess, although the balance could well swing back to renting property unless there is a change in the affordability of housing.

Interest rates round the world
UK	5.5%	Held
USA	3.0%	Down 1.25%
Europe	4.00%	Held
Japan	0.50%	Held

January’s dramatic three-quarter percent cut in US interest rates – followed by an even more dramatic half percent cut at the end of the month – could be seen as the actions of a strong Federal Reserve under Ben Bernanke. On the other hand, it might be an act of desperation by a bank that has run out of ideas and needed to at least try to put the lid on collapsing equity markets.

Certainly the action appears to have caused a bounce in the Dow Jones and other leading markets, so let us hope he was right. The problem is that such a massive rate cut is something of a one-shot cannon; he has little left in his armoury should the moves not work.

Commercial property

Commercial property can be difficult to sell

Commercial property has been taking something of a pasting recently with some commentators expressing surprise that a number of funds have imposed withdrawal delays. This is odd, since everyone knows that property takes time to sell and is subject to marketing conditions that are quite different from those applying to equities.

While money is flowing in, funds can afford to pay the few withdrawals from income; but when net outflows start to hit funds, for example when property prices look shaky, it is realistic to assume that it will be difficult to realise sufficient cash to pay out, so some form of delay – allowed for in all property funds – will be applied.

Oil
Oil prices have fallen back over recent days, after reaching historic highs. But it is worth considering that, while conventional wisdom says OPEC simply cannot afford to let world economies collapse by facing too high energy costs, there is nothing to say that they would not be prepared to sit on their hands for some time. After all, the oil will always be there, so why bother about a five or ten year hiatus in demand?

In reality, sustained high energy costs could be the trigger – even more than fear of global warming – for industry to make a concerted effort to find economically viable alternative sources of energy. This could do OPEC even greater long-term damage. Not to mention the oil companies. No wonder they invest so much time and effort in influencing world governments.

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