Investment Outlook
Investment Outlook - July 2006
As we commented in the last Investment Outlook, there again seems to be some disparity between the prospects for interest rate movements between the UK and the rest of the world. We have seen upward movement in interest rates in the quarter in the USA and Euroland and, since the quarter end, in Japan too, ending their near zero interest rate policy of the past five years. In the UK, however, there appears to be no clear consensus for a move in either direction, and against this background, it is surprising to us that sterling has remained relatively firm against both the euro and the dollar throughout the last three months. We continue to anticipate some weakness in sterling during the rest of the year and into 2007 as these differential interest rates impact more strongly on sentiment in the currency markets.
Oil prices rose during the quarter but we do not envisage any major rise in the oil price from current levels throughout the rest of 2006. On the other hand, it was noticeable that the prices of a number of other commodities, such as copper and gold, suffered sharp falls during the second quarter of 2006 and, although we subscribe to the view of a “super cycle” for commodities over the long term, it may be some time before these commodities regain the peak prices seen during the spring.
Bond markets worldwide were subdued during the second quarter of 2006 and we continue to see little value in fixed interest markets. Our funds thus continue to be underweight in fixed interest securities relative to equities. However, were yields on short to medium-dated securities in the UK to rise over 5%, we would look to reassess our position. These yield levels, however, may not be seen for some time as we continue to forecast an increased degree of issuance by the Treasury over the next twelve months, given the increasing funding requirements for the Government’s Public Expenditure Programme.
Turning to global markets, we have been disappointed by the progress made in Japan so far this year, as it had been one of our favoured areas for 2006. Nevertheless, the economic background to Japan continues to brighten and with confidence returning to manufacturing industry, prices are beginning to rise consistently and the threat of deflation now seems to have abated. Our view is that this will mean that Japanese domestic investors will look to move out of cash deposits and fixed interest assets and more into equity based assets meaning that domestic Japanese securities should rise in the medium term. To this end, we continue to advocate adding to holdings in Japan and envisage some strengthening in the yen relative to sterling. This strategy should result in sound investment returns over the medium term.
The US equity market has been more resilient than most markets over the past quarter despite the sometimes conflicting signals on economic policy sent out by the new Chairman of the Federal Reserve, Mr Bernanke. However, we still have concerns over the overall indebtedness of American consumers and it appears from both economic and anecdotal experience that the US housing market in areas such as New York, Florida and California is particularly soft. We envisage only modest progress from the American equity market over the next six to twelve months.
In Euroland, although some economic data may have been distorted by the World Cup during June, it is evident that both in France and Germany economic activity is starting to pick up once more. We continue to expect some modest appreciation of the euro against sterling over the next six months and retain a preference for German equities for the rest of the year. The strains of the Eurozone are becoming very apparent in the property markets of more peripheral countries, such as Spain and Ireland, and we see no particular evidence that these strains will abate in the short term.
There have been no major changes to our investment themes over the quarter although it has become apparent that the authorities in China have been putting measures in place to dampen down some elements of growth within the domestic economy. This has had some knock-on effects on pricing for commodities, such as copper, as has already been noted, and, in the short term, stocks in the resources sector of the market may come under some pressure. We continue to remain optimistic about the prospects for companies involved in the sourcing and retail of luxury goods as this area of global retail markets continues to remain particularly resilient. We also retain a strong bias towards property companies, particularly in the UK. The Budget in the spring paved the way for the introduction of REITs, a more tax-efficient structure under which UK based property companies may operate, and it has been noticeable that investment funds from abroad continue to target high profile property assets particularly in London and the South East. Rental values for prime office space both in the City and West End are continuing to increase and, as more foreign companies seek listings on the London Stock Exchange, there is a natural appetite for new Head Office facilities in prime locations in the UK.
Overall, therefore, we regard the decline in equity markets over the second quarter of 2006 as a pause for breath and continue to feel that economic fundamentals and valuations within global markets remain very reasonable. Despite the fact that one or two companies, who had envisaged floating on the market during the early summer, have delayed their introductions, we foresee no imminent let up in the pace of merger and acquisition activity within markets and also continue to see substantial stock repurchase programmes from major companies as being supportive to equity markets at or below current levels. Naturally, the threat of unforeseen political shocks from unstable parts of the world, such as the Middle East, cannot be ruled out, with necessarily adverse effects on investor sentiment, but, having seen solid support for equity markets following the volatility in June, we continue to recommend an overweight position in equities and an underweight position in fixed interest securities for the time being.
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