Archive for December, 2012

A Farewell To Qualms

Goodbye – all right, perhaps a little prematurely, but goodbye anyway – to you, 2012. While you brought your own mix of shocks and surprises, at least financial markets were less excitable as a rule than they had learned to become over the course of your immediate predecessors. Let’s take a look at some of your highlights …

Equity Markets

Fears over Eurogeddon and global slump had their share of the limelight over the year and produced some familiar episodes of funk. As in prior years, however, the sky did not fall in and almost all markets had a good 2012 overall. In price terms, the FTSE 100 is 6.6% up YTD, the S&P 500 up 8.7%, the Euro Stoxx 50 up 11.6% and the Nikkei 225 up 5.9% (all on a sterling basis). Currency made some big differences: in yen for instance, the Nikkei is 22.9% up on the year.

It wasn’t all gung-ho risk repricing, however; there was still too much chaos around for that. In Europe, for instance, safe-as-houses Germany comfortably outshone the wider eurozone with a 26.6% GBP price return to the DAX, while Milan couldn’t match the large cap index with a return of just over 6%. Then again, Germany wasn’t the zone’s top performer .. Step forward new entrant Estonia, with a 35.6% rise. Amazingly, the Athens Stock Exchange is up almost 31% too.

At a whole-world level too, the numbers show there was more going on than simple bullishness, or shared damage repair from the crash of 2011. In GBP terms, the MSCI World Index of developed market equity stands 12.3% above where it began the year, while the equivalent Emerging Market index has moved practically in lock step (+13.7%) – i.e. has still underperformed since H1 last year.


Fixed income markets offered greater clarity and greater confusion at the same time. Greater clarity, because the behaviour of government and credit markets followed a similar pattern of “risk on”: the spreads of weaker eurozone government bond yields over those of Germany came in as a rule, spreads on emerging market debt were also tighter, and credit spreads have tightened significantly for both investment grade and high yield corporate bonds.

At the same time, yields on “safe haven” governments drifted lower over the year as a whole; despite the recovery of sentiment, 10-year German debt yields 0.5% less than it did a year ago. This could be explained by relief over slack growth (leading to contained inflation and continued low policy rates) – but that is hardly consistent with strong returns to equity, where slower economic growth means lower growth in company earnings. Similarly, equity market revaluation arising from stronger confidence over tail risks should have been expected to go hand in hand with a sell-off in safe haven assets, which didn’t happen.


The commodity story is similarly varied. Oil trickled higher, with the Brent crude future about 3% above where it began the year. Or perhaps it fell – the American WTI index is lower by almost twice as much. So the gap between oil futures contracts in London and New York has widened to $20 per barrel; before 2011 it was reasonably firmly pinned to an average of zero. This is attributable to the relative pace of shale development in the US and European economies.

In metals, gold continued its strong run overall across a year in which it failed to beat its 2011 high – it’s about 6% up YTD. Amazingly, the gold price (in nominal dollar terms) has now not fallen over any calendar year since 2000. Silver has done a little better (+7.9%), though of course it’s had a rougher ride over the longer term and is much further below its 2011 top. For those interested, the ratio between the two prices (gold:silver) is roughly in line with the 40-year average now at 55.3x.


UK commercial property across all types and locations (as measured by the IPD index) is heading to be about 4% lower in terms of capital value over the 2012. Offices did better than industrial buildings, with retail property coming in last, though there has not been much to choose between them at the nationwide aggregate level. Overall, commercial property prices are about where they stood at the end of 2008 (following the lion’s share of the post-boom shock).

Land registry data on the residential property market is published with a longer than usual delay, but currently available figures suggest anything from flat growth overall to a modest sub-2% rise. Nationally, housing is still more affordable – or at least, cheaper in price terms – on average than it was at the 2007-8 market peak. Interestingly, the national figures conceal a safe haven effect which is visible at the more local level. The government data shows that prices in London have risen at about 4%, having held steadily above the peak since the second half of last year. While there is no official data on the subject the inferior reservoirs of anecdote and common sense suggest that the preference of international investment flows for the capital are behind this.


The year saw very little change here. OK, so the ECB slashed its main refinancing rate from 1.00% to 0.75%, but the other big developed world banks had little scope beyond sticking to their existing near-zero policies (0.5%, 0.25% and 0.1% in the UK, US and Japan respectively).


Let’s look at the negatives first:

  • In a low-growth year, equity market recovery has pushed earnings valuations out of cheap territory. Should forecast increases fail to materialise – for whatever reason – this should make those markets more vulnerable to a setback.
  • Stronger safe-haven bond markets could reflect a greater general level of comfort with the concept of government debt – and respect for the willingness of central banks to increase their influence over longer-term interest rates. But they do conflict with stock market optimism and it’s impossible to say with certainty which market is right.

And to end with the positive notes:

  • During 2012 markets flirted with the idea of renewed global catastrophe, which made a pleasant change from assuming it was absolutely, definitely just around the corner.
  • If this increase in confidence persists – in the bond markets most importantly – it will encourage confidence in the real economy to continue to trickle back as well.

Perhaps the most positive sign for those of us who try to behave like the fabled Rational Investor of the financial textbooks was this: differences in price movements within asset classes reflected discernible variations in fundamental behaviour. It was logical for Italian bond spreads to narrow by twice as much as those of Spain. At the same time, it was reasonable for Italian stocks to underperform German ones.

There was much that is difficult to explain, and the broad outlook for the world remains enigmatic. But 2012 gave us a little more stability in the financial world, a little more sensitivity to fundamentals and valuations and altogether less downright hysteria. If that background for 2013 stays in place then investors could well find themselves looking back on the past twelve months with some gratitude.

28/12/2012 at 4:17 pm

Bucking The Trend

The Autumn Statement has been and gone. It is perhaps a sign of its steady-as-she-goes ponderousness that the most interesting question it raised was whether or not the shadow chancellor fluffed a line of his reply due to bamboozlement or a slip of the tongue. (There was certainly nothing like the expansion of VAT to Cornish pasties to get our teeth into.) Various claims have been made about the political points the Chancellor might or might not have scored: economically nothing has changed.

Which is of course to say that growth has disappointed, borrowing targets have been missed and the plan remains to hope we can muddle through the rough patch with modest aspirations towards balancing the books over the medium term. Numbers wise, real GDP growth for the next four calendar years has been revised down from the March estimate of 2.0%, 2.7%, 3.0% and 3.0% to a new estimate of 1.2%, 2.0%, 2.3% and 2.7%. Gross debt on a Maastricht basis, which was forecast to peak in fiscal 2014-15 at 92.7% of GDP, is now predicted to peak one year later at 97.4%. All of which looks as perfectly manageable as ever it did and has done nothing to faze markets.

It was the topic of growth in Britain and around the world with which the Chancellor led off his speech. In his first sentence he said that “the British economy is healing.”

Both the speech and the revised economic projections raise the question: what will a healed UK economy be doing? What would the growth rate be if we and the rest of the world weren’t so sick?

Estimates of the trend rate of growth have of course varied over the years. At the tail end of 1999 the Treasury put the long term growth rate at 2.25%, which it viewed as conservative. Since then GDP has grown at an average annual rate in real terms of 1.8%. Over a longer (30 year) timescale the average rate has been 2.6%. Perhaps an estimate of 2-2.5% is about right.

Whatever the precise trend rate might be, however, there is no evidence to suggest that 0% – which is what we’ve seen over the last four quarters now – is it. There are causes of this weakness we can point to: confidence effects, overseas effects, the contraction of real incomes and so on. But insofar as these prove transitory, the point is that the UK growth rate should be expected to rebound.

Similar effects are observable elsewhere. In the US, the Congressional Budget Office estimates trend GDP growth of 2.3% over the next ten years. The 30 year average is currently 2.8%. Last year, however, quarterly growth slowed to 0.1% at one point, taking the annual rate down to 1.6%. Most recently it had rebounded to 2.5%.

As we get closer to the end of the year it becomes more tempting to predict the future. This is a bit of a mug’s game. Where economic growth is concerned a key question still hangs over the longevity of the various headwinds which have been holding it back. Still, it is worth remembering that in many cases growth is indeed being held back relative to trend. That doesn’t mean the only way for it to go is up. But it does mean that’s the natural path for it to take.

07/12/2012 at 3:53 pm

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