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Market Bulletin - Slow going

05 May 2015

Equity markets ease as UK and US first quarter growth figures fall short of expectations.

It was a week of disappointing news from the developed economies. Growth in the UK and the US turned out to have slowed in the first quarter, while European share prices registered their first monthly decline of 2015.

In the US, Q1 growth was expected to check in at an annualised rate of 1%. In fact, the economy almost stood still in the first three months of the year, growing by only 0.2%, compared with an annualised 2.2% in the final quarter of 2014. The strength of the US dollar, which made exports more expensive, was one contributing factor. Another was the lower price of oil, which depressed investment in the important energy sector. Short-term influences included bad weather and a West Coast ports strike.

The US Federal Reserve admitted that the US economy had lost momentum, noting that the latest employment numbers had reflected this by rising more slowly than expected. It left short-term interest rates unchanged at close to zero. The Fed acknowledged that growth in consumer spending had declined but said it still expected a "moderate" rate of economic growth. Exactly how moderate will determine whether or not rates rise in June, as markets had anticipated.

Scott Weiner of Payden & Rygel doubts that the Q1 figures will change the Fed's mind and reckons it will hike sooner rather than later. He believes that the next round of employment stats will show an improvement and that, after the halving of oil prices, US inflation has bottomed. He also sees a recurring pattern in quarterly performance over recent years.

"Since 2010, on average, annualised Q1 GDP has grown at just 0.5%," Weiner notes. "In comparison, Q2s have averaged 3%, Q3s 3.1% and Q4s 2.6%." Weiner believes that 2015 will turn out the same way.

The currency and securities markets had a difficult week, nonetheless. The dollar fell to a two-month low against the euro before recovering slightly to just under $1.12. Equities likewise had two days of losses, though the S&P 500 Index ended the week only 0.5% down. A sustained government bond sell-off took the yield on 10-year US Treasuries to their highest since mid-March.

Unhelpful for some

Unhelpfully for the coalition government, UK GDP growth in Q1 also fell short of expectations. Quarter-on-quarter growth had been forecast to slow slightly from 0.6% in Q4 2014 to 0.5%. The actual figure was 0.3%, the slowest rate for more than two years. Construction fell and manufacturing rose slightly, both as anticipated, but services output was slower than expected. While export orders from the eurozone are falling, consumer demand has remained healthy, thanks to low inflation and faster wage growth.

Capital Economics doubts that the UK recovery is on the cusp of a sustained slowdown. It points out that real household incomes are still on track for their strongest growth this year since 2001. Surveys of manufacturers’ investment intentions are holding up reasonably well, in spite of political uncertainties, and business and consumer confidence is high. "The UK is still on course to see decent economic growth of between 2.5% and 3% this year," says Capital Economics chief economist Vicky Redwood.

When markets heard the news, sterling dipped briefly but then bounced back to its highest level against the dollar for two months, ending the week at $1.51. In the UK housing market, Nationwide said prices increased by 1% in April (or an annualised 5.2%), the fastest monthly rate since last June. The FTSE 100 Index started the week by touching another record high, but caution set in following the GDP announcement and the index closed the week down 1.2%.

Greek twist

In another twist in the Greek debt drama, finance minister Yanis Varoufakis has effectively been removed from the negotiations with the Eurogroup, which represents Greece's creditors. Eurozone officials said they were "encouraged" by the move, which followed an acrimonious meeting of finance ministers in Riga.

If eurozone officials are more hopeful of a deal, the Greeks continue to take their money out of Greek banks. At the start of 2010, bank deposits were €238 billion. Today, they stand at €132 billion. In the last five months, outflows have reached €32 billion, or 17.5% of GDP, and are running at €500 million a day.

Worries over Greece have depressed eurozone bond markets, pushing up borrowing costs for the likes of Spain and Italy, in spite of the quantitative easing (QE) efforts of the European Central Bank (ECB). JP Morgan Asset Management put the chance of "some form" of Greek sovereign default at 50%, although its chief market strategist, Stephanie Flanders, argued that, despite the potential for market volatility, a partial default might not cause lasting damage to European markets if handled carefully. In the meantime, the safe haven appeal of Bunds saw German 10-year yields fall to new lows.

If eurozone QE is failing to prop up bond markets, the same was true for equities in April. Both markets enjoyed powerful rallies at the start of 2015 when the ECB announced its QE plans. For equities, the shine appears to have worn off for now; in April European share prices registered their first monthly fall of the year, with the Eurofirst 300 Index falling 3.4% over the week.

On the road

Elsewhere in Europe, following an extended power struggle with CEO Martin Winterkorn, Volkswagen group chairman Ferdinand Piëch resigned. Only days later, VW – which ranks second behind Toyota for global sales - reported an impressive 17% rise in Q1 earnings. "The resignation should mean a market refocus on the impressive performance of the company in the face of hard times in Eastern Europe and Brazil," says Stuart Mitchell of SW Mitchell Capital. "The VW brand is still confident of hitting a 6% margin by 2018, and China continues to perform well. Western Europe again demonstrates strong recovery, and cause for excitement comes from the very strong ŠKODA, where operating profit is up by 31%. The luxury brands continue to show excellent progress, with Porsche sales rising by 29% and Audi by 13%."

Tax ban

Closer to home, the election is almost upon us. In the most sweeping tax promise of the campaign, Conservative leader David Cameron pledged not to raise income tax, VAT or national insurance contributions in the next parliament, should his party govern. He promised to pass a law banning any such rises. Economists noted that this would tie the government's hands in the event of an economic shock, and former Tory chancellor Lord Lawson said Cameron's promises were "expensive or unwise or both".

The Institute for Fiscal Studies (IFS) criticised curbs on pension tax relief proposed by both main parties, saying they wanted to "dismantle an important and relatively sensible part of the tax system". The proposals, which would significantly reduce the value of tax relief for high earners, looked like "short-term ad hoc changes which we will come to regret", the IFS said.

The National Association of Pension Funds, the Association of British Insurers and the Trades Union Congress joined forces in a plea to take the politics out of pension policy. In a joint letter to the Financial Times, they called on the next government to put policy in the hands of an independent body.

"We are concerned about the risks of developing policy in a piecemeal way, driven by the political cycle," the letter said. "The long-term interests of savers, not the short-term interests of politicians, must be at the heart of pension policy." Those who would be affected by a cut in pension tax relief should consider taking advantage of current rules while they remain in place.

Payden & Rygel and S W Mitchell Capital are fund managers for St. James’s Place.

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