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Market Bulletin - One in three beers

20 October 2015

As market fears recede, investors are switching their focus to companies.

Perhaps the most significant market news of the week came on Tuesday with the announcement of the merger between brewing giants Anheuser-Busch InBev (AB InBev) and SABMiller. The deal means that one in three bottles of beer worldwide looks set to be produced by a single company. Belgian brewer AB InBev is the world’s largest, accounting for a quarter of the global beer market, and is set to acquire London-listed SABMiller, the world’s number two.

“With its successful track record in acquisitions, AB InBev may regard the current timing as a last opportunity to execute a major share deal for very little [debt] cost,” says Jonathan Asante at First State Investments. “We are disappointed in that it further reduces the number of available, good-quality companies that we are willing to invest clients’ money in; but this is the second such major M&A deal in a matter of months that has affected holdings in our portfolios.”

The AB InBev–SABMiller tie-up would rank as the third-largest takeover in history, the high-water mark of a year in which mergers and acquisitions activity has been at stellar levels. Bloomberg figures for the first three quarters show roughly $3 trillion of deals announced, the highest since 2007. The AB InBev–SABMiller deal will be worth $68 billion. Both companies enjoyed a stock bounce after the announcement – SABMiller rose 9.8% over the week while AB InBev finished up by 3.1%.

The announcement came in a week when markets also showed increasing signs of decoupling. Correlation between equity markets is down to record lows, evidence perhaps that markets are beginning to behave more rationally. The S&P 500 Implied Correlation Index has dropped 30% from its ten-month high in August, according to Bloomberg, reaching its lowest reading since 2007. A drop in correlations between markets provides greater scope for fund managers to take advantage of pricing inconsistencies.

Yet this shift does not mean that the global economy has entered a new phase of unalloyed growth. In fact, the International Energy Agency warned last week that global deceleration was increasingly a given (and that the oil glut would therefore persist in 2016).

Nevertheless, global stocks were trading at an eight-week high on Friday afternoon, while major government bond yields reached lows not seen for several months. In the US, the S&P 500 ended the week up 0.56%, with a large focus on corporate earnings – more than 30 S&P 500 companies announced results over the course of the week.

All this took place despite increased uncertainty about the timing of the Federal Reserve rate rise. Last week two Fed governors publicly expressed their opposition to any near-term rate rise. According to Neil Woodford of Woodford Investment Management, deferral is the most likely course.

“Corporate earnings are going to be difficult over the next two or three years,” says Neil Woodford. “The consensus view is the Fed will hike by March but I would argue the Fed isn’t going to tighten any time soon. The next move in US interest rates will be to ease policy, not to tighten.”

Moreover, inflation dropped to zero, the United States Department of Labor reported that its producer price index actually fell 0.5%, and industrial production dropped for a second consecutive month, down 0.2% against August. There was some solace in the form of core inflation, which takes oil (and other potentially misleading contributors) out of the equation. It rose to 1.9%.

Mr & Mrs Watanabe

In Japan, the Nikkei 225 ended its four-day week down 0.8%, having suffered a midweek dip, partly on news that Chinese imports had dropped 20.4% in the year to September. The Shanghai Composite Index enjoyed its second consecutive week of gains, rising more than 6% as investors took confidence that the summer correction had found its floor.

Japanese investors are concerned about domestic inflation figures – industrial production unexpectedly dropped 0.5% in August. Some economists argue that Japan is now in technical recession and the Bank of Japan is expected to introduce a further round of quantitative easing. But the Bank’s chairman sounded a more positive note, and the independent UTokyo index, created by Professor Tsutomu Watanabe at the University of Tokyo, puts year-on-year inflation at a healthy 1.4%.

Private Japanese investors also seem to be returning to equities. ‘Mrs Watanabe’, the catch-all term for Japan’s very significant pool of retail investors, apparently feels as positive as her namesake at the University of Tokyo. Over the course of this year, Mrs Watanabe’s mood has shifted, turning from market bear to net buyer of Japanese stocks.

But worries remain about China, where third-quarter growth dipped to 6.9%. Chinese equities may have bottomed out, but Chinese corporate bond yields have tightened dramatically in 2015 – perhaps too dramatically. Issuance is up significantly and investors have been borrowing heavily to finance bond purchases.

Old World dynamos?

The FTSEurofirst 300 ended the week up by a marginal 0.2%, its highest level since mid-September, but eurozone inflation fell to -0.1% in September (although the low oil price dominated). More encouragingly, core inflation was 0.8% and comments from a member of the European Central Bank delivered hope of a further round of quantitative easing.

More broadly, economic growth on the periphery remains encouraging; and even at the core there are positive signs, although German investor sentiment dropped and the DAX was slightly down over the week. Last week VW said it would cut capital expenditure, but Europe shows broader signs of economic health.

“We are positive on debt, Greece excluded, as Europe has taken far tougher medicine to pay off its debt than the UK,” said Stuart Mitchell of S. W. Mitchell Capital. “We are also positive on the European export-driven recovery.”

The UK itself had a mixed week. The FTSE 100 ended down 0.59%, while the September inflation figure came in at -0.1%, largely due to oil and clothing prices. On the other hand, unemployment hit a seven-year low of 5.4% and wage growth was up 3% despite zero inflation.

Yet a good deal of the focus in the UK was not so much on employment as on retirement. A pensions report jointly published this month by KPMG and the Association of British Insurers found that ‘pension freedoms’, the liberalising reforms announced by the chancellor earlier this year, have already elicited a strong response. Thus there was an 80% increase in calls to pension providers in the first month; while in the first three months, providers paid out almost £2.5 billion in cash and income drawdown payments.

But eager pension holders would be well-advised to tread carefully. Whether to transfer out of an existing scheme – and when to do so – are decisions that could have an enormous impact on retirement income. Perhaps even more important is the question of tax, which the reforms have made more of a worry for those subject to the higher rate.

On 25 November, George Osborne will deliver his Autumn Statement. Reports at the end of the week suggested the chancellor has backed away from announcing further radical reforms – Baroness Altmann, pensions minister, suggested that a final decision could take up to 12 months – but anyone who holds a pension would be wise to take note of suggestions for further change.

 

First State Investments, S. W. Mitchell Capital and Woodford Investment Management are fund managers for St. James’s Place.

The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.

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