economic update nov201

8/3/2019 Economic Update Nov201

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S P E C I A L I N V E S T M E N T B U L L E T I N

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Events over the last ew months have, once again, been dominated by Europe, in a sovereign debt crisis which hasbeen rumbling on or the best part o two years. Greeces transormation rom one o Europes astest-growingeconomies to the fnancial debacle we see today, and its subsequent domination o global markets, is all the moreremarkable given that Greece represents barely 1% o the eurozone economy, and by deault a minuscule portiono the global economy.

During the late 1990s, reely available credit made it possible or the Greek government to spend more thanits tax and income base to improve inrastructure and social services. The defcit the government accrued wasused to pay or pensions and public sector salaries, and devalued the drachma until Greece joined the euro in2001. How it satisfed the membership criteria is a question many politicians and economists are still askingtoday. The strength o the single currency allowed the Greek government to access resh fnance until thefnancial meltdown o late 2007/early 2008 hit the nations primary industries (such as tourism) hard, making itimpossible or the government to service the debt they had recklessly built up.

Despite a number o bailouts (the frst one in April 2010 or 45bn) and numerous crisis summits, signifcantrisks remain, although the three-pillars o a solution announced in October does, at least, suggest that euro-area leaders are committed to keeping the European Monetary Union (EMU) together. Whilst undoubtedly astep in the right direction, the deal is not fnalised and the detail remains absent. Furthermore, fscal policy istightening, monetary stimulus is weak, and banks are deleveraging in response to haircuts and the EuropeanUnions demand to bolster capital positions.

As European leaders struggled to come up with a new bailout plan or Greece, much larger ears loomed.Interest rates soared or Italy, the continents third largest economy, to levels regarded as unsustainable. Interest

rates or France also rose, whose banks hold large amounts o Italian government debt and where governmentfnances are strained. With the continents economy teetering on the brink, a growing number o economistscalled or the European Central Bank (ECB) to step orward as a lender o last resort to stop the contagion; amove the bank has resisted, insisting that a political situation is the one required.

Across the other side o the pond, there are indications that the US economy is improving, ater stalling over thesummer months. GDP data has surprised on the upside, with urther expectation-beating results rom employment,retail sales and durable goods, although rumours o a ailure by politicians to agree on steps to reduce public debthave again rattled markets. China also appears to be avoiding a hard landing with its Q3 GDP release.

It is however, the euro crisis and its possible contagion eects which has been at the oreront o investors minds

and heldback global markets. Despite the all in equity markets seen in the last quarter, businesses, especially inthe US, continue to hire. The US Employment Report showed an increase in payrolls o just over 100,000 andthe Institute or Supply Management (ISM) index remained in expansion territory in October, registering a

2.8% increase.


ECONOMIC

UPDATE

Economic updateNovember 2011


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UK headline data

Gross Domestic Product(GDP

)

According to fgures released rom the Oce or National Statistics (ONS), the preliminary estimate or thirdquarter (Q3) GDP was growth o 0.5%. This was better than many commentators had anticipated (the consensusorecast was or growth o 0.3%), and was largely driven by output in the service sector (increasing by 0.7%compared to a smaller rise o 0.2% in the previous quarter) and production sector (increasing by 0.5% comparedto a all o 1.2% in the previous quarter). The construction sector proved to be a negative contributor, decreasing

by 0.6% in Q3 ater an increase o 1.1% in the previous quarter. As the chart overlea demonstrates, whilst

growth remains positive the UK economy still remains smaller than beore the debt crisis o 2007/08.

In their supplementary analysis, the ONS admitted that interpretation of the estimate for Q3 is complicated by thespecial events in Q2 (for example, the additional bank holiday in April for the royal wedding), which are likely to have

depressed activity in that quarter. As such, it may be wise to look at Q2 and Q3 gures together, rather than separately;

on that basis GDP has grown by 0.6% in the last two quarters and 0.5% in the past year.

The index surveys more than 300 manuacturing frms, monitoring employment, production inventories,new orders, and supplier deliveries. By monitoring the index, investors are able to better understand

economic conditions. When the index is increasing, equity markets may be expected to increase because ohigher corporate proftability.

What is the ISM Index?

It is also worth recognising that despite the problems being encountered in the eurozone, and the risks to theglobal economic recovery, equity markets, particularly in the US have proved surprisingly resilient.

UK & US equity market performance year-to-date

20

15

10

5

0

5

10

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

DowJonesIndustrialAverageTR FTSEAllShareTR

Feb Mar Apr May Jun Jul Aug Sep Oct Nov

Dow Jones Industrial Average TR FTSE All Share TR

10

5

0

-5

-10

-15

-20

Jan

Source: Bloomberg, data from 1 January 2011 to 9 November 2011. FTSE Allshare and Dow Jones Industrial Average total return basis, rebased to sterling.Please note that past performance is not indicative of future performance.


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Whilst the fgures were better than expected, economists stressed they must be treated with caution. JamesKnightly, o ING Financial Markets commented: While the Q3 growth rate looks respectable, it is important to

remember that this follows a depressed Q2 gure. Indeed, the ONS stated that temporary one-o factors may have knockedup to 0.5% o Q2 growth. Consequently, we should have seen a big rebound. So, for the economy to have grown by only

0.5% in Q3 suggests the underlying picture remains weak.

Not surprisingly, George Osborne, Chancellor o the Exchequer, was more upbeat ollowing the release:The Britisheconomy has had a dicult journey from its debt-fuelled past. We have to take these gures one step at a time.

In defant mood, the Chancellor urther added:

We are determined to continue this journey so that wehave the growth and jobs we need. The economic gures

are a positive step forward for the country.

Ination

Consumer prices index (CPI) ination stands at 5% in October, down rom 5.2% in September; the beginningo what many economists are predicting will be a long trend downwards. Indeed, some economists believe therate could all below the Bank o Englands (BoE) 2% target level by the end o 2012. Chris Williamson o Markitcommented: The rate could well fall back to target in the next 12 months.

The rate had increased to 5.2% in September, but downward pressures rom alls in the cost o ood (due tosignifcant and widespread discounting by supermarkets and good harvests or certain produce), air ares and

petrol, contributed to the October all. Rising utility prices prevented the rate alling urther.

Retail prices index (RPI) ination (which includes mortgage interest payments and other housing componentsexcluded rom the CPI) stands at 5.4% in October, down rom 5.6% in September.

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

150bn

180bn

210bn

240bn

270bn

300bn

330bn

360bn

UK GDP, quarterly change (lhs) UK GDP, annual change (lhs) UK GDP (rhs)

-2.0% 210bn

-4.0% 180bn

-6.0% 150bn

UK GDP, quarterly change (lhs) UK GDP, annual change (lhs) UK GDP (rhs)

0.0% 240bn

2.0% 270bn

4.0% 300bn

6.0% 340bn

8.0% 360bn

Source: Oce for National Statistics, latest data to third quarter 2011.

UK GDP


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The all was welcome news or the BoE, as the Monetary Policy Committee (MPC) continue to resist increasinginterest rates rom current historic lows. Indeed, citing increasingly visible symptoms of rising stress in nancial marketsand the intensifying indebtedness of several euro-areas and banks the committee not only voted unanimously in avour

o maintaining the bank rate at 0.5%, but also voted unanimously in avour o urther quantitative easing (QE2)to the tune o 75bn (as revealed in the October minutes). The move lits the asset purchasing programme to275bn, and whilst the decision was not wholly unexpected, the timing was, with many commentators expectingthe BoE to resist QE2 until November at the earliest, with a fgure around the 50bn mark. The asset purchaseswill consist o nominal gilts, conducted over a our-month period, and spread evenly across residual maturities oover three years.

The deterioration in the economic picture appears to have orced the Banks hand. Whilst their principal objectiveremains monetary stability stable prices (low ination) and confdence in the UK currency the BoE believesits remit extends to aiding sustainable long-term economic growth; a stance not appreciated by the Banks critics,who believe they have abandoned their ocial goal in avour o a ocus on growth and support or the coalition

governments goal o eliminating the budget defcit.The view that ination will all sharply over the next year (as ood, energy and VAT eects drop out, and coreination fnally eases) is one supported by Capital Economics, who pointed out in their UK Data Response o18 October 2011: The headline rate also hit 5.2% back in September 2008, but was 1.1% just 12 months later. It is thisongoing belie that allows the MPC to maintain such loose monetary policy.

Employment

UK unemployment hit its highest level in 17 years, as the ONS reported that the number o people out o workjumped to 8.3%, up 0.4% on the previous quarter. This leaves the total number o people unemployed standingat 2.62 million, its highest since 1994.

The unemployment rate or 16-24 year olds hit a record high and breached the symbolic one million mark; ajobless rate o 21.9%. Meanwhile, the number o people out o work and claiming benefts rose or the eighthconsecutive month, by 5,300 to 1.6 million in October (source: Oce for National Statistics).

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

UK Base Rate UK CPI Inflation UK RPI Inflation

-2.0%

UK Base Rate UK CPI Ination UK RPI Ination

-1.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

-0.0%

Source: Oce for National Statistics, latest data to October 2011.


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Economists were troubled by the fgures; as Blerina Uruci o Barclays Capital commented: The data rearms thedisturbing labour market picture of rising unemployment and falling real earnings growth.

The fgures would suggest that job creation in the private sector is not strong enough to oset cuts in the publicsector, as the coalition had hoped, although on a marginally positive note, the increase in the claimant count was

lower than expected by analysts (source: Oce for National Statistics).

Other dataAccording to the Nationwide, average house prices in the UK rose by 0.4% month on month in October. Theunderlying three-month on three-month measure weakened slightly, alling back into negative territory by0.2%. However, on a positive note or homeowners, house prices rose by 0.8% on an annualised basis, the frstrise in seven months.

It appears unlikely that the mortgage market will provide ongoing support to house prices. Both the BritishBankers Association (BBA) and the BoE measures o mortgage approvals or house purchases ell, with the all

rom 52,300 to 51,000 in August, the frst since April.

Whilst it is too early to tell whether this is the start o a downward trend, as Samuel Tombs, UK Economist atCapital Economics remarked: Recent labour market weakness and the deterioration of conditions in wholesale fundingmarkets suggest that lending will remain subdued.

More positive news came in the October release o the Balance o Payments and Economic Accounts (Q2), whichindicate that the UK economy is better balanced and looking more healthy than previously thought. The currentaccount defcit in Q1 was revised substantially lower rom 9.4bn to 4.1bn, and the defcit shrunk urther to2.1bn in Q2. At just 0.5% o GDP, the defcit is now the smallest since 1998. The consensus orecast was or awidening in the Q2 defcit, however, an increase in investment income rom 7.5bn to 9.7bn was the biggestcontributor to the reduction.

The latest release o Economic Accounts showed that households have also made solid progress in repairingtheir balance sheets. A sharp and unexpected 1.2% quarterly rise in households real disposable income enabledthem to increase the proportion o their income that they save rom 5.9% to 7.4%. This increase suggests thathouseholds might be better positioned to deal with the ongoing squeeze on their incomes rom persistent high

ination and the coalitions fscal austerity measures.

Wider economyUnited States

According to fgures released rom the Bureau o Economic Analysis (BEA), the advance estimate or Q3 GDPwas the highest so ar or 2011, at annualised growth o 2.5%. This was marginally higher than the consensus

orecast and signifcantly higher than the 1.3% recorded or Q2.

A current account defcit occurs when a countrys total imports o goods, services and net investmentincomes are greater than the countrys total exports o goods, services and net investment incomes. Thissituation makes a country a net debtor to the rest o the world. I a current account defcit is fnancedrom long-term capital inows this can be benefcial or an economy, as inward investment can increase theproductive capacity o the economy. I the defcit gets too large, it can cause long-term fnancing problemsor a government, particularly i global confdence in the country begins to turn, and the defcit increases dueto the cost o the interest payments. A large current account defcit is oten a sign o an unbalanced economy,and could be an indication o structural weakness and/or an uncompetitive manuacturing sector.

What is the current account decit?


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US GDP

The BEA confrmed that the increase stemmed mainly rom a rise in personal consumption expenditures,exports, non-residential fxed investments and ederal government spending. Negative contributors were adecrease in private inventory investment, and state and local government spending.

The rise in GDP was seen as passing a key psychological threshold, as it edged above its previous peak, last seenway back in Q4 2007. Ater almost two years o recession and two years o slow recovery, economists dared toask has the economy nally entered its expansion phase?

It is evident that the fgures should be treated with caution. The increase in government spending, which ultimatelyhelped to boost Q3 GDP, coincided with the growing defcit in the US ederal budget seen over the past ewmonths. The latest release o the monthly Treasury Statement confrmed that the government defcit increased

by $64.5bn in September; a decrease o $69.6bn rom the $134.15bn defcit recorded in August, but still upsignifcantly rom September 2010. The current defcit in the 2011 fscal year is now $1,298bn which, at thecurrent rate, represents nearly 9% o the USs orecast 2011 GDP(source: Bureau of Economic Analysis).

Sustaining long-term economic growth is clearly not lost on the Federal Reserve, who have continued to holdcore interest rates at 0.25%, a level they have now been at since December 2008. Indeed, over the summer, theFed committed to keeping interest rates at current record lows or at least a urther two years, acknowledging

that downside risks to the economic outlook have increased.

Eurozone

Eurozone GDP grew by 0.2% in Q3, driven by a rebound in activity in Germany and France, matching the Q2fgure; Germanys Q3 GDP rose by 0.5% and Frances by 0.4%. However, the fgure remains sharply down romthe 0.8% recorded in the frst three months o the year (source: Moodys Analytics). The outlook or the eurozonehas darkened, and in an attempt to respond to the continuing debt crisis, the regions leaders announced a three-tiered plan ollowing an emergency summit in late October.

10

8

6

4

2

0

2

4

6

8

10

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

USQoQGDP

10

8

6

4

2

0

-2

-4

-6

-8

-101992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Source: Bloomberg, latest data to third quarter 2011. US GDP quarter-on-quarter percentage gures.


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The outline was to recapitalise banks to the tune o 100bn, reduce the Greek debt burden through a 50%haircut on Greek bonds (held by private investors; banks), and to leverage the European Financial StabilityFacility (EFSF) to over 1trn. However, it is ar rom clear that these plans will be decisive enough, and ollowinga brie period o positive market reaction, the recent trend o uncertainty and volatility returned.

Whilst it was hoped that China would contribute to the EFSF, this was looking ar rom certain even beoreGeorge Papandreou threatened a new crisis by announcing that a reerendum would be held to canvas opinionon Greeces continued membership o the eurozone; not just on the 130bn rescue plan agreed a month earlier.

However, with Greece itsel split on the content o any reerendum, the Greek PM announced he was readyto drop the proposal, in the wake o opposition rom the Finance Minister, Evangelos Venizelos. Papandreousubsequently agreed to step down, to allow the creation o a national unity government intended to secureinternational fnancing and avert a collapse o the Greek economy. Ater meeting with Antonis Samaras, theleader o the main opposition party, agreement was reached to orm an immediate coalition government, withelections to ollow ater the implementation o the decisions reached at the October emergency summit.

Attention in Europe has now turned to Italy and Spain, amid signs that these nations are being sucked urtherinto the ever escalating eurozone crisis. The yield on 10 year Italian bonds rocketed up 65bps to 7.47% on9 November, breaching the 7% level at which borrowing costs are widely regarded as unsustainable (source:Citywire, 9 November 2011). Spanish 10 year bonds also surged above 6% or the frst time since August as theytraded higher in line with moves in Italian debt, in spite o news that Mario Monti, a ormer EU Commissioner,would take the helm o a new coalition government in Rome (source: Financial Times, 14 November 2011). A newcentre-right Spanish government seems to have reduced the pressure with yields on Spanish bonds subsequently

alling by more than 0.5%

Unemployment data in the eurozone also painted an unhappy picture, as the jobless rate rose to 10.2% inSeptember rom 10.1% in August, a rise o 188,000 (source: Moodys Analytics). The rate appears likely to remain

elevated or a while yet, amidst major fscal consolidation and public sector job cuts.The ECB surprisingly cut interest rates by 25bps to 1.25% at their November meeting; a meeting chaired bynew President, Mario Draghi. Whilst a rate cut had been rumoured, it was not being priced in by the uturesmarkets, which had indicated a cut later in 2011/early 2012, with a urther 25bps reduction towards the end oQ1 2012 (source: Moodys Analytics). The new ECB President was keen to start his stewardship with a bang and

make a positive statement in the central banks eorts to combat slowing growth.

JapanThe Japanese Cabinet Oce confrmed that the economy grow by 1.5% in Q3, matching the market orecast,and ending the countrys technical recession ollowing the devastating March earthquake and tsunami. On an

annualised basis, the economy grew by 6% exceeding expectations o a 5.9% rise rom economists. The mainprop or the economy came rom government spending on reconstruction, an increase in manuacturing and arebound in trade(source: RTT News, 13 November 2011).

Analysts suggest that the economy may stall again in Q4 due to persistent strength rom the yen denting exports.The Japanese authorities clearly recognise the threat o the yen remaining stubbornly high, particularly againstthe US dollar, with the government intervening in oreign exchange markets, selling yen or dollars or theourth time in little more than a year (source: The New York Times).

A strong yen continues to be a burden or Japan, as it seeks a path to sustained recovery ater the natural andnuclear disasters. While companies have been quick to rebuild actories and restore supply chains, the yen has

undermined revival or the nations exporters, which drive much o its economic growth, by making theirproducts less competitive overseas.


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A weaker yen would provide a welcome boost or Japans exporters, allowing them to gain market share (bycutting the oreign currency price o their exports) or boost margins (by keeping the oreign currency priceo their exports unchanged). In addition, a weaker yen would help Japanese frms selling goods at home thatcompete with oreign imports.

Jun Azumi, the Japanese Finance Minister, confrmed that intervention in the oreign exchange markets wouldcontinue until the government was satised with the results. He called the yens climb excessive, blamingspeculative traders or the movements, and warning that movements did not reect the Japanese economic reality.

Mr Azumi commented urther:

I have repeatedly said that we would take decisive stepsagainst speculative moves in the market. The market has

not reected our economic position at all.

The success o these actions by the Japanese authorities will largely depend on whether investors continue to viewthe yen as a sae haven; i concerns persist regarding a global economic recovery, demand or the yen as a sae

haven could drive prices up urther.

China

Q3 2011 GDP grew by 9.1% in China, on an annualised basis, and by 2.3% on a quarterly basis, according to theNational Bureau o Statistics. This was below the market expectation, although some o the underlying componentsare aring reasonably well. Fixed asset investment year-to-date has grown by 24.9% compared to the same period in2010, slightly above expectation; industrial production increased by 13.8% compared to the same period last year,above expectation; and retail sales increased by 17.7%, also better than the market expected. Furthermore, the2.3% quarterly rise was slightly aster than the 2.2% rise experienced in Q2(source: National Bureau of Statistics).

In a welcome respite or the Peoples Bank, ination slowed to 5.5% in October, down rom 6.1% in September,and a three-year high o 6.5% in July. In addition, Chinas Logistics Federation and Statistics Bureau reportedthat an index o manuacturers input costs ell the urthest in 17 months in October. Separate surveys by HSBCHoldings Plc and Markit Economics showed similar declines, suggesting that Premier Wen Jiabao will have moreroom to loosen fscal and monetary policy in attempts to stimulate slowing economic growth (source: TradingEconomics, 9 November 2011).

Such a move would be welcomed by economists; as Zhu, Chie Economist at Beijing-based Citic Securities Co.Ltd. noted: Food and global oil prices have peaked and that means ination will fall. The decline will leave more room

for policy easing, such as looser credit, to help sustain growth.

Other Asia Pacic

Policymakers across emerging Asia are shiting their attention away rom tackling ination to supportingeconomic growth. Industrial production and exports are slowing across the major countries and the latestmanuacturing purchasing managers index (PMI) suggests the outlook is poor, with a reading o less than 50(indicating alling activity) in South Korea, Taiwan, Australia and Singapore (source: Capital Economics, GlobalEconomic Outlook, Q4 2011).

While the export-driven economies o Hong Kong and Singapore are vulnerable to a slowdown in the west, theregions economic undamentals as a whole are in a much better state than their western counterparts. Structuralactors such as catching up with income levels in the developed world, avourable demographics, and increasing

urbanisation, appear likely to provide continuing support to household spending. Government investment ininrastructure and production capacity will also likely support growth.


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In addition, unlike the west, policymakers in emerging Asia have more capacity to support growth, withrelatively healthy fscal positions providing governments with the scope to introduce stimulus packages i needed.Moreover, policy rates in the region have been increased since the 2008-09 global crisis, providing central banks

with room to cut interest rates once more; indeed, Indonesia has already taken this step.

Optimising investment opportunitiesThe world economy has continued to slow during the past ew months. With this in mind, and in a slightly dierentormat to previous Economic Updates, in this edition we turn our attention to the investment opportunities

which remain in such a tough economic environment.

Equities

Intelligent investors in shares should try to take advantage ofmarket uctuations, and not be too concerned about them.

Benjamin Graham

Making market uctuations your r iend is one o the three most important lessons Warren Buett learned romBenjamin Graham, widely recognised as the frst investment guru o our time (source: The Great Investors by Glen

Arnold). The degree o volatility and uctuation experienced in markets is not logical and, in the short term, thestock market oten misprices asset values.

The ear o missing out pulls investors in when markets are, or have already soared, and causes many to sell whenthey have already allen. It is this type o herd mentality which oten causes investors to buy and sell at preciselythe wrong time.

This is the scenario we potentially fnd ourselves in today. Investors have become earul that there is worseto come; that the share prices o all quoted companies, irrespective o their industry sector or market share,will decline. Such market pessimism can be indiscriminate. Investors ultimately end up disposing o shares inwhich there are strong grounds or believing they will recover in price, and this in turn, throws up exciting andattractive investment opportunities or others.

A prime example o this exists in large cap, blue-chip companies; companies in a strong and healthy position witha continuous record o generating profts and earnings during all phases o the economic cycle. Such companieshave seen their prices dragged down along with all others over the summer months, as a result o high-levelmacro-economic circumstances outside o their control.

AstraZeneca Plc is an example o one such stock. Over the period 5 July to 10 August, the share price ell by

nearly 20% rom 3,166.5p to 2,543.5p (source: Yahoo Finance). With a solid history o earnings generation in thepharmaceutical sector (a non-cyclical sector not wholly reliant on a buoyant economy), oering a dividend yieldin excess o 5%, and on a price/earnings (p/e) ratio o 8x, the attractions are clear (AstraZeneca Plc is a stockwhich eatures in the St. Jamess Place Equity Income, Managed Growth, Strategic Managed, UK & InternationalIncome, and UK High Income unds.)

As Neil Woodord o Invesco Perpetual, and Fund Manager o the St. Jamess Place UK High Income undrearms: We believe that the funds exposure to the non-cyclical pharmaceutical sector should prove rewarding over thelonger-term; we believe that the sector has far to go in terms of re-rating.

A similar view o the sector and o the investor mentality reerred to above is held by Nick Purves o RWCPartners and Fund Manager o the St. Jamess Place Equity Income und: When uncertainty increases, investor timehorizons tend to shorten and many start to focus on the macro-economic picture rather than concentrating on the longer-

term outlook for individual company cash-ows and how these are likely to be aected (if at all) by the current diculties.


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We think investors should be looking for cash generative companies with strong balance sheets and more predictable prot

streams, which oer a dividend yield of at least 4%, covered by company cash-ow to give a free cash-ow yield of at least

8%. Pulling this all together, we feel that today, the best opportunities can be found in the telecom, pharmaceutical, and

insurance sectors.

In times o economic turmoil, traditionally one o the saest places to invest in equity markets is in consumerstaples industries that manuacture and sell ood and beverages, tobacco and household products. These aretypically the last products to be removed rom the household budget when disposable incomes are being squeezed,

as is the situation now, due to rising ination and wage constraints.

A prime example o such a company is Unilever Plc, the worlds second largest maker o consumer products.Included in its product range are well-known names such as Bertolli, Knorr, Slim-Fast, Ci, Comort, Domestosand Dove. Unilevers heavy presence in the growing economies o emerging Asia, Arica and Latin America hascontinued to propel profts (source: www.unilever.co.uk). The company is one which eatures in a number o theSt. Jamess Place unds, including the Greater European Progressive, UK & General Progressive, International,Equity Income, Recovery, Managed Equity & Bond, Allshare Income, UK & International Income, and BalancedManaged.

Ater the events o the past ew months, investors need no reminding that equity investing can be volatile;however, history is clear; stock markets tend to rise over the longer term, despite short-term uctuations.

FTSE Allshare index performance since December 1971

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Dec-

71

Dec-

74

Dec-

77

Dec-

80

Dec-

83

Dec-

86

Dec-

89

Dec-

92

Dec-

95

Dec-

98

Dec-

01

Dec-

04

Dec-

07

Dec-

10

PriceLevel

OPEC Oil Crisis Black Monday

October 1987

First Gulf War

ERM Crisis

World Trade Centre

Bombing

Asia Currency

Crisis

LTCM and Russian

Crisis

TMT Stocks Bubble

Burst

9/11 Attacks

On US

Enron and

WorldCom

Scandals

Commodity Price and

Inflation Concerns

Rising Credit Costs,

US Sub-Prime Mortgage,

US Fed Interventions

Eurozone debt crisis and

Japan Earthquake, US

downgrade

4,000

2,500

3,500

2,000

3,000

1,500

1,000

500

Dec7

1

Dec7

4

Dec7

7

Dec8

0

Dec8

6

Dec9

5

Dec0

7

Dec8

3

Dec9

2

Dec0

4

Dec8

9

Dec0

1

Dec9

8

Dec10

PriceLevel

OPEC Oil Crisis Black MondayOctober 1987

ERM Crisis

Black MondayOctober 1987

World Trade CentreBombing

Russian Crisis

Asia CurrencyCrisis

Bubble Burst

on USA

LTCM and

WorldCom ScandalsUS Sub-Prime Mortgage,

US Fed Interventions

Enron andRising Credit Costs,

TMT Stocks

9/11 Attacks

Japanese Earthquake,US Downgrade

Eurozone Debt Crisis,

Ination ConcernsCommodity Price &

Source: Bloomberg, latest data to October 2011.

Free cash-ow is a measure o how much cash a business generates ater accounting or capital expendituressuch as buildings or equipment. Free cash-ow can be used or business expansion, dividends, reducing debt,or other purposes. It ollows that the ree cash-ow yield is the ree cash-ow per share, divided by the shareprice.

What is the free cash-ow yield?


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It is also worth reerring back to a point we have mentioned previously in Economic Updates. The link betweenequity market returns and economic growth is surprisingly tenuous, and the two do not always go hand-in-hand,with changes in market and investor sentiment playing a major role.

The early 1990s recession in the UK and US aptly demonstrates this point. UK GDP was in negative territory

rom Q3 1990, and did not return to consistent growth until Q3 1992 (source: The Guardian). However, overthe same time period (1 July 1990 to 30 September 1992), the FTSE 100 index (representing the 100 largestcompanies in the UK by market capitalisation) rose by almost 21%.

Similarly, GDP in the US ell by 7.8% rom a peak in July 1990 to the trough as at June 1992 (source: Bureau ofEconomic Analysis). Ater steep declines in the second hal o 1990, the market recovered strongly in Q1 1991,and recorded a total return o almost 12% over this recessionary period.

Bonds

This theory o investing in inevitables (a phrase adopted by Warren Buett to describe companies which, in hisopinion, are unlikely to see a change in market share and earnings capacity over the generations) applies equallyto corporate bonds. Many analysts are seeing the asset class as promising, with the recent sell-o creating anattractive entry point or investors. Exaggerated ears o mass deaults are, in the eyes o many, presenting investorswith unprecedented value in high quality corporate bonds. Across the investment grade arena, borrowing levelshave been reduced by up to 65% and ree cash-ow to debt ratios have increased by as much as 200% (source:Financial Express Trustnet).

With this in mind, the case or investment grade corporate bonds over government debt appears strong. Whilethe ormer oers attractive yields (due to recent price alls) with low deault risk (due to healthier balance sheets- according to Standard & Poors, in the 12 months to September only 1.9% o corporate issues deaulted), the

latter oers historic low yields, with the yield on 10 year UK gilts or example, at only 2.3% (source: Bloomberg, 9November 2011). Whilst gilts undoubtedly have a role to play as the bedrock o a conservative portolio, they oerlittle prospect o generating real returns in excess o ination over the next fve to 10 years.

FTSE 100 and S&P 500 performance from 1 July 1990 to 30 September 1992

30

20

10

0

10

20

30

40

Jul90 Oct90 Jan91 Apr91 Jul91 Oct91 Jan92 Apr92 Jul92

FTSE100TR S&P500TR

40

10

30

0

20

-10

-20

-30Jul 90 Oct 90

S&P 500

Jan 91 Jan 92Apr 91 Apr 92Jul 91 Jul 92Oct 91

FTSE 100

Source: Bloomberg. FTSE 100 and S&P 500 total return basis, rebased to sterling.


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l

Paul Read, joint Fund Manager o the St. Jamess Place Corporate Bond and Investment Grade Corporate Bondunds is seeing such a scenario in corporate credit: Weakness over the summer has left yields higher than they have been

for some time. There are an increasing number of attractive opportunities across the investment universe, as sentiment towards

corporate credit improves, after several months of risk aversion.

He emphasised:

In general, we believe core government bonds oer limited opportunitieswith yields that are negative in real (ination-adjusted) terms.

ConclusionInvesting in todays volatile markets can be emotionally taxing. Markets detest uncertainty, yet the last ewmonths have seen nothing but that, as eurozone leaders stumble rom one crisis meeting to another. Withcontinued lack o clarity and political resolve, it seems the volatility will not end any time soon. One thing

that can be said with certainty is that, despite the low growth environment we fnd ourselves in, investmentopportunities still exist or the prudent investor. However, to fnd those opportunities requires the expertise oa skilled and experienced manager, one who has encountered like situations in the past, and continues to enjoysteady inows o money into their und. The distinctive approach o St. Jamess Place is committed to having theright man behind the wheel to maximise those opportunities. This, along with a well constructed, diversifedportolio, which is actively reviewed and de-risked where necessary, can continue to satisy the medium to long-term investment objectives o St. Jamess Place clients.

UK members o the St. Jamess Place Wealth Management Group are authorised and regulated by the F inancial Services Authority.

The St. Jamess Place Partnership and the titles Partner and Partner Practice a re marketing terms used to descr ibe St. Jamess Place representatives.

St. Jamess Place UK plc Registered Oce: St. Jamess Place House, 1 Tetbury Road, Cirencester, Gloucestershire, GL7 1FP, United Kingdom.

Registered in England Number 2628062.

The views and opinions o the analysts and und managers quoted, are not necessarilythose held by St. Jamess Place Wealth Management.

Any reerence to individual companies does not represent a specifc recommendation to invest.

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