What chance of an Olympic bounce?
0Jamie McGeever of Reuters asked us to come in to discuss his finding that for the last five summer Olympics, there has followed massive outperformance of host countries’ stock markets the following year. Jamie wanted to know if the UK could continue that trend and what were the obstacles facing it.
The good news, at least on a relative basis, is that in a world where excess debt and the associated de-leveraging are key challenges, the UK looks to have the most coherent policy to optimising the way forward. Thus, the MPC is the most dovish of the major central banks (we expect a further £25bn of Quantitative Easing (QE) that would leave the Bank of England holding c40% of conventional gilts). Also we believe that QE is more effective in the UK than elsewhere with the average maturity of debt very long, at 14 years. There is also greater co-operation between the Treasury and the central bank than in any other major country, as evidenced by the recent ‘funding for lending’ scheme, the BoE accepting loans to the real economy as collateral, and with the BoE’s Financial Policy Committee given the secondary objective of supporting growth.
As for what’s happening, UK growth shows resilience relative to Continental Europe, with fiscal tightening having been watered down; the savings ratio is currently high (6.4%); investment intentions, employment and PMIs have rolled over much less than in Europe and it looks as if UK housing is now only 5% overvalued. Sterling can currently be considered a relative cheap ‘safe haven’ in our view, compared with other non-euro European currencies given its CDS spread. Pity the poor Swiss with their overvalued currency.
The positives for the UK market, at least on a relative basis against other developed markets are that QE should help equities (80% of the time, equities have risen post QE); the FTSE is a defensive market (looking at sector composition and correlation with lead indicators); around 85% of sectors trade on multiples below their global peers; 79% of earnings come from overseas and only 23% of sales come from Continental Europe.
That said it may be more helpful to think of UK market prospects in terms of scenarios, and before we know what the ECB will do, here’s how we can make sense of current market (FTSE100) levels and the period ahead to end year:
| Probability | Scenario | Index |
| 55% | Adequate low growth, no significant change to long term ‘risk appetite’ | 6,350 |
| 15% | Mild recession, lower bond yields, more risk | 4,400 |
| 5% | Severe recession, disorderly Euro breakup | 3,500 |
| 20% | Another Euroland ‘crisis’, little/no growth | 4,600 |
| 5% | Better growth, higher bond yields, improved ‘risk appetite’ | 7,000 |
| Weighted average | 5,600 |
Markets are one thing, but the devil’s in the detail and looking one cut down at sectors or style bets, post QE1 cyclicals outperformed, but economic momentum was improving; this is unlikely now and preferred QE plays may be stocks that have some of the characteristics of index linked bonds and cheap growth stocks, and there are stocks that have a CDS spread below that of the average G7 sovereign, a dividend yield above the average G7 bond yield, and higher international earnings (which makes it less likely they will be burdened with additional taxes). Also there are complementary more domestic plays that look cheap on the basis of cash return on capital invested and which are supported by decent earnings momentum. The key issue is risk asset exposure to the UK should be selective and there are significant risks to overall growth – suggesting that it’s way too early to support conventional cyclicals and that over-indebtedness will remain an ongoing challenge.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
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The Local Authority Treasurers’ Investment Forum September 25th, 2012, London Stock Exchange
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