January 2008 Newsetter...click here for full PDF version

Credit fallout hits markets
After 2007, investors are looking at 2008 with apprehension. The last few months have seen the collapse of the US sub-prime mortgage market, the credit crunch, and the first “run” on a UK bank for over a century. Speculation over the severity of the fallout continues to dominate headlines. Across the board, the credit crunch has led to a sharp increase in the cost of borrowing which has stalled merger and acquisition activity. Although many companies are in relatively strong financial shape, some – particularly smaller companies – may find tighter credit conditions hard. This could lead to job losses and higher unemployment figures. On the consumer side, a booming housing market had given UK homeowners confidence. However, data from the Christmas period is already indicating problems with consumer spending as general retailers in particular issue downbeat reports and even profit-warnings. As a result, sentiment amongst equity investors has taken a further knock. Nevertheless, the corporate environment remains in relatively good shape but selectivity and realistic expectations will be important. Any further bad news could meet with a disproportionate level of disappointment, but it is worth remembering that stock markets tend to be driven by irrational fear, not logic. The key is to stay calm, think long term, and be selective. In the words of Franklin D Roosevelt, “the only thing we have to fear is fear itself”.

Best of the bunch
There are over 1,500 unit trusts in the UK so how do you choose the ones which will perform? Using a good multi-manager to make the selections for you can reassure as your portfolio will being managed by an expert. There are two types: fund of funds managers select individual funds based on research and will then buy or sell them as performance prospects and market conditions change. Manager of managers invest preagreed allocations of a portfolio with individual managers and give them specific guidelines on how to run that money. Either approach can help form the ‘core’ for your wider portfolio or work as a first step into the world of market investment.

Agreeing to agree
A unanimous decision by the Bank of England’s Monetary Policy Committee (MPC) to reduce interest rates is not unprecedented, but it is uncommon. It last occurred in late 2001, when the MPC unanimously voted to cut interest rates in the wake of the 9/11 terrorist attacks. Six years on, the nine members of the Committee have reached agreement once again, voting unanimously in December 2007 for the first reduction in UK rates since August 2005. The MPC is in an unenviable position. On the one hand, it has to stay mindful of its primary task: keeping inflation below its rolling target of 2%. Inflation held steady in November at 2.1% – above the MPC’s target level – and lower interest rates could stoke inflationary pressures already fuelled by soaring energy and food prices. On the other hand, the MPC has to balance its duty to control inflation with the need to ensure that economic growth does not stall. An environment of high interest rates, combined with rising oil and energy prices and a slowing housing market is unlikely to foster a climate of confident consumers and healthy economic growth. The MPC’s unanimous decision to cut rates at a time when inflation is still relatively high suggests that the Committee is more preoccupied by the UK’s prospects for economic growth than by inflation, and the minutes from the Committee’s December meeting indicated that the ongoing crisis in financial markets and a slowdown in the housing market drove its decision to cut rates. However, the unanimous decision to cut, combined with the relatively dovish tone of the minutes from December’s meeting, suggests that the nine members of the MPC are more concerned about prospects for economic growth than many analysts had previously believed, and this has fuelled expectations of further cuts in the near future. Some analysts are speculating about the possibility of another cut as early as January 2008, when the MPC’s next meeting takes place. Any further cuts are likely to be well received by UK borrowers and mortgage payers; nevertheless, the Committee must still be concerned by inflationary pressures, and this might prevent them from cutting rates again too soon - or too drastically.

ISAs from 2008
In the last Budget, the Chancellor announced changes to ISAs which will become effective at the start of the next tax year, 6 April 2008. The highest profile is the change to investment limits as the Government eliminates the mini and maxi components. Instead, there will be Cash ISAs and Stocks and Shares ISAs, each with separate limits. The overall limit goes up from £7,000 to £7,200 and the limit for Cash ISAs or the cash element within a Stocks and Shares ISA will go up to £3,600. Within these limits, there is flexibility. You can, for example, put the maximum £3,600 in a cash account and £3,600 in a stocks and shares account. Alternatively, ifyou place just £2,000 in cash, you can use the remaining balance – £5,200 - to invest in stocks and shares. If you don’t need cash at all, you can put the full £7,200 into stocks and shares. You can also transfer Cash ISA holdings to a Stocks and Shares ISA without impacting on your new tax year allowance. So, if you have £10,000 already sitting in existing ISA plans then this amount can be moved to a Stocks and Shares ISA, yet your allowance of £7,200 will still be available. The only other change is to finally get rid of PEPs. Although no new money has been invested in PEPs since 1999, the distinction remained. The Government has finally given providers the opportunity to consolidate. If you have an existing PEP, you should see no difference, but do check with your adviser if you are unsure.

UK market update
The UK stock market played out 2007 with a whimper rather than a bang. It ended the year at 6,457, flat over the month and around 5%* higher than January. Going into 2008, the credit crisis remains unresolved, inflationary pressures continue and the macro-economic outlook is weakening. December did bring some light relief, however. Stockmarkets moved up in the first half as five central banks – the Bank of England, the Federal Reserve, the European Central Bank and those of Canada and Switzerland – promised to inject liquidity into the system. This unprecedented move was aimed at pushing down the inter-bank lending rate to a level more in line with base rates. The Bank of England unanimously decided to drop interest rates by a quarter point to 5.5%, in spite of November’s inflation figures showing CPI at 2.1%, still marginally above the Government’s 2% target. Higher petrol prices were counterbalanced by lower gas and electricity bills. House prices continued to fall for the second month, according to figures from Nationwide. Retail sales were steady in November, but there were signs that Christmas would not be as buoyant as hoped and some retailers discounted heavily in the face of flagging consumer confidence. The year’s top performing sector, mining, managed to end the year on a high as merger and acquisition activity heated up. *Source: Financial Express Analytics, 1 year to 31 Dec 07.

The US stock market
The US is the largest equity market globally with a 50% share of global stock markets. The New York Stock Exchange has more than 2,600 companies listed, which represent a global market capitalisation of over $22 trillion (source: New York Stock Exchange). The US stock market is well-known to many UK investors with recognisable brand names and extensive news coverage of market moves and corporate activity. Recent high-profile corporate scandals have knocked confidence, but have also forced the US market to tighten up its legislation considerably. However, the new legislation has influenced some companies to select other stock markets such as London, rather than New York as their base. For example, some Russian oil companies have chosen recently to list their company’s shares in London and Moscow instead. The progress of the US stock market is closely related to the health of the US economy, which is often seen as the driver of the world economy. In recent years, the markets have weathered rising energy costs and a series of interest-rate rises by the US Federal Reserve, but most commentators now believe economic growth is slowing, dragged down by a weak housing market. Interest rates were cut briskly is the wake of the sub-prime crisis, which should support stock markets for the time being. The US market also offers access to some unique, world-class companies not found anywhere else.

Be among the first
Because you cannot carry over your ISA allowance from one tax year to the next, March tends to see an increase in investment. But leaving it to the last minute isn’t necessarily the right way to maximise your benefits. Your 2007/08 allowance is available from April 6th 2007 - so why wait? For stocks and shares investors it can sometimes make sense to avoid market peaks or perhaps to invest monthly (which can help to smooth out any peaks and troughs of volatile markets). For cash ISAs however, it is better to invest as early as you can - to take advantage of the effects of compound interest over as long a period as possible.

The credit crunch continues
Repercussions from the US sub-prime crisis have been felt around the globe and it has already claimed the high profile scalps of the heads of both Merrill Lynch and Citibank. Central banks are taking unprecedented steps to inject money into the system but with no immediate end in sight, how is the credit crisis likely to play out in 2008? Although banks have already put forward some hefty write-offs, the full extent of the credit crisis remains unclear. The low share prices in the banking sector suggest that the market either doesn’t believe the figures or thinks there is worse to come. The problem remains that some securities markets have ground to a halt, making it difficult for banks to price their losses properly. Only when liquidity returns and those markets re-open can the banks gather a true picture of their losses. This will bring transparency back into the market and push down the high inter-bank lending rate that has caused so many problems. Is this likely to happen anytime soon? Most analysts believe the crisis has some way to run. Interest rates remain relatively high so there should be plenty of room for cuts but inflation remains an issue with the oil price stubbornly raised and commodities prices soaring. Central banks therefore have a difficult balance to maintain. The recent injection of liquidity has pushed down the inter-bank lending rate, but it remains historically high and is likely to stay elevated until confidence returns to the banking market. For trust to be restored, the banks will have to understand the full exposure of their counterparties to the sub-prime crisis. Central bank actions can only go so far. As risk aversion continues, banks will also remain reluctant to lend to either corporates or consumers. This will make earnings upgrades harder to come by because companies cannot borrow to invest in their businesses. Consumers are likely to find it more difficult and expensive to borrow, which will also curtail their spending habits. All this is likely to have a knock-on effect on the wider economy. Is there any light at the end of the tunnel? A swift restoration of confidence would minimise the impact on the wider economy, but there are many hurdles to overcome before that happens.

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