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Global Equities: Euro Zone crisis triggers sharp declines We were certainly correct in our conclusion in the last report, that we were moving into the ‘next phase of the equity cycle’. The last quarter has seen sharp falls across all global equity markets as the escalating crisis in the Euro Zone has unnerved investors and risk aversion has grown. Once again the fragmented political structure and the single currency have delivered a lack of urgency and most critically a lack of speed. Concerns over a Greek default and the ramifications that would have on the financial system, have been further augmented by fears over the finances of nations such as Italy and Spain. Investors have correctly identified that the ECB has had insufficient resources to ‘bail out’ these major nations. Banks would need recapitalisation and there have been signs of a credit ‘freeze’ once again. This has led the major European indices to sell off heavily. In Italy the MIB Index has fallen by 30%, in Spain the IBEX 35 has lost 22% and even the DAX Index in Germany has fallen by an alarming 28%. Whilst the prior quarter was typified by a lack of volatility, the last three months have seen huge intraday swings and any successful short term trading has proved virtually impossible. The other concern is that a recession in Europe now seems more likely, austerity measures are widespread and confidence levels are being eroded. US equity markets have also suffered, not only on the European concerns but also on fears that the US economy is also stagnating. Indeed it is likely that US GDP figures could flat line for at least three quarters. There is a distinct possibility that the Federal Reserve will start to focus on the unemployment rate as well as the inflation target. Recent comments that there was ‘significant downside risks’ to the economic outlook were the main reason for some of the most recent equity market declines. The S&P 500 Index is now down 15% on the quarter and the Dow Jones has declined 13%. Global consensus GDP growth forecasts have been revised downwards for both 2011 and 2012 to 3.5% in each year. It is mainly the ‘developed’ part which is suffering and the emerging markets have remained resilient. Such markets in 2012 look likely to still deliver over 5.5% GDP growth. Japan remains mired in structural and demographic issues and 2012 GDP will only grow by 0.9%. Over the quarter the Nikkei 225 Index is down 15%, in Brazil the Index is also down 15% and in Russia the main Index is down 20%. Looking forwards it is fair to say that, technically, markets are oversold and may enjoy a relief rally on the back of any firm plans to bolster the Euro Zone. The FTSE All Share in the UK is currently trading on 10.5x P/E ratio and offers a 3.77% dividend yield. Relative to other asset classes this is attractive. Many blue chip companies continue to enjoy strong balance sheets and with slowing top line revenues, we think merger and acquisition activity could accelerate. The concern is that with a lack of confidence, the capital expenditure cycle will be delayed but we are certainly getting to equity market levels now which offer longer term value.
Rates & Commodities GBP/USD GBP/EUR GBP/JPY SILVER GOLD EUR Crude Oil US Fed Funds UK Base Rate ECB Base Rate
Price at 30-Sep-11 30-Jun-11 30-Sep-10 1.5648 1.6067 1.5728 1.1634 1.1071 1.1548 120.7 129.433 131.25 1222.160 1510.010 1432.480 1629.00 1508.00 1311.00 104.26 111.68 81.42 0.25 0.25 0.25 0.50 0.50 0.50 1.50 1.25 1.00
% Chg Quarterly -2.61% 5.09% -6.75% -19.06% 8.02% -6.64% 0.00% 0.00% 20.00%
% Chg 1 Year -0.51% 0.74% -8.04% -14.68% 24.26% 28.05% 0.00% 0.00% 50.00%
7000
6000
5000
4000
FTSE 100 Index 3000 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 7000
6000
5000
4000
DAX Index 3000 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 7000
6000
5000
4000
Dow Jones Industrial Average Index 3000 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 World Indices FTSE -100 Dow Jones NASDAQ S&P 500 DAX CAC 40 Nikkei 225 Hang Seng FT All Gilts
Price at 30-Sep-11 30-Jun-11 30-Sep-10 5,128.48 5,945.71 5,548.62 10,913.38 12,414.34 10,788.05 2,415.40 2,773.52 2,368.62 1,131.42 1,320.64 1,141.20 5,502.02 7,376.24 6,229.02 2,981.96 3,982.21 3,715.18 8,700.29 9,816.09 9,369.35 17,592.41 22,398.10 22,358.17 166.46 155.68 161.09
% Chg Quarterly -13.74% -12.09% -12.91% -14.33% -25.41% -25.12% -11.37% -21.46% 6.92%
% Chg 1 Year -7.57% 1.16% 1.97% -0.86% -11.67% -19.74% -7.14% -21.32% 3.33%
Europe: The Future Path
Fixed Income: Quarterly Review
It is unfortunate that we are still focussing on the travails of the Euro Zone. It should have been sorted to a large degree many months ago, but the further compromise deals and lack of fiscal agreement has meant Europe has dominated recent weeks and led to increased investor risk aversion.
As financial ‘panic’ hit the global equity markets, so investors retreated to Sovereign bonds during the quarter, pushing yields inexorably lower. This has meant the 10 year Swiss yield has fallen below 1%, the US equivalent has fallen below 2% and in the UK yields have fallen below 2.5%. Add in some elevated levels of inflation in many economies and investors are facing negative real yields. The key question is, are things so bad in the global economy to make such yields palatable?
Indeed on a Citigroup volatility measure we are now back to the elevated levels last seen during the Lehman crisis. At the time of writing the broad Euro Stoxx equity index is down 24% year to date in local currency and sovereign bond yields in many countries remain at elevated levels. There are now real concerns that the debt crisis is now affecting the ‘real’ economy. Germany has just registered the lowest investor confidence figure since December 2008 and persistently weak business and consumer confidence could lead to further downside across the region. On a positive note, the renewed weakness in the Euro as a currency, after a bewildering period of relative strength, is good news for the exporting side of the economy. One thing that is certain is that the Greek people should be prepared for even more austerity measures. We are still in the midst of the nation trying to secure the next tranche of bailout monies to avoid default. However the very notion of markets rising/falling on the back of a mooted conference call, demonstrates that a swift resolution is vital. Fundamentally, the least painful option would be for Greece to leave the Euro, having undertaken some form of orderly default. At least the devaluation of the ‘drachma’ would create economic growth, although there could be short term elevated investor fears on the peripheral banks. Contagion is the word investor’s fear the most and the inability to solve the Greek crisis and quite frankly the lack of funds available makes the consequences of an Italian or Spanish bailout totally unacceptable. As an aside the thought of a leveraged European Financial Stability Fund as suggested by US Treasury Secretary Geithner makes us shudder! The French banking sector has very much been in focus, given not only the large holding of Greek bonds but also the rather optimistic provisioning. We would be in favour of some form of Government backed recapitalisation of the sector. There have already been stories that industrial companies, such as Siemens, have pulled large deposits from BNP Paribas and Societe Generale. Given the lack of political unity in the monetary union it could potentially be time for the dismantling of the Euro and the creation of a new currency regime. Another solution to the current crisis would be for the ECB to make an open ended commitment to purchase troubled sovereign debt for a period until yields fall into a pre determined range. It seems that the previous favoured route of issuing Europe wide bonds has been shuffled down the agenda, particularly since S&P stated they would not be guaranteed an AAA credit rating. In fact the estimated Government debt to GDP ratio under this scenario would be 95%.
Clearly the current phase of the Euro Zone crisis is highly dangerous and the independent, financial viability of many financial institutions has been called into question. The UK, given its position outside the Euro has enjoyed a safe haven rally; yields at the start of this quarter were still 3.5%. Over the quarter the European Central Bank purchased sovereign debt in the secondary market to try to bring yields down in nations such as Italy and Spain to ‘sustainable’ levels. As ever, as soon as this was completed yields moved out again! Essentially an open ended commitment is needed to purchase the bonds but this comes unstuck in the face of German opposition and is likely to have been the main reason behind the resignation from the ECB of Jurgen Stark. It will also be interesting in the coming weeks to whether the ECB, which is typically hawkish, give in to the politicians and reverse the interest rate cut of earlier in the year. In the US, the Federal Reserve has recently unveiled ‘Operation Twist’, in an attempt to keep long term interest rates at lower levels. There is no net new money added in the operation, simply an extension of durations. The policy was used before in the early 1960’s when the Fed was also concerned about economic growth. We already know that interest rates are likely to be unchanged until at least the third quarter of 2013 and it is our view that as well as the explicit inflation target, that an unemployment level may also be set. This could unnerve the bond markets as potentially the Federal Reserve will allow higher levels of inflation, until for example, unemployment falls below 8%. Given the ‘risk off’ conditions it has been unsurprising that corporate bonds have seen yields rise and spreads widen. This has particularly affected financial issuers with longer durations. The level of credit spreads is now suggesting at least a mild recession. With generally strong balance sheets, we would not be surprised if corporate default rates are less than the market is pricing in. 5.5 5.0 4.5 4.0 3.5 3.0
10-15 Year UK Gilt Yields
2.5 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11
Capital International
Source: Bloomberg - data as at 30/09/11
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Economy in Focus: Norway The Norwegian economy has been particularly resilient during the financial crisis with a relatively shallow recession and moderate increase in unemployment. As Norway moves into what is projected to be a strong recovery, the authorities need to plan how to unwind the extraordinary measures that were taken to confront the crisis. Interest rates have already been raised, the special liquidity measures have been progressively withdrawn and monetary policy will need to tighten further over the next two years. The appropriate pace of tightening will primarily depend on developments of the Norwegian economy and the outlook for inflation. Policymakers should also continue to pay attention to developments in the property market, which are fuelled by low interest rates, and trends in the foreign-exchange market, which could react to widening interest-rate differentials. An early consolidation of fiscal policy would reduce the need for monetary tightening and the related risk of exchange-rate appreciation. It is essential to maintain the basic fiscal framework, built round the “4% rule�, and soon start the process of bringing down the non-oil structural deficit to a level consistent with the rule. The Norwegian financial sector came through the financial crisis without serious damage. In the aftermath of the crisis it is important to strengthen the macro-prudential approach, in coordination with European and other international initiatives. Despite substantial income from petroleum wealth, Norway is nevertheless confronted with fiscal challenges in the long term. The number of older persons (aged 67 and above) is projected to almost double by 2060, making this age group as large as 40% of the working-age population. Because the bulk of net public transfers go to older people, government expenditures will increase sharply in the absence of reform. On this basis, the Norwegian authorities currently estimate a long-term fiscal gap, defined as the difference between the structural non-oil deficit and the expected return on the Government Pension Fund Global, of about 6% of mainland GDP in 2060.
In other words, by 2060, fiscal measures to increase revenues or reduce expenditures in the amount of 6% of GDP are needed to secure the sustainability of public finances. These estimates are surrounded with uncertainty and rely on a number of stylised assumptions, but taken at face value they imply that major policy changes are required, so as to avoid an undesirable increase in the tax pressure. Completing the pension reform and reforming the disability and sickness leave schemes, which are both crucial for achieving strong labour participation in the future, would make important contributions. Norway gives priority to the objectives embodied in the OECD Green Growth Strategy and sees itself as a pioneer in some areas. The sustainable development strategy, an integral part of the documentation for the budget, spelt out the key principles that were intended to guide policymaking and a set of quantitative indicators that are intended to give an indication of progress. Its focus on preserving natural capital and the precautionary principle can indeed be seen to be reflected in Norway’s policy aims on climate change and on fisheries, two otherwise rather different problems. Another principle is the use of cost-efficient means to achieve these policy objectives. In many ways Norway has pioneered the use of such measures, introducing a CO2 tax early on and adopting individual quotas in fisheries. But in other ways policy prevents them from playing their full role, exempting significant sectors from the CO2 tax and now from the emission trading system, and restricting the tradability of quotas in fishing. Some potential conflicts between sustainable development objectives could be given fuller recognition, and that Norway can and should follow through more strongly the logic of its pioneering use of economic incentives to further sustainability goals.
The Norwegian economy has been particularly resilient during the financial crisis Capital International
Yara International Yara International is the world’s leading chemical company that converts energy, natural minerals and nitrogen into essential products for farmers and industrial customers. Their industrial product portfolio includes environmental protection agents that prevent air pollution. Yara is headquartered in Oslo with operations in more than 50 countries and sales to about 150 countries. Yara’s global activities range from phosphate mining and ammonia production, through commodity trade and energy arbitrage, to building local market knowledge and developing customer relationships. The backbone of the company’s operations was large scale ammonia and fertiliser production in Europe, but in recent years new capacity has been added in region’s with low cost gas supplies, the Middle East and North Africa, Trinidad and Australia, today representing about 35% of Yara’s production volumes. The stock market seems to place too much emphasis on changing trends in the likes of corn and wheat prices rather than focusing on the actual price level, and the implications for fertiliser economics. Yara has an approximate two month lag effect on market prices, which means that the quarterly running rate should work as a six to twelve month benchmark adjusted for a negative or positive valuation factor. Looking at the latest revenue figures there is a positive 10% growth factor. A key feature is the strong balance sheet that reduces market and industry risk. Recommendation: BUY
Statoil Oil Company Today, the company is one of the world’s largest suppliers of oil and gas. In 1972, the Norwegian State Oil Company, Statoil, was formed, and two years later the Statfjord field was discovered in the North Sea. In 1979, the Statfjord field commenced production, and in 1981 Statoil was the first Norwegian company to be given operator responsibility for a field, at Gullfaks in the North Sea. Statoil merged with Norsk Hydro’s oil and gas division on the 1st of October 2007. The new company was given the temporary name of StatoilHydro, and the new company reached a size and strength for considerable international expansion. The company changed its name back to Statoil on 1st November 2009. The Statoil share has demonstrated defensive qualities, from peak to trough in 2008; the OBX was down more than 70% while Statoil was down approximately 50%. The key risk factors to the share price are future oil and gas prices, production ramp up and production guidance, as well as the increasing gas portion of the overall production. Over the next few years the company is expected to increase its gas production from 40% to 45%. An increased portion of gas contract based on spot prices could have a negative impact on Statoil’s future earnings and relative position to less gas intensive peer companies. Recommendation: BUY
Telenor Group Telenor is the leading provider of mobile telecommunications and fixed line communication services in Norway and the leading provider of television and broadcasting services to customers and enterprises in the Nordic region. Telenor is also a significant provider of mobile telecommunication services internationally. Telenor’s current operations fall within three geographic clusters: Nordic (Norway, Sweden and Denmark), Central Eastern Europe (Hungary, Serbia and Montenegro) and Asia (Pakistan, Bangladesh, Thailand, Malaysia and India). Telenor has a total of 31,698 employees in its fully consolidated operations, of which 24,837 employees resided outside Norway. The telecom sector has historically performed well in challenging macro conditions, and Telenor only saw a very modest downturn in the last recession. Telenor is attractively valued, both from an absolute and relative perspective. Record low debt level could enable the company to significantly increase dividends from current levels (7-7.5% total yield). Adjusted for costs related to the India expansion, the share is attractively valued at about P/E 9x on the latest 2011 EPS estimate. Recommendation: BUY
© Capital International Limited 2011
Economy in Focus: South Africa South African equity markets reflected global investor anxiety during the third quarter of 2011 with financials and industrials struggling while gold miners enjoyed strong gains as the precious metal gained 9.7% over the quarter, having surged by more than 26% at its peak during August. Gold has been a consistent theme over the last 12 months as the precious metal has risen 39% in Rand terms over the period. Smaller producers with flexible or zero production hedging policies have been favoured during the bull market in gold while the larger players have been more cautious and have been playing catch up to a large extent during the third quarter. AngloGold Ashanti Plc and Gold Fields Ltd (South Africa’s fourth and seventh largest companies by market capitalisation) both gained by more than 20% over the quarter having largely missed out on much of the earlier gains. Retailers also fared well as analysts considered the sector as better placed than many of its peers to pass on inflationary costs to consumers. Woolworths Holdings Ltd, the upscale retailer of food and clothing increased profits by 8.5%, raising hopes that surplus cash would result in a share buyback, pushing its share price up by 22.6%. South Africa’s largest retailer, Shoprite Holdings Group also rose following a solid performance and a confident investor presentation. It proposed opening over 100 new stores across South Africa to counter the threat from WalMart’s entry into the South African market thus preserving the incumbent’s dominant position. With GDP growth anticipated at 3.3% for 2011 and rising by a further 1% over the next two years, investors are buying into the retail sector in the belief that growth will fuel demand without leading to the high inflation seen prior to the 2008 crisis and precipitating significant Reserve Bank activity to stave off the inflationary threat. Another beneficiary of this effect is Tiger Brands Limited, a major manufacturer of food products and pharmaceuticals with a robust product line and defensive attributes. The last 12 months have seen Shoprite and Tiger Brands rise 22.7% and 16.8% respectively. Promising results from two of South Africa’s telecoms companies also lifted the broader market; MTN, South Africa’s largest company by free float and its biggest fixed line and mobile operator showed significantly improved performance after a torrid 12 months. Its investments in Nigeria are now starting to deliver, making its decision to pay $285 million for a GSM licence in 2001 now reaping rewards. Company estimates suggest that data usage will play a greater role in revenue growth to rise towards 20% to 30% of total group revenue. The company is active on 22 African and Middle Eastern markets with an average mobile penetration rate of approximately 40%, leaving ample capacity to continue its trend of growing profits faster than revenues.
Capital International
Increased data usage by subscribers was key to MTN’s rival Vodacom, growing revenues by 8.1%. Vodacom, which is majority-owned by Vodafone, is a pure mobile telecommunications story and has dominant positions in South Africa, Tanzania and Malawi. Confidence was less visible in the banking and financials sector; the dual-listed Investec lost 18% as concerns over contagion from the Eurozone crisis continued to persist with banking stocks suffering globally. The same macro concerns dominated the performance of the diversified miners such as BHP Billiton and Anglo American which both fell 18% as the prospect of global recession emerged once more. Their core businesses of base metals and coal were seen as highly exposed to any potential setback due to their heavy reliance on Asia and China in particular. The Rand itself had a particularly poor month, even by its volatile standards, and indicative of the extremely high volatility in the currency markets. The Rand weakened against virtually every global currency bar the Polish Zloty and the Brazilian Real. It weakened over 15% against the US Dollar as investors sought refuge in the global reserve currency and the Japanese Yen against which it saw an even more dramatic movement, falling by over 20% as the Yen is perceived as less reliant on external sources of funding and therefore carries more of a ‘safe haven’ premium. Rapid unwinding of carry trades was also a factor in the speed of the decline as speculative trades in the higher yielding Rand were sold to close out short US Dollar and Yen positions. Whilst unemployment in South Africa remains stubbornly high at 25%, its combination of a rich blend of natural resources and its geographic positioning as the gateway to the natural wealth of sub-Saharan Africa provide opportunities to investors leaning toward an export-led and commodity-driven global recovery.
Emerging Markets Debt Emerging market assets have fallen recently as investors have moved out of local emerging market currencies and back into the relative ‘shelter’ of the US Dollar. Much of the recent movement was triggered by the US Federal Reserve which stated that the downside risks to the US economy were now ‘significant’. This is the reverse of the flows which we have seen over the last couple of years, where investors had almost considered local emerging market debt as a safe haven away from the Euro Zone debt markets. There has been a long held view that returns on such debt would surpass UK inflation for instance, as the currencies would enjoy a long term, structural strengthening against Sterling. A study of UK pensions funds found that the average allocation to emerging market debt was less than 1% of the overall assets, compared to the emerging countries share of global GDP up around the 30% level. Despite improving liquidity and falling credit spreads, some are fearful that such bonds have become over-owned by foreign investors and that a wave of redemptions could lead to another crisis. For instance, the Indonesian Government revealed recently that foreign investor holdings of its debt had fallen by nearly 6% in just one week. The economic prospects for the Emerging markets remain far brighter than for many Western economies and it strikes us that the recent falls are somewhat over exaggerated and it could be an interesting period to build positions in Emerging credit. One of the biggest challenges remains inflation, which in Brazil is currently running at over 7% per annum and crucially is now affecting ‘inflation expectations’. The minimum wage is due to increase by 15% in 2012 and many private sector wage settlements are now running at 10% per annum increases. Current redemption yields are approaching 12% on Government debt, so compared to the UK, the net yields could still look interesting. Currently corporate bonds only make up 20% of the benchmark but this is likely to grow in time. There will be an increasing transition of issuers moving from the high yield area into high grade and eventually investment grade as they develop. There will also be a trend towards both Government and Corporates issuing inflation linked bonds. This could be a particularly interesting area for credit investors as you are essentially getting insurance cover, although they do tend to incur a longer duration. One thing that is certain is that the Emerging currencies are likely to remain volatile, although some weakness will act as a support to the export sector. With the recent sharp falls in commodity prices there will be some weakness in the likes of the commodity currencies such as the South African Rand and the Mexican Peso. In a surprise move recently, the South Korean Central Bank stepped in to support the Won with a $4 billion measure and in Brazil, the Central Bank has spent nearly $3 billion to try to stop the rapid decline in the Real.
Investors have moved out of local currencies & back into the US Dollar
Gold should continue to benefit from its ‘safe haven’ status Capital International
Market Outlook: Commodities
Currency Insight: Swiss Franc
Investors are currently struggling in assessing the short and medium term prospects for the commodity sector. There are a wide range of views which seem to be finely poised between optimism and mild despair, influenced heavily by the Euro Zone crisis and a potential recession in the US. In the third quarter, base metals look set to experience a fall of around 6-7% and have been resilient in the face of the increased investor risk aversion. Although, there are now some signs that this is beginning to break down, in part created by the recent strength of the US Dollar and downgraded GDP growth forecasts.
The long sustained rise in the relative value of the Swiss currency has certainly augmented its position as one of the world’s leading reserve currencies Indeed it was only as recently as 2000 that the legal requirement for 40% reserve backing in Gold was removed by a national referendum. The neutrality of the country, the healthy current account surplus, political stability and strong Government finances have long been supportive factors.
Copper has been very volatile recently and despite having some of the best supply/demand fundamentals, is probably the most exposed to weak economic sentiment. This is primarily because the selling price is still so far above the costs of production. The industry has been suffering from falling grades, although production levels are forecast to pick up in 2012. A supportive factor will be that the Chinese de-stocking cycle appears to be coming to an end and so imports could start to pick up. However the broad message for Copper will be one of volatility. Crude oil has been weak in the current quarter falling by over 15%, primarily on downgrades to global GDP forecasts and the prospects for renewed production from Libya. There are grounds for thinking that demand from non OECD nations will continue to be robust and act as a major support to the price. It would take a relatively severe double dip recession to take the price per barrel down towards the $70 level. The third quarter of 2011 will after all register the strongest level of oil demand ever. The risks to further disruptions in Middle East supply remain high, notably Iraq where the local situation remains very dangerous and Algeria, which controls a vital hub. We therefore remain positive on the Energy sector. Precious metals offer a mixed picture, although Gold should continue to benefit from its ‘safe haven’ status, investors should however keep a close eye on the US Dollar. Over the quarter the metal is currently up 16%, boosted by the Fed declaration that interest rates would be on hold until at least mid 2013. The technical uptrend has also remained in place and it looks like the average price for 2011 will now be over $1,600 per ounce. Given the large net inflows into the metal, notably in ETF’s, it will be interesting to see how long the current turbulence will last. Agricultural commodities have been more robust in the last quarter, with a broad based increase of just over 4%. Historically the sector has moved independently to other asset classes and the long term global demographics remain highly supportive. However there has been a growing level of criticism at the scale of financial speculation in the sector, which is contributing to growing food price inflation. It is estimated that speculators now account for 60% of the agriculture futures market. Of the specific underlying commodities, we believe that Wheat is starting to look interesting, supported by some poor US weather conditions.
The rises in the Franc however, have caused pain for the domestic economy and only recently have economic growth expectations been further downgraded. The Federal Government now believe that GDP growth in 2011 will be as low as 1.9% and for 2012 growth is seen as low as 0.9%. The previous growth forecasts were 2.1% and 1.5% respectively. The export sector has been a clear loser in recent months. The extent of the rise in the Franc was highlighted in the unexpected move by the Swiss National Bank of an imposition of a ceiling on the exchange rate against the Euro. This was the first such move in over 30 years and the authorities stated that they would defend the target with the ‘utmost determination’. This move prompted a record fall in the currency and could have been a major contributory factor in the recent ‘rogue trader’ losses announced by, rather ironically, UBS. The Bank has also reduced the Libor rate to zero from 0.25% to further lessen the attractions. Essentially the Central Bank will create unlimited amounts of Francs and sell them against the Euro to contain the level. Clearly the costs of such an exercise will be difficult to ascertain but they are likely to be very large figures indeed. The phrase ‘endless’ has been used. Investors will remember the huge sums that the UK Government lost in the 1990’s trying to defend the Pound and equally the vast sums that speculators such as George Soros made on the other side of the trade, particularly on ‘Black Wednesday’. Over the summer months when Euro Zone fears hit their highest, the exchange rate of the Franc against the Euro hit parity, making a 16% rise for the year. On the global purchasing power index as measured by the OECD, the Franc was approximately 40% overvalued. Swiss corporate earnings have thus far been remarkably resilient in the face of the currency strength, but recently Nestle highlighted the problems, reporting a 13% fall in sales and focussing on productivity gains to rebuild margins. Other companies to struggle have included the watchmaker Swatch and the industrial conglomerate, ABB. It is fair to say that the major exporters have all been lobbying hard. There have been other countries that have also been forced to take action over currency valuations, notably Japan. On August 4th the Bank of Japan achieved an unenviable one day record of $58 billion spent in one day on currency intervention. Unfortunately such measures have done little to weaken the Yen. Brazil also made an aggressive interest rate cut during August, which has seen the Real fall by over 7% in recent weeks against the US Dollar.
© Capital International Limited 2011
Sector Focus: Hotels & Leisure Hotels have delivered somewhat volatile trading data so far this year. In January and February London demand dipped, but a strong March, a sparkling April and a spectacular May and June suggest London’s juggernaut run isn’t ready to stop just yet. Outside London, hoteliers managed to keep revenue per available room (RevPAR) growth positive in the six months to June. Regional average daily room rate (ARR) still fell by 1.9% in April and a further 0.5% in May, despite easier comparables. To understand these latest trends and what’s powering certain hotel demand segments faster than others and why some may be stalled or at best idling we need to look to a range of issues including the constituent strands of GDP growth. This shows that although the economy experienced 0.5% growth in Q1 and 0.2% in Q2, consumer spending and investment in the UK contracted. Both are expected to bounce back again which is better news for hotels. However, in the current environment it’s anything but easy to know what many corporates and consumers are planning. The super rich may be alive and well and spending in London but many UK consumers are struggling. London’s hotel market continues to perform considerably better than the UK regional market. But in the first two months of 2011 the capital saw a reversal of recent demand growth with unexpected occupancy declines in January and February of 2% and 3.8% respectively, taking occupancies to 69.2% and 75% respectively. Demand picked up again in both March and April, but was flat in May and June. Surprisingly, the Royal Wedding in April doesn’t appear to have attracted the bonanza some observers hoped for. Nevertheless, despite the impact to corporate business from the protracted Easter shutdown, it was a very good result as occupancy in April recovered to grow by 3% to 79.9% and ARR saw further strong growth of almost 12% driving a 15% gain in RevPAR to £100. In May it was all about rates as a 19.3% leap drove RevPAR up by 20%.
Capital International
Inbound travel, especially for business appears to be picking up. With consumers under pressure, despite their enthusiasm for holidays, continued business confidence and travel is essential to support the hotel sector recovery. Overseas visits to the UK are estimated by the Office of National Statistics to have increased by 4% in Q1 2011 to 7.5 million visitors compared to Q1 2010, with business visits continuing to strengthen, up by 9% to 1.74 million visitors. Holiday visits were up by 2% to 1.95 million. The provinces continued to recover from recession slowly in Q1, but growth has been fairly lack lustre and conditions are likely to become more challenging as the region’s higher susceptibility to weaker domestic demand continues. Consumers face testing times and consumer spending remains under pressure. Improving business volumes triggered the recovery of the domestic hotel market, with business room nights up by two million nights in 2010 and continued recovery will depend on business confidence holding up. Despite some easy comparables with 2010, hoteliers overall managed to lift rates by only 0.8% in Q1 2011, compared with a decline of 4.5% in 2010. In April regional hotels managed a 2.6% occupancy gain but rates saw their first fall of the year, with a 1.9% decline to £57.38. In May rates fell a further 0.5% to £59.56 and occupancy only managed a 0.9% rally. Of course the Provinces are a large area and, as ever, performance varies considerably by city, product and brand. All regions experienced a moderate rise in output in 2010 and the same is expected in 2011. The South East may tend to lead the recovery to some degree, while Northern Ireland, the North East, Scotland and Wales are likely to be worst hit by public sector spending and could lag behind. In addition, there remain plenty of more headwinds to confront and much to worry about that could derail the sector’s progress.
InterContinental Es aut qui natio deri tes con non pore sit offic tem ex ea volenis est reicia dolorat eaquidem. Ehent del magnihi llupti site nonseni rerehenda pelenda ditiunt, qui te eria etur, venimagnatum erum in cum evel imos et ius in nam, quibus rem et ipsaper umquam deleniatur audist quunti nihicidusam santiur? Ihillan dandicias iusam autem sim vendica borecuptas endam nosa anihill aborrorist lat aut mosanit qui idellentem. Hendita tiaecus aspid qui dolestibusam quae prest volupic illuptat re dem volupic tendignatur? Quis iurerun tectatectur, sa voluptur sit et, si nobit latiumqui qui il ium core, te volor assintius sita il ium in et exera dus sequis voluptatet adis ea es nus pe conestiatur sum ipsant quiasperia voluptatint pellese quaeserrovid quae eum quamentis solum ium excerorum estiuntur sim et apeditatet mi, ipitiusam re volorer ectiandem fugit que lique arum utatur? Liquamus rescipide doluptur? Qui as adiae veni autam sunt pro qui to que labo. Ut quia comnis ium qui optatiu ribeaqu untions enditia spicaecus, voluptate nonectatio. Xerferoratur mosam, ipsanduntin num faceper fernatem quiae reris aut alis derianimus. Endandanis demporro in recte simolores eaqui blantio magnim ex elibus, odipsam dolorehenis sit, et re culparum fugia vitiis quasper chiciam quam quis dolore poressit, sim acita volor simusda Recommendation: BUY
Carnival Corp
Whitbread Plc
Es aut qui natio deri tes con non pore sit offic tem ex ea volenis est reicia dolorat eaquidem. Ehent del magnihi llupti site nonseni rerehenda pelenda ditiunt, qui te eria etur, venimagnatum erum in cum evel imos et ius in nam, quibus rem et ipsaper umquam deleniatur audist quunti nihicidusam santiur?
Es aut qui natio deri tes con non pore sit offic tem ex ea volenis est reicia dolorat eaquidem. Ehent del magnihi llupti site nonseni rerehenda pelenda ditiunt, qui te eria etur, venimagnatum erum in cum evel imos et ius in nam, quibus rem et ipsaper umquam deleniatur audist quunti nihicidusam santiur?
Ihillan dandicias iusam autem sim vendica borecuptas endam nosa anihill aborrorist lat aut mosanit qui idellentem. Hendita tiaecus aspid qui dolestibusam quae prest volupic illuptat re dem volupic tendignatur? Quis iurerun tectatectur, sa voluptur sit et, si nobit latiumqui qui il ium core, te volor assintius sita il ium in et exera dus sequis voluptatet adis ea es nus pe conestiatur sum ipsant quiasperia voluptatint pellese quaeserrovid quae eum quamentis solum ium excerorum estiuntur sim et apeditatet mi, ipitiusam re volorer ectiandem fugit que lique arum utatur?
Ihillan dandicias iusam autem sim vendica borecuptas endam nosa anihill aborrorist lat aut mosanit qui idellentem. Hendita tiaecus aspid qui dolestibusam quae prest volupic illuptat re dem volupic tendignatur? Quis iurerun tectatectur, sa voluptur sit et, si nobit latiumqui qui il ium core, te volor assintius sita il ium in et exera dus sequis voluptatet adis ea es nus pe conestiatur sum ipsant quiasperia voluptatint pellese quaeserrovid quae eum quamentis solum ium excerorum estiuntur sim et apeditatet mi, ipitiusam re volorer ectiandem fugit que lique arum utatur?
Liquamus rescipide doluptur? Qui as adiae veni autam sunt pro qui to que labo. Ut quia comnis ium qui optatiu ribeaqu untions enditia spicaecus, voluptate nonectatio. Xerferoratur mosam, ipsanduntin num faceper fernatem quiae reris aut alis derianimus.
Liquamus rescipide doluptur? Qui as adiae veni autam sunt pro qui to que labo. Ut quia comnis ium qui optatiu ribeaqu untions enditia spicaecus, voluptate nonectatio. Xerferoratur mosam, ipsanduntin num faceper fernatem quiae reris aut alis derianimus.
Endandanis demporro in recte simolores eaqui blantio magnim ex elibus, odipsam dolorehenis sit, et re culparum fugia vitiis quasper chiciam quam quis dolore poressit, sim acita volor simusda
Endandanis demporro in recte simolores eaqui blantio magnim ex elibus, odipsam dolorehenis sit, et re culparum fugia vitiis quasper chiciam quam quis dolore poressit, sim acita volor simusda
Recommendation: HOLD
Recommendation: BUY
Hotels have delivered somewhat volatile trading data so far this year Š Capital International Limited 2011
Treasury Services: Euro Zone Exposure It’s fair to say that “the Euro Zone is intensive care”, but that the real problem is getting consensus on how to cure it of its recurring solvency ills and allow it to once more assume its important role on the global economic stage. With French banks, according to some sources, leveraged more than four times France’s GDP, and banks in other Euro Zone countries potentially in a similar situation, it is little wonder market volatility has shot up dramatically in recent weeks as European politicians show little sign of being able to resolve the problems definitively as opposed to simply just doing enough to somehow muddle through each crisis as it develops. Several potential solutions have of course been suggested including allowing the ECB to support solvent governments with unconditional and unlimited liquidity, but so far the ECB and Germany among others appear reluctant to go down this road fearing that purchasing government bonds is tantamount to monetising sovereign deficits. In its final analysis ‘The Economist’ contemplates the likely cost and impact of some countries such as Greece exiting the Euro and warns that while there could undoubtedly be advantages longer term, the short term cost both financially and in terms of potential civil unrest could be very high. In conclusion “the real worry for investors and European leaders alike is that a Greek departure could trigger panic elsewhere, with runs on banks in Portugal and Ireland and maybe Italy and Spain. Though the euro area may have proved a disappointment in economic integration, financial integration has gone apace – which now proves the opposite of a consolation. The Euro Zone offers scope for contagion and confusion on an epic scale. That is what makes its crisis so troubling and so hard to treat.” All this gloom is not a surprise and we therefore have to take steps to balance this. For the moment however until the Euro Zone crisis is resolved, Capital Treasury Services will recommend the following: ‘continue to underweight those countries within the Euro Zone and focus on areas/banks and financial institutions that might be more insulated’. We have not held any peripheral bank names in the portfolios for several years, especially in Greece or Italy and more recently we have reduced our exposure to French names. Otherwise the CLMA portfolios are very conservatively positioned and continue to be so. Our investment philosophy for the funds under management is capital preservation first and foremost, liquidity, and thirdly a competitive yield, but not at the expense of the first two objectives.
Capital International
Events: China Summit The Isle of Man will be promoted as an international business centre at an event in Shanghai in October. Representatives from the Capital International Group, Department of Economic Development and the ILS Group will attend the China Offshore Summit event on October 26 and 27. They will take part in a half day seminar event called “The International Tool Kit: Achieve your wealth management goals through international offshore structures and investments.” The seminar will address the benefits of using effective investment management, offshore fund structures with a global fiduciary services provider and will use Isle of Man case studies and solutions to show individuals how to achieve their wealth management goals. There will be a dedicated audience of more than twohundred and fifty business leaders and entreneurs from around the globe and everyone will certainly ensure that they take the Manx message home with them. Anthony Long, CEO of the Capital International Group of companies stated that the Group’s presence at this summit is further evidence of how far they have come in such a short space of time - something definitely worth celebrating on the anniversary of our fifteenth year in the financial services. The China Offshore Summit has been designed to explain to China’s top financial intermediaries how they can benefit from the unique asset management and corporate product offerings available in the world’s international offshore financial centres. The Isle of Man is an established platform where business success and prosperity are commonplace and are delighted that we will be promoting the Island’s unique offering to our Chinese delegates. More than two-hundred and fifty Chinese professionals, entrepreneurs and financial intermediaries will attend the China Offshore Summit which will include presentations, workshops and panel discussions addressing issues in China’s outbound offshore investments. Anthony went on to say “this is a momentous occasion for the Group. We are looking forward to our involvement at this prestigious event showcasing the Isle of Man alongside the Isle of Man Government and the ILS Group, as well as being able to promote our comprehensive range of investment services.” To further support the Island’s presence in the Far East both the Department of Economic Development and the ILS Group will exhibit at the Society of Trust and Estate Practitioners (STEP) Asia conference in Singapore at the beginning of November.
RDR Update: Getting Ready The Retail Distribution Review (RDR) is a key part of the consumer protection strategy by the UK Financial Services Authority. It is establishing a resilient, effective and attractive retail investment market that consumers can have confidence in and trust at a time when they need more help and advice than ever with their retirement and investment planning. The Isle of Man Financial Supervision Commission has maintained a watching brief on developments of the RDR and has been assessing the potential impact of this initiative on its licenceholders and the Isle of Man’s financial services industry generally. Earlier this year, the Commission confirmed its intention to introduce principle elements of the UK’s RDR into the Isle of Man’s regulatory framework with added responsibilities being placed on those individuals who provide investment advice to retail clients. In the context of the Isle of Man Financial Services Act, it is intended that RDR will transmit directly to Class 2 (3)(7) licenceholders and therefore should not apply to all companies within the financial services industry on the Island. RDR has particular aims of ensuring that those who are providing advice to the retail market are professionally qualified to a higher level than ever before and that their knowledge is maintained by comprehensive, relevant and annually audited Continuing Professional Development (CPD). It is an unfortunate reality that knowledge and experience are no longer enough to perform at certain levels within the financial services industry and as a result, competence may only be established by professional qualification. So while RDR will affect a relatively small percentage of the industry, companies have taken this opportunity to raise the bar of professional competence for their entire management and control structure. By compelling directors, senior managers, manager and aspiring managers to become professionally qualified, it is envisaged that on the required implementation date of RDR that not only will the required financial advisers be RDR compliant, but the entire management structure of financial service companies will also be able to tangibly demonstrate integrity and excellence both internally and externally.
RDR is a key part of the consumer protection strategy by the FSA in the UK © Capital International Limited 2011
Capital International
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