Monthly market update
July 2008 - Markets overview
Cash
Sterling: The Monetary Policy
Committee (MPC) again left rates unchanged at 5% following its
meeting in July. Seven members of the MPC, including the Governor
Mervyn King, voted to maintain base rate at the current level,
however, there were two dissenters. One voted for an increase of
0.25% to 'keep medium term inflation expectations anchored' whilst
the other voted for a cut of 0.25% to 'avoid inflation
undershooting the medium term target'. Market participants are
expecting rates to be kept at 5% during the months to come as the
MPC relies on an economic slowdown in the UK to bring inflation
back to target.
US dollar: The Federal Open
Market Committee (FOMC) has kept rates on hold at 2% following its
early August meeting. Headline inflation has been rising driven by
food and energy prices, and consumers' inflation expectations
remain high, however, households are not well placed to do anything
about this. Rising unemployment has resulted in a moderation in
wage growth and unit labour costs have been falling sharply - there
is no evidence of a wage-price spiral developing. As in the UK, the
FOMC expects a weaker economy and faltering demand to result in a
moderation of inflationary pressures and an easing in hawkish
interest rate expectations.
Equities (Sterling and US dollar)
The weakness which equity markets suffered
through June continued during the first half of July -by the 16th
the FTSE 100 had fallen over 1200 points in less than 2 months.
Ongoing pressure on the banking sector weighed heavily on investor
sentiment and a sharp fall in profits coupled with a very gloomy
outlook from Marks & Spencer darkened the mood. The second half
of the month saw a reversal in fortunes for equities in the UK,
particularly banking shares, which rallied strongly towards the end
of July. From a broader perspective, the MSCI World Index fell
1.96% in sterling terms during the month, which followed an 8.59%
fall in June. As expected, the effects of the credit crunch are
spilling over from the finance sectors to the wider economy in the
developed world, highlighted by the very poor trading conditions
recently reported by BMW, the German carmaker. Rising costs, weak
demand and deteriorating debtor books are increasingly common
problems faced by corporate management across numerous sectors and
industries.
Property (Sterling and US dollar)
The weakening UK economy remains a headwind
for the asset class as it has a negative impact on rental growth.
The withdrawal of credit or refinancing on less attractive terms
also continues to create a difficult environment for leveraged
investors. Many commentators are arguing an increasing number of
sectors in the UK commercial property market have fallen below
'fair value', however, they suspect the decline has not yet
bottomed as markets commonly overshoot during a correction.
Bonds
Sterling: Through July, both
UK gilts and corporate bonds recovered from the losses posted in
June. Inflation concerns remain a headwind for the asset class.
However, with consensus building for inflationary pressures to ease
during the second half of the year, investors are refocusing their
attention on the yield curve and future interest rate expectations.
Some economists are forecasting the UK base rate to be as low as
3.5% by the end of next year, which potentially presents
opportunities for fixed income investors.
US dollar: A key feature of
the US bond market through July was the out performance of high
yield versus investment grade -a sign some investors are 'bottom
fishing' and seeing value in distressed debt. Another significant
development during the month was the crisis at Freddie Mac and
Fannie Mae, the government-backed market makers for secondary
mortgages, as the state of the housing market continued to worsen.
The IMF has recently published a paper stating it sees no end soon
to falling US real estate values which has not improved the outlook
for mortgage backed securities. In common with the UK, economists
are arguing easing inflationary pressures will leave room for the
FOMC to cut rates and some have forecast Fed Funds at 1% by
mid-year 2009.
Alternative investments (Sterling and US
dollar)
Hedge funds: July proved to
be a very difficult month for hedge funds reflected by a fall of
over 2.50% in the HFRX Global Hedge Fund GBP Index. Many fund
managers are positioned long of commodities and short of financials
which has proved a very lucrative trade during 2008 -however, the
rally seen across financial stocks during the latter half of the
month coupled with falling commodity prices resulted in managers
suffering losses on both sides of this trade. Poor performance
through July has left the index quoted down 2.54% for the year,
which is a disappointment for some investors in the asset class,
however, with global equity markets down 12% over the same period,
the capital preservation afforded investors is clearly evident.
Commodities: Having traded
just above US$147 a barrel during the month, oil traded down
towards US$120a barrel as July ended, which represented the biggest
decline in more than a year. The slowing global economy may well be
finally tempering demand and leading to a softening in the price of
not just oil, but base metals too. The S&P Goldman Sachs
Commodity Index fell 11.82% in July and this number helps calibrate
the losses hedge fund managers have incurred on the trade described
earlier. Falling commodity prices, particularly oil, will improve
investor sentiment markedly and will also be well received by
central bankers given the mandates they have to fight
inflation.
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