Economic Forecast - July 2009 …

This is the latest in a line of reports dating back to 2005 (published on the internet since 2007), where we have accurately reported and sometimes predicted events; such as the housing crash, the state of the economy, public finances and, even, the madness of the banks!

Many people have an opinion on the current state of investments and the only constant, seems to be that everybody has a vastly different viewpoint to the next person.
To understand where to invest, and what to invest in, needs to have both a pragmatic view of the world and its economies, as well as systems to back it up. Listening to highly qualified advisers such as the Independent advisers at AisaProfessional should certainly help you gain a better understanding of investments, with confidence that we have been doing the job of reporting accurately for years and have the systems in place. Furthermore we were in the running for the Money Marketing awards 2009!.

We should warn you that the views in this letter represent the opinions of Aisa and should not be construed as a statement of fact. Further advice should be sought before enacting any investment or tax planning. The Financial Services Authority does not regulate opinions on the economic outlook, nor does it regulate some forms of tax advice or comment.

Outline

Throughout 2008 the global economy moved quickly towards recession. This was not an isolated recession, caused by Inflation, interest rates or government borrowing, but a global economic downturn brought about mainly due to excessive asset values prolonged by leveraging (borrowing). When people became unable to repay their borrowing, or could not identify who held the debt and at what value, then this debt became ‘toxic’ and the Banks started refusing to lend to each other. How will economies perform in the near future? What will happen from here?
The banks had started to lend again (interbank spreads were back to ‘pre Lehman levels’), green shoots have been discussed but a hiccup developed in June 2009 with further bad data coming out of America. In the last week many commentators have said that the worst is behind us, but with still substantially lower credit available than 2 years ago, asset prices have still not stabilised and that we can expect a long slow (and bumpy) recovery.

UK Economic Outlook
Governments around the world have provided a massive stimulus in to the global economy that seems to have averted a 1930’s style depression. Given the size of the stimulus, it is expected that inflation will be the result, although this is not expected to happen immediately; some commentators are now reporting that this may be lower than generally thought and later than predicted due to the election in 2010. Additional reasons given are, as unemployment continues to rise it will exert a drag on the economy, the Chancellors proposed spending and borrowing is unsustainable and will have to be revised and high levels of debt will need to be repaid. It is thought that this will mainly be from cuts in public spending rather than tax rises, although some tax rises for 2010 have already been announced.
The logic goes that spending cuts will increase unemployment further and suppress inflation. Thus, the probability is that the UK economy has avoided the depression scenario and now needs to be navigated through the painful process of repaying the huge overhang of debt. As in any scenario, this will provide opportunities as well as difficulties. As far as investing goes, let us now consider the different asset classes in turn.

Equities

Equities fell off a cliff in 2008 as a 1930’s style depression was priced in. This has now been seen to be overdone and in the last six months, the markets have seen gains, to the middle of June, in the region of 25% (although there is ongoing volatility as this is written). Ironically, those with high risk attitudes and who invested six months ago could now crystallise gains out of this dire economic situation! From here, although the returns are likely to be volatile, the ‘overall’ path to the end of 2010 should now be upwards. Short term volatility will cause those who dislike risk to avoid equities, but long term returns should be good.
The returns are likely to vary according to the sectors in which you are invested and the stock selection. Some commentators are asking whether now is the time for passive investing? We are in a cycle where obtaining out performance is inconsistent. There is no doubt the most successful fund managers perform over a period of 5 years or more and that they produce returns in excess of a passive tracker fund. However, in the remainder of 2009 and 2010, how difficult will it be to outperform? Surely an argument can be made for looking for greater performance from a small part of the equity funds you hold and going for passive returns from an index tracker where indices are near their lows?
Stock selection does have its benefits. The rally in UK equities over the last few months has produced some notable winners. Among those that have benefited are the mid-caps, many of which have provided returns far better than their larger peers. Some investors say their risk appetite has begun to return, and so small and mid-cap firms offer a particular appeal - with higher risk comes the potential for higher returns.
The apparent stabilisation in economic data has given cause for optimism, although a true economic recovery may be some way off. The recent weakness of sterling may continue, making exporting attractive, and it may signal good ‘buy’ opportunities from foreign investors where they can buy more sterling than before. There is support for the UK equity market from its extremely low valuation in terms of earnings, dividend and free cashflow. In short, we see an opportunity-rich market in the foreseeable future, and sterling may remain weak for sometime, but is likely to recover against other currencies that have yet to be fully explicit (the Euro).
Many firms with decent franchises have been priced for failure, often on account of balance sheet issues, and a good fund manager will ensure they are well placed to take advantage of such situations. Accepting that volatility will be a feature for some time to come, we are optimistic on investing in equities as long as you see them in the long term rather than short term.

Cash

It is difficult to continue to make the argument that we were, saying cash is the best bet. That was yesteryear and this is now. There is no longer a great argument for holding cash now in any great quantity, at a time where interest rates are at their lowest level on record, and many banks have state backing. Obviously an emergency cash deposit holding is always recommended, but after this need is covered there is little point holding this asset class when Cash yields are close to zero. Whilst those with a cautious attitude to risk will be looking for recommendations we have decided to add a section now on structured products.

Structured Products
A growing demand for Absolute Returns (beating Cash) and Capital Protection has lead to a growth in the market for guaranteed investments. These are usually asset backed investments where the institution purchases a type of derivative called an ‘Option’. This gives them the right to purchase a share at a specific price, so if their chosen share moves in the right direction they will exercise that right. However if the share goes against their expectations they simply do not purchase the share, therefore only losing the premium price paid for the Option. This structure allows large companies to offer more attractive returns than cash with 100% capital guarantee. Most products require the money is left invested for 5 years; however it sometimes possible to take the money early without penalty or even with some of the growth.
Structured products often raise their head at times like these and there is some argument to be made that if you feel the markets are likely to rise over 5 years, then why pay un-necessarily for a guarantee, and lose flexibility. Clearly, like everything, you should only consider structured products for part of your overall portfolio, and be aware of the downsides. However, for cautious investors, it could be a good type of investment to consider.

Property

UK rental values are falling as occupational demand for property mirrors the weaker economic environment. Low interest rates are creating a false dawn of affordability, which we anticipate will change again, probably during 2010. We do not think, despite what newspapers and estate agents are writing, that we are out of the woods yet. Already, we are seeing fixed rates increasing.
Residential property will continue to be affected by rising unemployment and we expect to continue to see property to continue to fall in value for some time yet albeit at a much slower rate. Taking into account the high costs of purchase, the tax, and the lack of liquidity property is not an easy option. International Property has been affected by credit constraints reducing the availability of capital for Property investment.
We consider that property should not be a large holding within a portfolio at the moment. With falling rental income, greater defaults through company failures and rising unemployment, we consider that the real time bomb still exists – that of rising interest rates and costs. We feel it remains advisable to avoid property purchase for 2009 and re-assess it in 12 months from now. There is far better value to be obtained elsewhere.

Fixed Interest

Such was the fear that a depression and very high level of corporate defaults was inevitable, that UK government bonds were in high demand and yields were falling. As this fear passes, the capital value of corporate bonds has seen good gains. There will still be defaults of course as we navigate through this economic storm but not at the expected levels in 2008 and so corporate bonds where a good buy as we said in late 2008.
However, investors are becoming uneasy about the very high levels of UK government debt, and this is leading to falling capital values of UK government bonds on one hand and increasing yields on the other. Governments are forced to offer higher levels of interest to get the capital they require. Some of the potential gains in these areas have been missed now and these assets are likely to be less certain of gains in the future, but opportunities still arise.

Conclusion

Are you interested in making money, getting income or forgoing both, in order to protect your money?

Throughout 2007 and 2008 AisaProfessional predicted that those of you purely in Equities or Property, at that time, were going to suffer increased volatility, possible high risks, and that you should take advice. Some people did and others did not! Remember that we combine our advice with the latest in tax planning, to prevent you losing more money to the taxman than you should.

We believe that fundamentals are returning. We also believe that the change in the world order will be accelerated by this economic storm, and that it is very important to review your portfolio and holdings in light of this. We believe to keep one step ahead, now is the time to structure your portfolio for growth, whether this is via structured products for those requiring a low risk approach or via an individualised portfolio including international exposure for those more accepting of risk.

James Pearcy-Caldwell
Director

Dated 5 July 2009 – valid for 6 months. AisaProfessional is a trading style of Aisa Direct Ltd, authorised and regulated by the FSA as Independent Financial Advisers. 1 Fordbrook Business Centre, Pewsey, SN9 5NU

Notes …

Please note that the opinions expressed in this letter must not be construed as statements of fact – you should carry out your own further research before coming to a decision and before taking any action.
The views in this letter represent the opinions of Aisa and should not be construed as a statement of fact. Further advice should be sought before actioning any investment or tax advice. The Financial Services Authority does not regulate opinions on the economic outlook, nor does it regulate some forms of tax advice or comment such as this.

* This newsletter has been prepared with all possible care to ensure its accuracy. It is based on our current understanding of legislation and HMRC practice. 
* Neither Aisa Direct Ltd nor any of its employees can accept responsibility for any errors or omissions. You should seek further professional advice prior to action.

This should not be deemed as individual advice and you should seek further information particular to your individual circumstances. For further information, contact AisaProfessional on (0845) 838 7279.