Crawford investment strategy report: Poor economics and a rising market

Date: 23 Sep 2010


The Crawford Report sayslast few week have provided statistics showing a slowing economy in the USA and the UK. However the markets have surged upwards, through the summer ranges, taking many investors by surprise. The traditionally poor month of September has resulted in stronger markets for no great reason. Volumes remain weak as many investors are continuing to sit on the sidelines.

It appears third quarter trading has been poor for the Investment banks on Wall Street. There are fears of job losses and analysts are cutting earnings estimates.Client activity was, as expected, very slow for the summer months of July and August. However September has not made up for the shortfall and the volume of trading activity remains very low.

The trading boom of a year ago, as the market recovered, is unlikely to be repeated. These poor trading results combined with concerns over the global economic recovery and new regulations are likely to keep the sector under pressure. Overall we are concerned about the third quarter reporting season. It will be a difficult earnings comparison for many sectors as economic activity a year ago was much stronger.

FedEx, the US package shipping company, has warned of a slowdown in economic growth. The company is considered a bellweather for the global economy because of the broad range of goods it transports across the world. They have announced a consolidation of its struggling freight business and 1,700 job losses.

Debenhams is the latest high street chain to warn of rising prices. The group said that cotton prices and freight costs would push up prices by between 5% and 8% next year. Cotton has vaulted above the key $1 for the second time in history over worries about a shortage of fibre. Floods in China and Pakistan have been the main causes.If these costs cannot be absorbed into the supply chain then they will be passed onto customers. Last weeks inflation report showed that the price of clothes rose 2.8% in August. This helped push core inflation from 2.6% to 2.8%.

UK Economics

UK Borrowing: Borrowing increased by £15.3bn in August. This was a record high for the month and was £1.8bn higher than a year ago.Public sector debt is now at 64% of GDP. These are poor figures and the ones that the austerity packages will be designed to cut. Clearly the UK is going to have to be very austere and the consumer very frugal in order to see a decline to more sustainable levels. Will the economic recovery survive in the midst of such cuts?

UK Unemployment: There is evidence that public spending cuts are starting to take their toll as the number of public sector employees dropped 22,000 in the three months to July. In the same period private sector employment was up 308,000. This rise was driven by part-time workers.

Pay in the private sector has increased 1.2% in the past year which is well below the levels of inflation. The retail price index, which includes housing costs, has increased 4.7% in the past year. Households are thus poorer and this will effect sentiment and the strength of the recovery.

UK Lending: Mortgage lending in August was the lowest for any August since 2001. Mortgage approval declined, hitting the lowest level since April last year. Approvals from UK lenders fell to 45,000 in August from 47,000 in July. The data and trends add to evidence that housing market activity is drying up.Average UK property prices have fallen for the last three months.

Separate figures showed that lending to UK business continued to contract and that M4, “broad money growth”, had increased 0.2% month on month and 1.8% year on year. These figures are the weakest on record and shows that the UK economy is struggling to maintain growth.

Small firms are still struggling to get new credit. The few companies reporting easier access to finance were medium to large businesses. Despite the government and business leaders pushing for banks to help businesses the amount of lending to UK manufacturers has barely changed in two months.
Bank of England: The quarterly bulletin has found that high street banks have not been passing on the cuts in base rates to mortgage borrowers thus increasing their profit margins and rebuilding their capital base.

Lloyds has added around £5,000 to a typical home loan since the crisis began over two years ago.

The typical rate on unsecured loans such as personal loans and credit cards has actually risen from 8.5% to 11%. They are hedging against defaults on this lending and that they cant now sell payment protection.

Banks have been able to achieve these margins as there has been a reduction in the degree of competition in the sector following the crisis and ultimate consolidation. This is not good for the consumer or the recovery.

US Economics

US State Jobless Report: After a few months of modest improvement most states showed a worrying increase in unemployment during August. Twenty-seven states reported a rise in unemployment, thirteen showed a decrease and the rest were unchanged. California has an unemployment rate of 12.4%. More concerns for President Obama.

Fed Meeting: The Federal reserve said it was prepared to take new steps to boost the economy but deferred any action at this meeting. The next meeting is on Nov 2nd and 3rd when they will update their official forecasts, which will include inflation and employment levels.It is problems with both these factors which will probably result in the announcement of the second quantitative easing program.

They will push cash into the banking system by buying Treasury bonds and forcing down long term interest rates. More money in the system may produce a level of inflation and reduce unemployment. Other measures could be to give further aid to the housing market and even increase inflation targets. Republicans will not be pleased at the extra spending but the recovery is struggling and clearly needs help.

US Inflation: Core inflation, which excludes food and energy, showed no increase for the month of August. Core inflation is only up 0.9% over the past 12 months which matches the lowest 12 month gain in 44 years. However energy prices increased 2.3% after an increase of 2.6% in July. Food increased 0.2% over the month The recession and weak recovery has almost banished core inflation but the rising costs of food and energy will cause problems and can’t be ignored. Meat is trading at a 20 year high as corn and wheat prices continue to soar due to global droughts and floods and now poor harvests in the USA. Further increases are expected in food prices as the impact of the wheat crisis has not fed through to shop prices.

US Consumer Sentiment: The Reuters/University of Michigan survey has shown that sentiment is at its worst level for more than a year.Confidence has edged downwards as prospects for the economy were judged less favourably and distress over jobs and finances intensified in upper income families.

The possibility of the “Bush” tax cuts being removed has eroded confidence in upper income consumers in recent weeks.

A survey has reported no change in the confidence of US homebuilders. High unemployment continues to deter consumers from buying. The survey also showed that expectations for the next six months were not much better in terms of the amount of houses that would be built. For builders, the massive supply overhang of exisiting homes presents brutal competition to the new home market.A sector still very much in trouble.

US Foreclosures: A record number of homeowners lost houses to their banks during August as lenders worked through the backlog of distressed mortgages.Banks foreclosed on 95,364 properties in August, topping the May record by 2%.High unemployment, wage cuts, negative home equity and restrictive bank lending points to lingering pain in the housing market.

US Housing Starts: Rebounded more than expected in August, suggesting that the market was beginning to stabilize following the end of the homebuyer tax credit. However it must be remembered that this rebound is from very low levels and confidence remains extremely low.

Further figures showed that mortgage demand was down despite record low interest rates and the house prices have fallen for the second month in a row.The housing sector continues to be a major drag on the US economy.

Eurozone Economics

Ireland: There are fears in the markets that Ireland may turn to the IMF for a multi billion bail out. This has already prompted the ECB to intervene in the irish bond market to stop prices collapsing. 10 year bonds jumped to a yield of 6.17%. The cost of insuring Irish sovereign debt against a possible default has risen as investors remained extremely nervous about funding the country’s financial system. The feeling is that after Ireland has done so much, in terms of spending cuts, and is still under pressure shows the problems ahead for all stressed sovereigns.

Ireland’s austerity package to reduce Europe’s largest budget deficit has already led to higher unemployment, lower revenues for the government and companies going out of business.
Auction: Ireland managed to sell €1.5bn of bonds but had to pay yields much higher than in August. 4 year bonds were yielding 4.8% compared to 3.6% 4 weeks ago. This shows that people are growing more concerned and are demanding a bigger return to participate. Short term this helps Ireland but long term it still has to repay these bonds and the interest payments.

Greece: Has been given more time to restructure its struggling financial sector with the postponement of the latest stress tests for their banks.The IMF, ECB and European Commission have agreed to delay testing the solvency of banks by one month to the end of October.The delay means that the banks’ Q3 results will be available as well as the outcome of the capital raising by the Bank of Greece.We continue to advocate that Greece will have to default, at some point over the next couple of years.

Portfolio Comments: Funds

New Earth: We have never been fans of ethical investments as they tend to lack the requirements for producing good earnings. However EU regulations on landfill and the high tax response by the UK government has resulted in the fund making money from the incentive to avoid paying increasing taxes on rubbish local authorities and commercial contracts wish to dispose of. Landfill tax has already increased over 300% in ten years and is rising rapidly. The underlying company also has the double edge earnings from the waste treatment and the renewable energy it recovers from the waste.

Hancock Preferred: We have successfully invested here before and have returned as we feel more investors will be looking for the increased return that they cannot receive in the over-inflated bond market. There are increasing worries of a government bond market collapse if inflation appears.
The preferred are a type of hybrid which provide a specific dividend but also the potential for capital appreciation due to the merits of the underlying equity.

Gold: Deutsche Bank commodity research stated that the gold rally had further to run forecasting that gold bullion could hit $1600 an ounce in two years.This was due to favourable interest and exchange rates plus new sources of demand from both the public and private sector.The commodity hit a nominal all time high of $1283this week. In real terms, adjusted for inflation, the all time high is $2300 set in 1980.

Individual Equities

Arm Holdings: We made 17% in several weeks and felt much of the good news, including a potential bid, was in the price. The P/E is now very demanding with much of the recent price rise due to rumours of a bid from Intel or Apple.The directors have also been selling. We have kept it on our watch list and will look to buy if there is a pull back.

LVMH: Massive demand from the Far east and China has resulted in demand overtaking supply for many of the companies handbags. We have purchased ahead of what is expected to be a good festive season for the company.Chinese are travelling more often as there has been a relaxation on passports and visa applications. Chinese import taxes make luxury goods 30% more expensive than in Paris or London.The Chinese luxury good market is expected to grow by 35% this year and will account for about a third of the group’s overall growth.Although Chines consumers remained very brand conscious they are also value orientated and will pay for goods that are superior.
LVMH’s first half sales rose by 16% on last year to ‚Ǩ9bn. First half profits rose 53%.

Caterpillar: Has broken through the key horizontal resistance levels last seen in pre-Lehman collapse summer months. The company is the world’s largest manufacturer of construction and mining equipment.It is geared to a global recovery, especially in the developing world. A recent World Trade Organisation survey suggests that global trade will grow at record levels this year. Volumes are expected to rise 17% in the developing world and 11% in the developed world.Caterpillar has a 20% long term growth rate and a 2.5% dividend yield.

Cisco: Fundamentals look good but performance has been very poor after Q2 results and the Chairman’s statement. The company has a vast amount of cash and may increase its dividend. There is also expected to be a large amount of spending by corporate America over the next twelve months.

Boeing:Maker of the 787 Dreamliner aircraft. Asia’s “V” shaped recovery has triggered a boom in budget airlines in the region as major carriers set up partnerships and subsidiaries.
Indonesia is buying 20 new Boeing aircraft.

The Arab states of the Gulf have embarked on one of the largest re-armament exercises in peacetime. They have ordered weapons worth over $123bn from the USA. Boeing will be the principal supplier of new fighter jets and upgrades to existing planes.
This has been driven by the prospect of Iran marrying its arsenal of long range ballistic missiles with unconventional or, in time, nuclear warheads.

Deere & Co: Manufactures and distributes a range of agricultural, construction, forestry, commercial and consumer equipment. The company also provides replacement parts for its own products and other manufacturers.While the rest of the world frets over the failed harvests in Russia and floods in Asia, the U.S. estimates that farm income will rise by 24%. Agricultural exports are expected to increase this year to the second highest on record.

Intel: We have added to our small position. The share has broken free of the 50% retracement level. This level was a major hurdle going forward and we feel that Intel can regain some lost ground over the coming weeks, assuming general market trends remain favourable. The company is paying a dividend of 3.3% which will provide support.


Euro: We have Hedged. Successful debt auctions by Greece, Ireland and Spain gave the currency a boost this week. We believe that Euro upside is still limited, against most currencies, as the higher costs of the funds will intensify pressures on government finances. This will lead to the risk of a slowdown in Europe and continued concerns over the sovereign debt of the weaker nations.

US Dollar: Hits fresh lows against the Yen and the Euro as the Fed opened the door to further quantitative easing. This may result in short term weakness against the other major currencies such as the Yen and the Euro. In fact it may result in the Japanese having to intervene again to protect their exporters.

Australian Dollar: Rose towards a two year high after policy makers said they may need to increase interest rates if the central bank’s forecast is realized for the nation’s economy to continue expanding at its trend pace or faster.

Sterling: The Bank of England signaled that policy makers are moving closer to adding more stimulus to the economy. In the minutes of the last meeting they said inflation risks were substantial in both directions! this shows the problems being caused by commodity increases and the sluggish consumer recovery.

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