Market Commentary

Economic and Market Review

Key points for June 2010

•  A difficult end to a difficult quarter

• Government bonds rally on safe-haven status

• Fiscal squeeze finally hits UK

• Global equities buckle under worries

UK

June in the UK was all about the Budget and BP. Just to recap: the structural deficit is expected to be cut from 11% of GDP to 1% over five years. Growth for this year is forecast to be 1.2%, and 2.3% next year. CPI inflation is forecast to run at 2.4% and 1.9% over the next two years respectively (2.7% this year). Public sector net borrowing of £149 billion is forecast to fall to £37 billion by 2014/15. A bank levy, which will be collected annually from 2011, will raise £2 billion a year, with an offset from the reduction in corporation tax to 24%; and VAT will rise to 20% from January 2011. Changes to national insurance for low-paid workers could also provide some relief to retailers. Capital gains tax will remain at 18% for basic rate tax payers, and rise to 28% for higher rate payers, whilst allowances will be indexed – all three measures broadly welcomed.  Ratings agency Fitch gave its approval, and gilts and sterling rallied in predictable fashion. The ten-year gilt yield fell from around 3.5% to 3.36% over the month, as concerns about the Budget eased. The Sterling trade-weighted index appreciated from 80 to 82. As for BP, the clawing back of the first quarter dividend took the market by surprise. The stock remains attractive on valuation grounds, having been buffeted by political posturing; however, income-seekers must keep a close eye in consideration of a lack of dividend. Overall, economic data over the month were mixed, although May’s inflation figure came in at 3.4% (from 3.7%) the previous month, suggesting a peak, if only for now. The FTSE 100 fell 5% over the month, with the FTSE 250 -2.56%, and FTSE Small Cap (ex-IT) -7.13%, largely on concerns about sovereign debt defaults and slowing growth in China; and potential for a double-dip recession in the US and Europe. Over the quarter, the FTSE 100 was down 12.6%; FTSE 250 – 7.13% and FTSE Small Cap (ex-IT) -5.29%.

The aforementioned woes plagued global markets too: over the month the S&P 500 was down -7.97%; Europe -3.58%; Japan -4.42%, and emerging markets -3.58%. Over the quarter, these figures stood at -10.19%; -13.83%; -7.87% and -7.01% respectively. Similar to gilts, US-Treasuries gained on safe-haven status. Oil ended the month down at $75.37 per barrel as global growth fears took hold; gold was up at $1,242.25 troy/oz, again on safe-haven status.

On the Budget – Mr Osborne has received plaudits for acknowledging the enormity of the problems facing the UK, but this remains a fine balance between fiscal restraint and the incentivisation of growth. We have continued to see gilts strengthen; however, for this Budget to hold weight, the private sector must feed the economy, whilst the public sector braces itself for severe pain.

More broadly speaking, having felt as though it was reaching a resolution, the potential for a liquidity crisis in Europe has hit confidence again. European banks are under scrutiny as we await the results of the stress tests. The G20 leaders have declared their intentions to slash deficits by 50% by 2013 whilst still nurturing economic growth. Theoretically speaking, it’s all possible, although we believe policy error remains the biggest risk at this crucial time.

Julian Chillingworth
Chief Investment Officer