| INVESTMENT REVIEW SECOND QUARTER 2007
Returns from equities were generally positive over the quarter.
Takeover activity continued to dominate markets with the City
rumour mill in full spin. However, with official interest rates
rising in many countries, bonds performed poorly over the period
with prices falling as yields on benchmark 10-year Government
issues rose firmly above 5% in the US and UK. Global economic
news was dominated by the state of the US housing and mortgage
market, with investor concern focussed on the potential wider
impact upon the economy and consumer sentiment.
In fact uncertainty over the outlook for global inflation heightened
dramatically. Although there was no change in official US rates
over the quarter, the yield on the benchmark 10-year Treasury
closed at 5.03%, higher by 0.35%. Base rate in the UK was lifted
in May and the 10-year Gilt yield rose by 0.46% to 5.46%, with
expectations of at least another rise in the second half of the
year. Eurozone rates were raised by 0.25%, the yield on the 10-year
German Bund rising from 4.10% to 4.57%. For fixed income investors,
so used to a twenty year bull market, the quarter resulted in
losses across the board of over 2% in Sterling terms as measured
by the FT Actuaries All Gilts Index.
The question remains as to whether this sudden shift in yields
is simply a normalisation of “real” interest rates
from historically low levels or represents a growing belief by
market participants that inflation is becoming a more serious
issue. Problems relating to the impact of these changes have been
most apparent in the US “sub-prime” mortgage sector.
Rumours of problems at two high profile hedge funds investing
in mortgage-related securities surfaced during June and provided
further fuel to the debate over the transparency of valuations
within some hedge fund portfolios. Investment bank Bear Sterns,
as key backer to the funds, stepped in late in the quarter to
provide a $3.2bn loan in order to provide support and avoid their
collapse. The issue of “toxic waste” in the form of
“Over The Counter” derivatives, consumer debt levels,
extremely narrow credit spreads and excessive leverage suggest
that the volatility seen over the second quarter may yet create
more problems in global debt markets as we move into the second
half of the year.
Despite these concerns US equities actually gained over the quarter;
the S&P 500 rose by 4.1% although with Sterling at a 26 year
high against the US Dollar those gains were reduced to only 2.6%
in Sterling terms.
Perhaps surprisingly Asian and emerging markets performed well
over the quarter. Despite continued volatility in the Chinese
domestic equity market, investors remained focussed on the growth
outlook being maintained. The Shanghai Composite index closed
higher by 15.1% over the period although this was 11.8% below
its’ peak in late May. The Japanese Topix index rose 3.2%
as the economy continued its longest uninterrupted period of growth
since 1945. Elsewhere equities across Asia performed well, rising
11.4% as measured by the MSCI Asia-free index and a similar picture
was presented by the MSCI Emerging Markets index, rising 11.5%.
European markets continued to rise as the Eurotop-300 index climbed
4.2%. Individual returns from key markets were mixed with gains
led by the German DAX index, rising 12.8% as labour reforms and
corporate restructuring continued to deliver earnings growth.
Elsewhere the French CAC-40 gained 5.5% with hopes that the mandate
provided to the new Prime Minister will allow him to build a platform
from which a similar reform programme may be developed.
UK equity market returns clearly demonstrated a shift in investor
sentiment towards “Mega-Cap” over “Mid–Cap”
stocks. The mid-cap FTSE-250 and smaller companies indices declined
by 3.3% and 2.4% respectively whilst the FTSE-100 rose by 3.3%.
UK domestic politics were dominated by the change in Prime Minister
and a broad reformation of his Cabinet team although at the time
of writing it seems too early to draw distinct conclusions on
any changes to economic policy.
Commodities provided mixed returns over the period. Metals prices
gave up some of their recent gains as demonstrated by Gold (lower
by 3.5%) and Silver (down by 9.1%), whilst soft commodities firmed
over the quarter and the Oil price revisited $70, the highest
level for a year. Trading ranges within key currency markets continued
to be fairly tight with the exception remaining Yen, which fell
a further 3.8% against the US Dollar to close at 123.26. The US
Dollar continued its decline against other key currencies however,
with Sterling closing a fraction above $2.00 and the Euro at $1.35.
July 2007
(Data source: Bloomberg) - All returns in local currency terms
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