Eurozone still dominating UK stockmarket
So a reasonably stable start to July ended when Valencia applied to the Spanish regional assistance fund, which caused renewed concern over the sovereign’s ability to continue to fund its deficits.
This particular bout of anxiety was enough to drive Spanish bond yields above the perceived bankruptcy level of 7 per cent. Draghi’s response to markets in his presentation at the Global Investment Conference left no doubt as to the willingness of the ECB to do ‘whatever it takes’ to save the euro. His assertion that the policy response ‘will be enough’ sent Spanish yields back below 7 per cent (at the time of writing, they remain at 6.7 per cent) and set equity markets back on a positive trajectory. Markets’ subsequent anticipation of policy action from the ECB left little room for anything other than disappointment at the bank’s August meeting. So far, the setback has only lasted one afternoon and markets have managed to maintain some positive momentum. The ability of the ECB to stretch its mandate of protecting the functioning of the monetary system to buying government bonds on an indefinite basis is still in doubt. The conditions that would require the realisation of Draghi’s recent statement are such that it has to be hoped that the measure is never needed.
Looking at economic data, the UK PMI was noticeably weaker at 45.4 in July from 48.4 in June. This comes on the back of a 0.7 per cent reported contraction in UK GDP in the second quarter. The double bank holiday for the Diamond Jubilee is being cited as responsible for a large proportion of the decline and employment trends in the UK suggest that recent GDP numbers may have underestimated actual activity. We therefore believe that the state of the UK economy may be somewhat better than some of the official numbers suggest.
On the monetary side, the Bank of England announced a further £50bn of QE, the ECB cut the repo rate to 0.75 per cent and the deposit rate to 0 per cent. Meanwhile, the People’s Bank of China cut the lending rate to 6.0 per cent in response to falling activity and inflation. The easing in global inflation is the one major positive over the last few months. The reduction in consumer price inflation should help to ease the squeeze on real demand, while the more marked fall in producer price inflation should mean that companies may be able to protect margins even in the face of slowing global activity.
We remain cognisant of the subdued trends still present in China and increasingly in the US. We also continue to expect an increase in focus on the potential issues presented by the impending ‘fiscal cliff’ as we approach the end of the year. On the slightly more positive note, there are a few signs that the eurozone economy, though still on a negative trajectory, may be beginning to stabilise. We have said before that we were wary of raising exposure to industrial cyclical stocks due to the likelihood of management reducing guidance at results presentations. The majority of company reports for the last quarter have now been issued and there have been considerable cuts to analysts’ forecasts for a number of these companies in response to cautious management statements. We now feel that market expectations for company profits are becoming less onerous for share prices of industrial companies and have therefore begun to add to our exposure to this area of the market.
Julie Dean is a UK equity fund manager at Cazenove Capital