IMF Offer Hope for 2010 Return to Growth

The International Monetary Fund (IMF) has released a World Economic Outlook update with revised 2009/10 output predictions. The July 10th publication is a timely follow-up to the comprehensive and excellent April 2009 report, which in great detail highlighted the failings within the banking sector (which prompted a global recession) and offered readers a number of common sense, and academically robust solutions to prevent a re-occurrence.

The latest IMF outlook is cautiously optimistic. Of significant interest is the revised output forecasts for 2009 relating to developed and emerging nations. Recovery expectations have been uniformly lowered for developed countries, and predominately raised for emerging nations (Mexico a notable exception).

On cursory examination with world output predicted to fall by -1.4% in the current year pessimists can legitimately cite a global recession, but closer inspection provides some surprises and indeed reinforces hopes that 2010 will most definitely close the door on the most serious economic challenge since the Great Depression.

Revised output expectations, by country or region for 2009, are below with strongest output detailed first:

China 7.5%
Emerging Asia 5.5%
India 5.4%
Middle East 2.0%
Africa 1.8%
Brazil -1.3%
World -1.4%
US -2.6%
Euro-Zone -4.8%
Japan -6.0%
Russia -6.5%
Mexico -7.3%

The revised world forecast for 2010 offers 2.5% output growth, year-on-year, with only the Euro-Zone predicted to stay in recession, albeit it by a modest -0.3%.

The IMF cites recent massive fiscal and monetary government stimulus as the primary reason for the 2010 growth prediction. Keen eyed observers would be forgiven for interpreting the IMF message as an implication the European Central Bank and Euro-Zone authorities have acted with insufficient haste and action in tackling the recession. A review of ECB monetary action over the past 18 months supports that implication.

Clearly emerging countries have generally faired better than developed nations, except for Mexico and Russia for country specific reasons. Mexico has suffered disproportionately following the swine flu pandemic whilst Russia entered the global recession as the “least favored” trading partner following a number of commercial, energy and geo-political disputes with key commerce partners. Russia’s inability to diversify its economy away from oil and gas also created a slump in the face of fast falling energy prices.

Overall the IMF report does imply a very high probability of a widespread return to economic growth late in 2009 or early 2010. Bearish equity investors, who have convinced themselves that risky assets are poised to return to March lows on the back of doomsday economic predictions, may have revisit their price targets.

BoE Pauses Quantitative Easing to Digest Impact

The UK produced more than its fair share of economic headlines this week. Interest rates were kept on hold at the historical low of 0.5%, as expected. Not one commentator predicted a rise prior to the announcement and there was a similar paucity of predictions suggesting the Bank of England Monetary Policy Committee would cut rates further. The BoE did take the opportunity though to ambush markets with a surprise statement regarding its quantitative easing program. The £125bn originally agreed is almost fully utilised, with only £15bn of the budget remaining. The BoE have decided to pause the program when the £125bn initial budget is fully utilised.

Markets were broadly expecting an expansion of the policy. UK Gilt prices fell sharply in response, with yields spiking, as investors reduced exposure to the asset class on realisation a major buyer of bonds would imminently retire from the Gilt market, at least temporarily. The BoE advised it was keen to digest the economic and inflationary impact of the easing to date before possibly injecting further cash into the economic system. Following the announcement a number of analysts speculated the BoE had seen enough improvement in economic data to persuade them further action might provoke inflation and that the BoE, despite their cautious sound-bites, were confident the economy is already returning to growth.

Preliminary Q2 GDP data is due shortly, followed by a Q2 inflation report in August. Following those announcements, the BoE is likely to hold sufficient data to cement a decision, one way or the other, regarding the need for further stimulus.

UK Recovery Hopes in Retail, Manufacturing, Housing

UK economic news over the week continues to point to a modest return to growth in Q2 and Q3 relative to a very weak Q1. Most pleasing is the breadth of improving news covering a number of sectors including services, housing, manufacturing, equity markets and consumer confidence. Looking briefly at each issue:

1. The service sector grew in June for the 2nd successive month.
2. The residential property market has enjoyed positive price growth in three of the last four months.
3. The Purchasing Managers Index (PMI) a broad measure of UK wide business activity has risen above 50 (the line between contraction and growth).
4. Equity markets, although not building further on March to May’s gains, are staying firm with bargain hunting helping prices on weakness.
5. Even the depressed retail market is showing signs of recovery, with the Marks & Spencer Executive Chairman, Stuart Rose, suggesting an element of “stabilisation” has returned to the high street.

This gradual market-wide improvement, combined with the government’s commitment to maintaining spending at high levels (albeit at an unsustainable level of expenditure), suggests a return to positive Gross Domestic Product growth will be officially reported within weeks, following the recent positive estimate from the National Institute of Economic and Social Research. It’s not all blue skies though. A UK sustained recovery still requires key trade partners, the US and Euro-zone to enjoy a return to growth and challenging as the domestic economy is, confidence and demand in America and Europe is even weaker. Also, like a black cloud hovering near-by, the UK banking sector though saved from catastrophe, still has a mountain to bad debts to formally process as the banks gradually, quarter by quarter, book losses on aging debts they previously hoped for settlement on.

Northern Rock, the nationalised bank, confirmed as much this week when it released news it had breached the minimum regulatory requirement on its capital base strength. Commentators suggest the breach could only have occurred if the bank had lost a further £500m in the first six months of 2009, in addition to the billion pounds plus, lost in 2008.

Northern Rock is particularly vulnerable as the bank processed a large proportion of its mortgages at very high loan-to-value ratios at the peak of the property market. Even taking into consideration the more prudent residential mortgage acceptance criteria previously adhered to by the two most vulnerable big banks RBOS and Lloyds Group, it’s hard to imagine they will survive Q2 and Q3 unscathed.

ECB Decision Makers Prepare for Summer School

Representatives of the G8 are meeting again as I write, to practise the art of talking. The self-described syndicate of “main industrialised countries” have perfected the process of conducting a whirlwind of meetings, agreeing a globally co-ordinated strategy, presenting unity to the world’s press then returning home to focus on their own unique objectives. China and India must be increasingly bemused at being denied a seat at the exclusive G8 table which remains a predominately European and Anglo-Saxon affair. Admittedly Japan is a member, one of the six founding members from the first 1975 meeting, as is Russia which joined in 1991, but the group remains an old-boys club for Europeans and North Americans who cling to the memories of global economic dominance, long faded. Actually, there aren’t eight members at all in the G8. There are nine. The European Union also has membership. For clarity, the complete roll-call consists of the US, UK, France, Germany, Italy, Canada, Russia, Japan and the E.U.

Maybe because the British and French economies have been in relative decline for the longest, eroding their delusions of self-importance, they have most forcefully argued for the inclusion of the five key emerging economic powers, (Brazil, India, China, Mexico and South Africa) into a permanent enlarged forum to replace the G8. Meanwhile, Japan, devoid of oil and commodity resources, has been more than empathetic to the view that the Middle East should be represented. Under such circumstances, it’s easy to see why a Federal Reserve meeting or dare I say a Condoleezza Rice visit to China is actually of more economic significance than the annual G8 photo-shoot.

Cynicism aside, even if G8 action is inevitably absent following the meeting, the leaders still discuss the issues and therefore the agenda, in itself, is worthy of discussion. This weekend’s agenda includes the design of an “appropriate framework” to extract the unprecedented economic stimulus executed in recent months. The inclusion of such a discussion point proves two things. Firstly, the global economy as a whole, is recovering. Secondly, it supports the growing view that inflation is returning and if unchecked may become a real obstacle to stable growth in 2010/11.

The G8 have a major challenge on their hands. Regular readers of this column are well able to identify this. The rate of recovery differs greatly from country to country. China never fell into a recession. Commodity producing regions are already benefiting from fast-rising resource prices. The UK economy apparently returned to positive growth in April. The US economy is still a hit-and-miss proposition, albeit improving by the week, whilst Europe remains the problem child. How can a single global strategy be executed, withdrawing economic stimulus, as whatever pace is chosen for that strategy it will be fundamentally wrong for countries at either extreme of the global economic recovery?

The French, apparently, are trying to kill off any discussion regarding the easing of current stimulus measures, whilst at the other end of the economic spectrum, Canada, is lobbying for support to agree an “exit strategy” fearing inflationary pressures. Meanwhile, the US acknowledges some progress made but is keen to let the stimulus package run for some time yet before drawing excess liquidity out of the financial system.

If you can legitimately blame poor Anglo-Saxon risk controls, within the banking sector, for creating the global recession, it’s equally valid to suggest the European Central Bank (ECB) is at fault for allowing Europe to trail the UK, US and Asia in the global recovery. ECB monetary policy over the past year has been just unforgivable. But don’t take my word for it. Let’s review what the International Monetary Fund (IMF) articulated in their recent European economy review.

The IMF, in the very first paragraph of its June 8th report commented Europe needs to “take further decisive action, especially in the financial sector”. The report progressed, suggesting the European bureaucrats were missing “a proactive strategy” and they should pursue a “cleansing of the financial system without delay”. Unemployed Europeans must be dying of frustration. At least the Americans and British left no monetary stone un-turned in their efforts to stimulate growth. The author of this damning report, the IMF, is rated very highly indeed. The institution is full of quite brilliant economists. With relatively limited power it has competently pursued its primary aim of helping countries improve their macroeconomic and financial infrastructure since its inception in 1944. I would gladly pass European monetary policy control to the IMF immediately, thereby allowing ECB members to attend the excellent London School of Economics summer school course in Introductory Macroeconomics, which I can vouch for, following my attendance nineteen years ago. Of course, I joke, ECB decision makers should be well capable of tackling the intermediate course.

UK Equity Bears Seek Early Hibernation

Doomsayers, serial pessimists towards UK equities and the British economy are sitting a little lower in their seats today. But three short months ago, at the dawn of spring, when the equity rally was so new, so fragile, equity trading bears stretched their necks, held their heads above their trading room screens and gently mocked opposing colleagues who dared to hope for a sustainable rally. If few of those March optimists were brave enough to openly predict a sharp market-wide rally, fewer still also forecasted a return to positive economic growth in Q2. Even six weeks ago, the grim reaper of wealth, depression, was still cited as possible by those who refused to hope. It took the arrival of summer before the optimists finally outnumbered their brow-beaten foe yet irregular readers of this column may have missed earlier reports of economic green shoots such was the monopolisation in newspapers and on TV of the recent political chaos. However, for the time being at least, the battalion of political Benny Hill’s have returned to their constituencies to triple-check their mortgage expense claims allowing investors and commentators to return to the useful practice of economic analysis.

Most timely therefore, is this week’s headline recovery story which is undoubtedly the best yet. The well respected National Institute of Economic and Social Research (NIESR) has released an estimate suggesting the UK economy expanded in April by a modest 0.2% and strengthened further into May. If proved accurate, and the NIESR usually is, April will prove to be the first month for a year that has enjoyed positive economic growth. This is good news indeed and worth clarifying. I will therefore put it in terms that even a Chancellor of the Exchequer, one who requires assistance to complete his own tax-return, can understand. The recession might be over. It might be over, not definitely. I can just see the top of that bear’s head. No. He’s gone.

The Global Economy

The US looks increasingly primed to return to economic growth in 2009, before Europe. The more assertive action by the Federal Reserve via aggressive rate cuts, Fed balance sheet expansion, widespread government fiscal easing and banking sector intervention have all contributed to the consensus expectation of a Q3/Q4 recovery. Incredibly, so quickly are market-wide forecasts changing, the US futures market is now pricing in a 59% probability that interest rates will increase in Q4 2009. A month ago, such a suggestion would have been ridiculed by most analysts.

This about-turn, from deflationary to inflationary concerns, is not based on vague hope of a recovery in demand. Sharp price increases have already been seen in commodity markets. Expectations of monetary tightening, rather than additional injections of liquidity, were further supported on Friday following an unexpected improvement in non-farm payrolls data, discussed below, and confirmation Federal Reserve officials met last week to discuss potential timing of credit tightening measures to wean investors off the abnormally high levels of manufactured liquidity.

It’s worth looking at the non-farm payrolls data in more detail as it is one of the most keenly anticipated regular economic reports, with a proven ability to move markets significantly when the actual data differs greatly from the consensus, as it did this month. Interestingly, the numbers were still bad (payrolls fell by 345,000 in May), but not nearly as bad as the 500,000 to 520,000 reduction predicted by most analysts. Also released was the country-wide unemployment rate, which rose to 9.4% relative to an average forecast of 9.2%. Although, unlike the payrolls data this rate worsened more than expected, a number of market commentators interpreted this data with rose tinted glasses suggesting more long-term jobless who previously had no hope of finding work were now registering officially as job-seekers. On a corporate level both General Motors and American Express are expected to make further job cuts, whereas Wal-Mart (The owner of UK’s Asda), confirmed it was looking to recruit 22,000 more staff in line with its US store expansion plan. The US economy has now lost 6 million jobs since the start of the recession and the current unemployment rate is at a depressing 26 year high but the monthly rate of job losses looks likely to ease through the rest of 2009 relative to H1, before the US returns to employment growth sometime in 2010.

Naturally, in the face of such job uncertainty, US consumers have changed their spending habits. More Americans are saving. April saw the highest ratio of consumer saving to spending in 14 years. Consumer borrowing has also eased with April seeing the 2nd biggest fall in lending, since records began ($15.7bn lower). This return to relative prudence was and still is desperately required to fix the personal balance sheets of consumers who are burdened with too much debt and not enough savings.

The continuation of better than expected US economic data helped the dollar rally against the yen, euro and sterling, though there are domestic issues in Britain that also encouraged dollar appreciation against the pound. The Australian and New Zealand dollars also appreciated against most G7 currencies as investors chased yield, investing in currencies offering a higher return. The USD rally also reflects widening sentiment that the US will lead western economies out of the recession. Not surprisingly, the dithering European Central Bank is still paying catch-up and an ECB spokesman dropped hints on Friday that rates may have to fall further in the Euro-zone to stimulate growth.

UK Politics, the Economy and Markets

The UK economy is slowly recovering. The green shoots of consumer demand, stabilisation in house prices, a 3 month stock market rally, the banking sector back in profit and deals being agreed in a buoyant commodity sector are collectively more than adequate evidence. There is still much work to be done, but a return to growth is highly probable in the not too distant future. Ironically, some of the credit can be allocated to the same institutions and quasi-governmental bodies that got us into this debt fuelled mess in the first place, but nevertheless, there is now clear light at the end of the recessionary tunnel. Of course there is always a chance that the fragile recovery will fade and the recession will be prolonged, particularly if business and consumer confidence in UK PLC has a reason to retreat. So what is the biggest threat to growing confidence and a successful UK economic recovery? I believe the largest single threat is further political chaos. I would suggest our politicians should be in back-to-back meetings creating an environment in which the unemployed can get back into work. They should be working with the Bank of England to ensure the £125bn stimulus package is used as quickly and efficiently as possible. Or, equally important, cutting back on red-tape in an effort to reduce the country’s growing debt burden, predicted to be £175bn in this tax year alone. Unfortunately, such crucial objectives hardly got a mention this week. The country had to suffer politicians, the names of whom were largely unknown to us a month ago, whinging over their career prospects or smirking at cameras with “rocking the boat” badges in an appalling episode of self-indulgence and self promotion. The local election results, in which Labour received its lowest ever share of the vote, will produce further unbearable months of political back-stabbing and manoeuvring, probably all the way to the next general election. Meanwhile, Barack Obama was giving a free master-class in statesmanship, touring the Middle East and receiving standing ovations from Arab audiences on his vision for the region and the world. I can’t imagine Obama has been busy submitting dubious expense claims for a non-existent mortgage either.

I empathise with readers who feel economic and stock market reviews should minimise political banter but UK politics and economics have never been more closely aligned, except during the World Wars. Further evidence of the political impact on equities and currencies was seen this past week, when both the FTSE and Sterling, fell back sharply, albeit temporarily, on unfounded rumours that Gordon Brown had resigned. Politics is markets.

Other news included a hold on interest rates. The Bank of England monetary policy committee voted to keep rates at 0.50%. The decision was in line with expectations and analysts were more focused on possible policy changes to the additional stimulus package, which so far has allocated around £125bn of the £150bn budget for boosting economic growth and lending. A number of commentators quite rightly suggested that that impact has been less than forecasted and the remaining £25bn, yet unallocated, will need to be utilised over the summer months unless lending activity accelerates from the current sloth like rate of growth.

Wood Group PLC (WG.L)

Wood Group has ably taken advantage of the growth in energy demand since the 1970’s. Now, its 28,000 employees provide engineering and maintenance services to oil and gas exploration and production partners in 46 countries. ‘Engineering’ and ‘maintenance’ to be fair, hardly scratches the surface of the technical expertise required to overhaul gas turbines and provide engineering support on deep water exploration projects, two of Wood Group’s specialities. Such expertise is not easily replicated on a global corporate scale and after years of above average growth, Wood Group has secured itself a seat at the top table of integrated energy services companies.

The group’s history dates back much further than the 1970’s. The firm can trace its roots back to a 19th century Aberdeen based small fishing fleet. Two decades later, in 1912, the family business expanded into ship repair and marine engineering. Steady progress was made thereafter and in 1964 Ian Wood (Sir Ian Wood, since his Knighthood in 1994) joined the family company and the business further diversified its engineering credentials and reach. However, it was the development of the North Sea oil industry, largely serviced from Aberdeen, which gave Wood Group the opportunity to build its revenues from the millions, to billions. In 1982 the fishing and oil services businesses were separated and John Wood Group, the engineering and oilfield logistics specialist, was formally born. Through the 1990’s the firm continued to grow impressively through both organic achievements and a series of astute international acquisitions which turned the Scottish business into a global player. Before Wood Group listed on the London Stock Exchange in 2002, the firm was already providing key maintenance and engineering services to some of the very biggest and demanding names in the energy industry including BP, Shell, Talisman, BG, Enterprise Oil, Gazprom and ChevronTexaco.

Sir Ian Wood, Chairman, deserves much of the credit for the success story. Born and educated in Aberdeen, Sir Ian Wood graduating from Aberdeen University in 1964 with a first-class honours degree in psychology. Within 3 years of joining the family business, then John Wood & Son, he became managing director. His deep understanding of business and the energy industry has been frequently recognised since. He received the award for Young Scottish Businessman of the Year in 1979, was awarded the CBE in 1982 in the New Year’s Honours List, and the Knighthood 12 years later. Sir Ian Wood was also the joint winner of Scottish Business Achievement Award Trust in 1992 and winner of the Service category award in the 1992 Corporate Elite Leadership Awards. Following more than a century of commercial success, and worthy recognition, the Wood family have naturally accumulated significant assets and is now one of the wealthiest in Scotland retaining a significant stake in Wood Group. Sir Ian Wood, in particular, is a keen philanthropist and he launched the Wood Family Trust in 2007, with a personal contribution of £50m, to support the economic development of Sub-Saharan African communities. The charitable fund also focuses on the development of young people in Scotland.

Moving from the past to the present for Wood Group. Regular readers of this weekly review will already have a clear understanding of the current recession and its impact over the past 12 months on energy prices. The almost unprecedented fall in prices, both in terms on the percentage fall and the speed of the decline, from $147 per barrel caused understandable concern across the industry and Wood Group was no exception. Several months ago, when Wood Group released its 2008 annual report, the management statement announced excellent figures for the past year but also articulated caution for 2009 unsure of the timing in the recovery of energy prices. As we have already seen, that price recovery is already in motion.

Through the recession Wood Group management have persevered with policy of pursuing growth via both organic means and acquisition and the balance sheet is sufficiently robust to give the company ongoing flexibility in this regard. The firm also extended its bank facilities of $950m to 2012, providing a further buffer against the unexpected. Such is the strength of cash flow generation management had the confidence to increase the dividend, whilst many other companies were hoarding cash in the months of economic uncertainty. Wood Group, acutely aware that a number of its energy exploration customers would delay new green field projects, invested more in its field life extension solutions to help partners squeeze more production and income from existing fields. The policy made sense for both Wood Group and its production partners, building output from existing assets at low risk, rather than speculating into potential higher return, higher risk exploration ventures in a period of falling energy prices and economic uncertainty.

There was another incentive for energy production companies to delay exploration projects. Not only was there downward pressure on fuel prices, there was also downward pressure on the costs associated with the development of such sites. In this challenging environment with associated profit margin pressures, Wood Group has continued, through the quality of its relationships and expertise, to gain market share particularly among new exploration entities that need the reliable and steady hand that a partner like Wood Group offers. Wood Group has also deepened its relationship with the established players with 2008 notable wins including the front end engineering design (FEED) services contract for Chevron’s Jack and St Malo projects in the Gulf of Mexico and pre-FEED services for ExxonMobil’s Scarborough development in Western Australia. The mature North Sea fields also provided a contract win from TAQA, a relatively new entrant in the production business. For those readers unfamiliar with the development life cycle of energy projects, FEED contracts are an early stage, high influence contribution in the planning stage, rather than late stage, low influence contribution like project management contracts.

Currency movements through 2008 also helped earnings, when converted to Sterling, with the strengthening of the dollar boosting profits for UK investors. That bonus, of course, may reverse this year if the current trend of USD depreciation continues, as the majority of profits are generated in US dollars.

Wood Group analyses its financial and management performance using key performance indicators (KPI’s), which primarily focuses on return on capital employed (ROCE), earnings before interest, tax and amortisation (EBITA) and adjusted earnings per share (EPS). Improvement was seen in two of the three KPI’s in 2008, relative to the year before, with EBITA growing to $441m from $318.4m (up 39%) and EPS progressing strongly to 52.1c from 36.9 cents (up 41%). ROCE was almost flat, falling marginally from 19% to 18.2%. Management also assess “safety cases” at work per million man hours, which pleasingly fell to 3.3 from 3.9 whilst non-KPI financial data included an 18% increase in revenues, a 29% increase in the dividend, and a 48% rise in profit before tax. Perhaps most telling is the fact more than 75% of revenues are via long-term contracts, not here-today-gone-tomorrow short term projects.

It’s difficult to pick holes in the performance of the company, which naturally leads investors to ask the inevitable question; has the recent rally in equity prices already squeezed the near term growth potential out of the stock?

Certainly, the chart implies the ‘easy’ gains are behind us. The stock, now 282p, has rallied strongly from a low of 152p seen late in 2008, a gain of some 85%. However, even after the recent rally the stock is still quite some distance from the 2008 high of 503p, though only the most bullish would suggest a return to that heady level is likely over the next year or so. A more likely scenario would be the stock broadly tracking energy prices (a primitive indication of the health of the energy industry) as well as general equity market sentiment. Both of these parameters are progressing well and we are therefore more inclined to predict further gains rather than a retreat, for buy and hold investors. For day-traders needing ‘oomph’ in their day to day volatility, we feel there are better instruments to utilise that offer more gearing.

The Global Economy – 29th May 2009

For some weeks now this weekly review has ‘called’ Q1 or Q2 2009 as the trough of the economic cycle. Initially there was much risk in the statement as the global and US recovery was by no means certain, but as the weeks have progressed the ongoing stream of economic data has increasingly supported this view. The consensus among market commentators has also moved towards our more optimistic pro-recovery stance and now a Q3/Q4 recovery is a mainstream prediction, rather than the hopeful rhetoric of the enlightened minority. Our view did of course fully consider the unusually bitter and sharp contraction in growth primarily caused by very poor leadership in the global banking sector, ineffective regulatory risk controls and appalling credit procedures in the mortgage and commercial lending market place. But whilst we accepted this scenario as depressingly and worryingly unique in modern times, with only the depression of the 1930’s having close similarities, we also reflected on the impact of the unprecedented wall of money flooding into the global economy via government and central bank stimulus packages and its effect on demand. The global economy has never enjoyed such internationally co-ordinated monetary easing or the simultaneous hard–cash injections by governments, to shore up the balance sheets of strategically important institutions. The consequences of this combined stimulus are already being seen in the price of commodities, including oil and gold. Looking beyond the current market-wide inflation data which does not yet fully reflect improving demand outside of the resource sector, we predict that deflation will not only fade from the vocabulary of pessimistic US economists, but that concerns over inflation will return with vengeance within 18 months. The real challenge for 2010 is not achieving stronger global economic growth, a scenario which looks inevitable relative to 2009, but how to restore stable economic growth without killing the US consumer spending recovery with sharp interest rate rises, the usual primitive remedy for rising inflation. We would stress this view is not implying the deep structural problems within capitalism are being fixed. A move away from a cyclical, debt based economic system would need to be implemented for that. Nor is it an equity market prediction, which is below. But we do think the US and global economy, in terms of Gross Domestic Product, is set for a significant improvement from its Q1/Q2 trough.

Looking at the most recent US economic news in more detail, revised data now indicates the US economy weakened less than initially estimated in Q1 contracting at a 5.7% annualised rate, rather than the 6.1% fall previously announced. Investor’s, prior to the announcement, had been even more optimistic and predicted on average, the figure to be revised to a 5.5% contraction. Also, for the first time in a year, US corporate profits after tax increased, albeit only by 1.1%. The figure is a vast improvement on the 10.7% slump seen in the prior quarter and surpassed the consensus Q1 forecast of a 7% fall. Dissecting the Q1 GDP figures more closely, weakness in exports more than off-set a stabilisation in consumer spending, which accounts for around 2/3rds of US economic activity. Interestingly, some very competent market analysts are putting their neck on the block and are predicting much shallower weakness in Q2 and a return to positive US GDP growth in Q3. Unfortunately, unemployment is a lagging indicator so the US economy is likely to suffer rising jobless claims for some time yet even when the wider economy has returned to growth. The current unemployment rate is 8.9% and looks set to reach 10%, with the car manufacturing sector and Michigan, its home, likely to suffer most.

The growing expectation of H2 2009 economic recovery, and the view that equities were grossly oversold, prompted the sharp appreciation of equity prices in the period from early March to mid-May. At the end of that 10 week rally we highlighted that in the short-term prices look stretched after such a short sharp spike and a pause in upward momentum was inevitable. 2 weeks later that pause appears to be coming to a conclusion and the next move in the S&P 500, the diversified large cap index, is imminent. Based on the current trend of improving economic data and index technical factors we suggest the next significant move is up. The S&P 500 is at 907 (at the time of writing) from a March low of sub 700 and a further rise to near 1,000 would likely complete the technical recovery from the manic depressive state in investor confidence that caused the oversold trough in prices seen in March. A summer lull in trading may interfere with the timing of this view, but the next major move for US equities, we believe, is up. Time will tell.

We briefly mentioned oil. It’s worth taking a closer look at the market as the recent price action, we suggest, is a fore-taste of further inflationary pressures to come in other areas of the global economy. Reflecting for a moment, a barrel of oil fell from $147 during mid-2008, to a little over $32 by December of the same year. Since then oil has pursued a near-relentless recovery to pass $65 on Friday, twice its cyclical low. Statements from OPEC members have reinforced the view that the current rally is not a false dawn for oil bulls. The Saudi Arabia Oil Minister, Ali al-Naimi, long respected for moderate and reasonable analysis of the sector commented the market is “ready” for $75-$80 per barrel prices later in 2009. His views are based on already firming Asian, Middle Eastern and Latin American demand, not pie-in-the-sky guess work. The start of the US holiday driving season also suggests we are more likely to see $80 than $50, next. From a technical view, the price of oil has crossed its 200 day moving average and a number of oil analysts are now suggesting $60 is the new floor in prices. Politicians who side-lined their pro-green sound bites through the worst of the recession will soon be marketing their renewable energy credentials again.

Before progressing on to the UK, let’s take a brief look at the Euro-Zone economy where investment ‘professionals’ are still talking about deflation following release of May’s data which showed prices flat at 0.0% compared to the same month a year earlier. Readers will be forgiven for being confused. “Haven’t I just read oil prices have doubled and the global recession is definitely easing?” You did. But the Euro-zone is different to the US and other economies because the European Central Bank executed a monetary easing plan that was so mistimed (late) you would be forgiven for thinking they were trying to pre-empt the next recession, not cure this one. Not only were the box-tickers at the ECB too late in cutting rates, they unbelievably were still raising interest rates in July 2008 when corporate confidence had already stalled and seasoned financial sector analysts were busting blood vessels in stress as we approached the near-collapse of the global banking industry.

UK Equities – 23rd May 2009

Aquarius Platinum is one of the lesser known large cap mining firms listed in London and is off the radar screens of most mainstream UK investors. A cursory look at the stock chart over the past 18 months and you would be forgiven for thinking you have had a lucky escape. Investors who bought in at the peak of the cycle at 800p plus would still be suffering enormous losses and few of those investors, I imagine, were brave enough to top-up their position aggressively when the stock retreated to 100p, such was the equity market pessimism 6 months ago. Fortunately, for those with nerves of steel and bi-annual price checkers, the awful and temporary price volatility bears little resemblance to the long-term strategic case for platinum, which remains robust despite the current sharp recession.

Platinum, as many readers will know has multiple uses, including jewellery, industrial and ETF investment (Exchange Traded Funds). Admittedly, the price of platinum offers magnified exposure to global GDP growth with all three sources of demand suffering in times of economic contraction, but over the long term, as the precious metal is a very scarce resource, the prospects for platinum and therefore AQP are promising.
Aquarius however has challenges over and beyond the current global recession. Although primarily based in South Africa, the firm also has operations in Zimbabwe, a deeply troubled and chaotic country. Also, unlike BHP Billiton, Eurasian, Rio Tinto, Lonmin, Vedanta and numerous other FTSE listed mining firms, Aquarius is very much focused on just one resource, platinum, so lacks the diversification and multiple revenue sources of its competitors. In the global commodity business being reliant on just one precious metal is akin to opening a restaurant and only selling steak and chips. The stock is therefore pretty much just a punt on the market price of platinum and for keen followers of the metal offers a leveraged play. Alternatively, holders can file away the share certificate and await the inevitable acquisition rumour-mill but there are numerous other commodity stocks that offer better risk-adjusted return potential for both long-term holders and day traders.