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UK Data Highlights Road to Recovery Intact

Slowly but surely the UK economy is moving further from the trough of the recession. Latest data from the retail and housing sectors suggests the recovery remains intact despite a “double-dip” in investor confidence in the US which has recently infected the appetite for risky assets globally.

UK retails sales, a tidy measure of consumer confidence, rose 1.4% in June relative to the same month a year earlier and new enquiries for home purchases rose for the 8th consecutive month, another firm sign of improving household sentiment. Also the RICS house price survey (Royal Institution of Chartered Surveyors) rose to its highest level since September 2007 and more surveyors now predict house prices increases, rather than declines, over the next quarter.

Also reassuring are the latest comments from the Bank of England. The deputy governor, Charles Bean, referring to the BoE’s decision last week to pause quantitative easing (at the £125bn initial budget) suggested more funds would not be needed if sufficient liquidity and circulation could be secured from existing stimulus.

The comments reinforce the view that the Bank of England Monetary Policy Committee are already pencilling in an exit strategy, in fear of inflationary pressures, from the unprecedented monetary easing campaign. Subject to the recovery persisting the BoE will likely look at raising rates late in 2009 or certainly in H1 2010.

Last week this review reported an improvement in the UK housing market. Further reports from the sector have reinforced this view including a survey from the Royal Institution of Chartered Surveyors (RICS) which detailed the smallest percentage of estate agents, in 18 months, reporting price declines. Property sales are now at their highest level since August 2008. Halifax and Nationwide have also reported better sentiment with both suggesting a healthy bounce in prices during May. A RICS spokesman indicated “activity is picking up and prices at last stabilising.” RICS did provide some caution though, suggesting the number of properties on estate agent’s books is at a 5 year low. This shortage of available property may be propping up prices, rather than any structural improvement in mortgage availability or wider consumer confidence. In any event, it appears possible that the housing market has bottomed, which along with low interest rates and rising equity markets should further aid the confidence of potential buyers, persuading them to pursue a transaction rather than just market-watch.

The UK Economy – 30th May 2009

In the UK, investors digested the Financial Services Authority stress test results for the banking sector. All the big banks; Barclays, RBS, Lloyds Group and HSBC passed the examination, though RBS and Lloyds would have failed were it not for the recent government bail-outs. The stress test was applied to ensure the banks were sufficiently financially robust to cope with a possible further deterioration in the UK economy and considered a scenario of a 6% fall in GDP, 12% unemployment, a 60% decline in commercial property prices and a 50% collapse in residential property prices. Observers quite rightly argued that the criteria could have been decided on the “back of an envelope” years ago and was hardly a doomsday scenario considering the falls in GDP and property prices already seen. Overall, welcome as stress-testing is, surely if it was that simple, it should have been done before the near collapse of the UK banking sector, not after. But politicians and bureaucrats are uber-skilled at closing the barn door after the horse has bolted whilst reciting cosy sound-bites, and at least they have their “back of the envelope” stress test in place for the next recession. Of course there is another side to the argument, maybe a practical one. The UK economy won’t collapse, thanks to monetary easing and government stimulus. If the stress test criteria was considerably more challenging and therefore some of the banks failed the test, the only party with deep enough pockets to fix the problem is the government (the tax-payer), who has already paid a heavy price. Maybe that’s why the exercise was less of a stress test, and more of a balance sheet tickling contest?

Let’s move on to a more positive note. UK house prices rose in May by 1.2% according to the Nationwide Building Society. The rise, the 2nd in 3 months, has eased the year-on-year decline in prices from -15% to -11.3%. Nationwide attributed the welcome price increase to weak supply, with home-owners reluctant to market their property at current depressed price levels. The data is the best monthly improvement year-to-date and follows: April -0.4%, March 0.9%, February -1.8% and January -1.3%.

In foreign exchange markets, Sterling moved higher against the Dollar over the week continuing the recent trend of USD depreciation in favour of perceived higher risk currencies. Traders also attributed the recent strengthening of Sterling to the gradual improvement in UK economic data, including higher mortgage approvals and a cautiously upbeat Confederation of British Industry survey which highlighted a probable stabilisation in consumer sentiment and a deceleration in the speed of economic contraction within the UK. Another equally feasible reason for Sterling’s good progress is that the pound, like equity prices, was previously over sold and is therefore in the process of returning to a ‘fair price’.

To close our look at the UK, equity prices mirrored the performance of the dominant US market and made slight progress over the week, though the FTSE 100 continues to trade in a 4,300 to 4,500 range as it has for most of May. This pause for breath, as discussed in the global section, is likely to end very soon.

The Global Economy – 9th May 2009

The Global Economy Hope has turned into expectation. Through Q4 2008 and Q1 2009 commentators and analysts were steadily downgrading their economic forecasts and pushing back deeper into 2009/10 their predictions for an economic recovery. However, early in March we saw equity markets fall to new lows, then rally on bargain hunting, and since then cautious optimism has gradually returned to the banking sector and wider economy. Investors and economists increasingly feel there is light at the end of the economic tunnel and the bottom in the economic cycle occurred in Q1, or at worst in the current quarter. The unanswered question is will the global economy stabilise at current levels and provide flat to modest economic activity (an ‘L’ shaped recovery), or will the massive stimulus packages provided by G8 Central Banks spur the global economy into a ‘V’ shaped recovery accompanied by a new bout of inflationary pressures? Equity markets, particularly in the US, seem to be leaning towards to the latter scenario with further gains made this week leaving the 2-month equity rally intact with improved risk appetite spreading from speculators to more mainstream and conservative long-term equity investors.

Ironically, the foundation for improving confidence is not a new, and surprising, trend of good economic news. It’s because certain key data announcements have not been as bad as predicted. In fact it’s near impossible to find any data releases year-to-date, outside of China, that even the most cheerful economist could describe as good but when expectations and investor moral is so low, as it was at the turn of the year, quite bad economic news particularly from the US, still the world’s most influential economy, is greeted with relief and a new bout of equity buying.

A perfect example relates to US employment data, released on Friday, which indicated a further 539,000 jobs were lost during April, compared to a negative 590,000 consensus forecast. The figure, depressing by any normal measure was actually the best, or to put it more accurately, the least worst figure in 6-months encouraging commentators and even President Obama to articulate optimism that the recession was easing in its severity. However, many of the upbeat commentators omitted to mention the data was flattered by a 60,000 temporary boost to US government payrolls relating to contract workers employed for the 2010 census count. Nevertheless confidence is a crucial ingredient in any recovery and as long as the press and investors hold onto their cautious optimism we should see, later in 2009, stabilisation in US housing market which will thereafter encourage US consumers, the backbone of the US economy, to return to what they do best; shopping.

In Canada, the employment news was also better than predicted with a small increase, 35,900, in payroll numbers. Closer to home, the European Central Bank cut Euro-Zone interest rates for the 7th time since summer 2008 reducing the cost of borrowing 0.25% to 1.00%, an all-time low. The European economy is highly likely to recover later than the US due to the ECB being behind the curve on monetary easing but the latest rate cut is welcome nevertheless, though is widely viewed at best as ‘better late than never’.

UK The FTSE ended the week higher, tracking US equity gains. The recent better than expected UK banking sector updates also supported sentiment. The headline UK index has now progressed around 13% in the 5 weeks to-date during Q2. Inevitably some sectors continue to fair better then others. Resource and financial stocks continue to out-perform house builders, property and industrial related equities. This trend, many commentators suggest, is likely to continue with key analysts, Goldman Sachs and Morgan Stanley, downgrading leading property companies or advising clients to sell, whilst house builders remain vulnerable on the expectation that the sector will need further injections of capital to strengthen beaten-up balance sheets. News that house prices declined 1.7% in April (Halifax data) also encouraged equity investors to allocate cash elsewhere on the presumption that the UK property market may be the last sector to enjoy a recovery. On a more upbeat note regarding the affordability of homes, the sharp decline in prices over the past year, (17.7% lower) has improved the house prices to earnings ratio, which is now at a 6 year low of 4.26 according to Halifax. Lower interest rates have certainly helped but with rising unemployment and mortgage availability still not back to normal (pre-Lehman) levels the picture for the rest of 2009 is mixed at best.

Other UK specific news included a hold on interest rates. The Bank of England Monetary Policy Committee opted for no-change to the current rate of 0.5% but did announce an expansion of the £75 billion quantitative easing program adding a further £50bn to help the UK recover from the “deep recession”. The BoE also indicated that it did not consider inflation to be a threat hinting borrowers can expect to enjoy low interest rates for some time yet, certainly into 2010, based on current data.
Look forward, the FTSE is likely to track the S&P 500 pretty closely so the wealth of diversified UK equity investors remains at the mercy of US market sentiment. However, only the most pessimistic market analysts suggest the current rally is a false dawn, and predict a return to new fresh lows. The consensus forecast predicts flat performance or further gains through Q2, with inevitable bouts of short-term profiting taking when markets progress too-far, too quickly.

BHP Billiton PLC (BLT) 1544.00p BHP Billiton, the largest mining company in the world, enjoys balance sheet strength and financial security that most global companies, indeed most countries, would keenly like to replicate. The 2008 annual report, released before the global recession hit, is almost impossible to fault. Seven consecutive years of profit increases, an EBITDA* interest coverage of 49x and $32.1bn returned to shareholders via dividends and share buy-backs, since the BHP and Billiton merger in 2001. Clearly the company efficiently captured the growth in demand, primarily from Asia, for iron ore, copper, nickel, coal and oil, and rewarded shareholders handsomely. The headline figures point to an extremely well run company but hardly scratches the surface of the firm’s operations. BHP Billiton has an impressive portfolio of over 100 mining operations in 25 countries with (as at the end of the last tax year) a further 28 projects either in development or undergoing feasibility studies. The current operations have accumulated $60bn of net operating cash flow in the last 5 years. Commentators have typically associated the terms “China” and “BHP Billiton” in the economic articles for some years now and for very good reason. Their future prosperity and growth are aligned not just in the demand and supply of commodities but fundamentally and politically. China, committed to a unique style of capitalism within a controlled economy needs resources to maintain high economic growth rates thus allowing the spread of wealth through its enormous population. When BHP Billiton was honoured with the task of producing the 2008 Beijing Olympic medals, it confirmed the company was not just another trade partner but was fundamental to the well-being of China, its economy and was in the thoughts of the highest echelons of Chinese political circles.

So the question for investors, considering the long term fundamentals remain excellent for BHP Billiton, how has the worst global recession in 75 years hit current year demand for commodities and BLT profits? Casual observers may be surprised. The firm, in its recent production update, surprised markets with record year-to-date output of iron ore and oil. Interestingly, iron ore shipments cancelled by some customers were sold on the spot market without discomfort. Looking forward, there is further evidence, if any was needed, of the competence of management. The Q1 2009 exploration update should be renamed the “on schedule and on budget project update”. All the oil, gas and LNG projects, (Shenzi, Atlantis North, Pyrenees, Angostura, Bass Strait and North West Shelf) are on target. The Canadian potash project covering an incredible 7,000 square kilometres also highlights the firm’s determination to build on its current portfolio of products and secure new revenue streams. Even in the absence of merger and acquisition activity, BHP Billiton can look forward to growth from expanding the output of its current portfolio of long life, low cost, upstream assets and even a sharp recession seems unable to hold back the success story.

*Earnings before interest, tax, depreciation and amortisation.

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