Market commentary

May 2009

Economic overview

Economic data released during the month confirmed that the global economy remains in a downturn. At the meeting of the G20 global leaders in London during early April, the gravity of the situation was underlined when a concerted package of stimulus measures totalling USD1,100 billion was quickly put forward and endorsed by the participating nations. The measures agreed and implemented included an increase in the rescue funds available to the International Monetary Fund to USD750 billion from USD250 billion as well as other instruments designed to facilitate trade and investment.

Although weakness persists and very real risks to the downside remain, behind the hastily assembled packages there was some cause for renewed optimism as a slowdown in the pace of decline of economic data showed tentative signs of a return to stability. Headline numbers in the UK continued to look weak, however. For the first quarter of 2009 UK economic growth in the UK, as measured by Gross Domestic Product (GDP), fell back 1.9 per cent quarter-on-quarter, its worst performance in over three decades. While much of the deterioration was generated by the manufacturing sector, the depth and speed of decline of the services sector surprised most commentators. According to the current pace, economic contraction looks set to hit 3.25 per cent for the full year 2009.

Manufacturing output data fell 0.9 per cent, month-on month, for February, but this represented a less severe decline than was expected. The wider industrial production measure decreased 1.0 per cent month-month, taking the yearly rate down to 12.5 per cent from, -11.6 per cent.

Other economic data, however, showed some more positive signs. Although unemployment continues to rise, the pace of growth slowed to lower than expected. Figures from the Royal Institute of Chartered Surveyors suggested some improvement in the numbers of house sales, as well as a reduction in the stocks of homes. Mortgage approvals also appear to be stabilising. Nevertheless, the UK Government's 2009 budget was downbeat, with expectations for UK growth downgraded for this year and the next. Public sector debt as measured by Public Sector Net Borrowing was increased significantly, hitting record levels, and government growth forecasts of 3.25 per cent for 2011 - 12 were received with scepticism.

Against this troubled background and supported by inflation figures which softened to 2.9 per cent - surprising most analysts - the Bank of England maintained interest rates at 0.5per cent by a 9-0 majority and continued with their programme of quantitative easing, with the pan to purchase assets worth GBP75 billion.

The eurozone was buoyed by the decision of the ECB to cut its interest rate by a quarter of one percent to 1.25 per cent during the month of April (reduced to 1.00per cent in early May), but perhaps more so by the hint that it may commence quantitative easing during May. The move was in response to data measures that continue to weaken. GDP for the 4th quarter of 2008 was revised down to -1.6per cent quarteron- quarter and -1.5 per cent year-on-year. Industrial production also declined by 18.4 per cent during February. There were some optimistic notes however, as the Purchasing Manager's Index rose by 2.7 point to 36.7. Though still consistent with a sharp contraction, this is the highest level since October 2008.

In response to more mixed data in the US, the Federal Reserve left the Fed Funds interest rates within their target range of 0.0 per cent to 0.25 per cent. GDP growth continued to decline, losing 6.1per cent quarter-on-quarter for the first quarter of 2009; the third consecutive quarterly decline following the 6.3per cent drop during the 4th quarter of 2009. The employment situation in the US showed no sign of improvement during March however the rate of decline looks to be tapering. The ISM index continued to inch higher during March, the third consecutive monthly rise.

UK

Despite headwinds from weak economic data and the swine flu pandemic threat, UK markets rose with strength during the month. The FTSE 100 Index rose 8.5 per cent, whereas the broader FTSE All Share Index gained 9.9 per cent. Bolstered by rising base metal prices and increased demand from China's manufacturing sector, the Materials sector of the FTSE 100 Index rose with particular strength. Kazakhmys, the copper miner, rose 44.2 per cent during the month, crowning a 131.6 per cent gain for the year to date. Copper in particular has benefitted from renewed interest from the emerging markets. Of the other top tier mining names, Eurasian Natural Resources, Xstrata and Anglo American returned 31.9 per cent, 30.2 per cent and 25.3 per cent respectively, which put them in the top ten performers within the FTSE100 during the month. Among the top five performers over the month however, most of the names were from within banking and insurance. The anticipation of an economic recovery, combined with the response of the US banking system to the stress tests imposed upon them by the US government, endeared investors toward the sector. Barclays was the principal beneficiary of investors' attention as its stock rose 90.2 per cent during the month, closely followed by the Royal Bank of Scotland which rose 70.6 per cent.

Among the poorest performers during the month Friends Provident, Cadbury and GlaxoSmithKline suffered as investors preferred companies which would benefit the first from a cyclical recovery.

Gilts (including index-linked gilts)

Gilts performance fell back during the month as yields rose and the flight-to-quality that had sustained prices waned in the face of investors' greater appetite for risk in spite of the deteriorating outlook for the UK economy. The FT All Stocks Index lost -1.3 per cent. Despite the support offered by the programme of quantitative easing, investors were also deterred by the large level of government bond issuance in order to bolster public finances that had already led to the first failure of a government bond auction in over 7 years.

Global bonds

Investors continued to prefer riskier assets during the month damaging the price of longer-dated US and eurozone bonds. US Treasuries fell by 1.9 per cent, whereas eurozone bonds managed a slight gain of 0.64 per cent. During the month the Federal Reserve left interest rates on hold within their current range, stating that the while the pace of economic contraction appeared to be somewhat slower, economic activity would remain weak for a while. The Fed refrained from expanding its programme to buy further treasuries and this decision pushed yields higher. From an economic perspective the eurozone continued to deteriorate, with the IMF contesting that the GDP contraction is expected to continue into 2010.

Currencies

During April, the US dollar lost ground against the currencies of key commodity producing nations, such as Australia. The performance against other major currencies was more mixed, with the US dollar predominately flat versus the euro, but relative weaker compared with the yen, where it lost 0.3per cent and Sterling where the dollar weakened -3.3 per cent. The rise of sterling was greeted with some surprise considering the UK's economic momentum continues to look weak.

Europe

European equity markets rallied strongly over the month up 13.0 per cent and outperforming a number of other equity markets. The gains were principally driven by improvement in investors' risk perception, aided by the US economy which looked closer to reaching its nadir. Consumer confidence measures in Europe also showed some level of improvement climbing to -31 in April from -34 a month earlier. New industrial orders also improved, down 0.4 per cent month-on-month versus a 3.4 per cent drop in January. Banks led much of the gains in Europe over the month, with ING Groep gaining 70.7 per cent and Unicredit appreciating 50.5 per cent. Nevertheless much of the newsflow over the month focussed upon the announcement from Fiat that it was considering the purchase of the European operations of GM and Chrysler. The news was the catalyst for a rally in automobiles that drew in Renault, VW and Porsche.

US

Equity markets rallied during the month as investors reacted warmly to the news from the ongoing stress tests placed upon the banking system by the government. During the month the S&P 500 index rose 9.4 per cent, while the Dow Jones Index gained 7.4 per cent. The move also reflected a further stabilisation of some economic numbers. First quarter earnings releases also produced some positive surprises. Out of 243 companies in the S&P500 that published their results, more than 67 per cent reported positive surprises, with half posting an increase in earnings-per-share of greater than 16 per cent for the quarter. Unlike April the top performers within the major indices over the month were not all from the banking sector but spread more widely. Investors renewed risk appetite in the face of more sanguine data points were felt by other more cyclical areas of the market. Ford, Office Depot and Dow Chemical all produced strong gains of 127.4 per cent, 97.1 per cent and 89.8 per cent respectively.

Japan

The unveiling of Japan's long awaited additional stimulus package alongside improved sentiment among other Asian nations, including China provided a strong boost to equity markets over the month. The Nikkei 225 index rose 9.2 per cent during April. Although markets were soothed by the Bank of Japan's assessment that Japan would return to growth late in 2009 and into 2010, economic numbers on the whole appear weak and the rally seemed principally driven by an uptick in US car sales. While the outlook for Japanese company earnings still looks uncertain, investors are taking the opportunity to purchase companies where valuations, although boosted recently, remain at relative historic lows.

Asia ex Japan

In line with other risky assets, Asia ex-Japan equities benefitted from the rally in global equity markets during the month. Emerging Asia closed up 13.4 per cent over the month. China gained 6.5per cent, while Taiwan, Korea and Indonesian markets rallied 14.5 per cent, 12.6 per cent and 19.6 per cent over the same period. On the whole markets benefitted from improvements in US economic data as well as from US corporate earnings reports beating consensus expectations. In addition further improvements in Chinese economic data suggested government support may have started to pass through to the broader economy.

Emerging markets

Emerging Market equities performed with strength during the month gaining 12.2per cent during April and led by Eastern European and Latin American equities which gained 19.1 per cent and 12.1 per cent respectively. The moves were driven by a variety of factors which includes the recently increase IMF powers to help troubled economies, somewhat improving the outlook for the Eastern European economies. In addition markets gained from the few improvements in the economic outlook primarily from the US and China, where macro indicators also improved and government stimulus packages may have started to pass through to the real economy.

Oil, gas and gold

Oil completed its third monthly gain in April tracking equity markets on optimism that the pace of decline in the global economy is slowing. The price opened at just below USD50 per barrel at the beginning of the month and climbed to USD51.1, posting gains of 2.9per cent over the month. However, stockpiles in the US show a significant inventory overhang, which could exert downward price pressure. Natural gas prices fell back by 9.5 per cent during the month as demand tailed heading into summer. The gold prices also fell back 3.4per cent as investors moved away from more defensive areas in favour of more risky asset classes.

All figures, source: Bloomberg, total return in sterling terms unless otherwise stated.

For professional advisers only and not for distribution to retail clients. The views expressed are those of HSBC Global Asset Management and do not constitute investment advice. No liability is accepted to recipients acting independently on its content. Information has been obtained from sources HSBC Global Asset Management (UK) Limited believes to be reliable but which it has not independently verified. The value of investments and income from them can go down as well as up. Past performance refers to the past and is not a guide to future returns. Changes in rates of currency exchange, particularly where overseas securities are held, may also affect the value of your investment. Investments in emerging markets are by their nature higher risk and potentially more volatile than those inherent in established markets. All rights reserved. Issued in the UK by HSBC Global Asset Management (UK) Limited. Authorised and regulated by the Financial Services Authority. © Copyright HSBC Global Asset Management (UK) Limited 2009 - 16723 - SC130509OT