Market commentary

July 2009

Economic overview

Global investors' appetite for more risky asset classes continued during July as even with a weaker start to the month, the overall impetus to purchase equities was sustained by improving economic data and robust company earnings figures. The Bank of England (BoE) held interest rates at 0.5% during July. Despite this marker of continued economic uncertainty, the decision not to extend the quantitative easing programme for July prompted investors to speculate whether this indicated a level of improvement in the economy that would render this stimulus measure unnecessary going forward. This notion of having reached an 'endgame' provided the positive sentiment which endowed investors with the appetite for the riskier asset classes. Further support for UK investors came from other measures of economic health. Consumer spending rose 1.2% month-on-month, which was higher than analysts expected. Although aggressive discounting from retailers and good weather helped boost this figure, the scale of the rise was well received. UK house prices also rose 1.3% month-on-month during July, capping an upwardly revised gain of 1.0% during June. Consumer Prices Inflation (CPI) also fell below its 2% target rate for the first time since September 2007. The figure dropped to 1.8% year-on-year in June, from 2.2% year-on-year during May. Finally, consumer confidence showed signs of stabilisation. The Nationwide measure of sentiment improved from 54 in May to 58 in June. Nevertheless, the overall health of the economy remains weak and vulnerable to external shocks. Second quarter Gross Domestic Product (GDP) was poor and contracted 0.8% over the quarter. Strong sentiment also enabled the markets of overseas economies to make strong gains. In the US, comments made by Ben Bernanke, the chairman of the Federal Reserve (the Fed), that “the US economy has the necessary tools to help it pick up this year” found favour with investors. Indeed, this mood was helped by better than expected second quarter GDP figures. Although they still registered a fall of 1.0% (annualised), this was better than the 1.5% that was anticipated. Sentiment received further support from healthy retail sales and stronger indicators of manufacturing and non-manufacturing activity from the Institute of Supply Managers (ISM) and the Purchasing Managers Index (PMI). Many indicators are now nearing levels they last achieved prior to the collapse of Lehman Brothers in 2008.

UK

During the month, the consensus GDP growth forecast for the UK in 2009 was revised downwards by 0.3% to -4.0%. The year-on-year fall in GDP, of 5.6%, is the worse since records began in 1955. Analysts expected a smaller 0.3% decline in the second quarter following the hefty drop in the first. The UK service sector (the largest contributor to the UK's economy) dropped by 1.6% quarter-on-quarter in the first quarter and 0.6% quarter-on-quarter in the second. This somewhat dampened hopes of a stronger recovery in economic activity for 2010 and was echoed by the IMF, which repeated its warning with regards to the UK, stating that any recovery will likely be “slow and subdued”. Over the month, industrial production fell more than expected, down 0.6% month-on-month in May against a 0.3% gain in April. Of greater concern and in line with other regions, employment data continued to deteriorate, albeit at a slower pace as suggested by the lower than expected jobless claims in May. In addition, the UK budget deficit continued to weigh negatively on the economic outlook. UK public sector borrowing requirements climbed to GBP 18.8bn in May, 96% higher than a year earlier while in the same period total tax receipts have dropped 11%. Overall, despite the improvement in selective economic readings economic activity continues to be weak and question marks remain over the timing and magnitude of a possible recovery. UK annual inflation slowed again in June as the CPI fell to 1.8% year-on-year from 2.2% in May, below the BoE 2% target. The main factor behind the inflation slowdown was an easing of the rise in the cost of food (lower prices for meat, milk and fruit) and non-alcoholic drinks. Core CPI was steady at 1.6% year-on-year in June.

Gilts (including index-linked gilts)

Government bonds (Gilts) and index-linked government stock posted negative returns over the month, as investors preferred riskier asset classes such as equities and corporate debt. Although some indicators showed improvements, economic activity in the UK remains weak suggesting a muted recovery. Supply concerns could place pressure on UK Government bond prices, as the financial authority continues to issue record amounts of debt to support the economy and stimulate spending. The heavy supply, coupled with the potential for a resumption of the asset-buying (quantitative easing) programme, could lead to rising expectations of inflation in future. However, these concerns seem to be already reflected in the bond prices.

Global bonds

After declining for most of July, US Treasury prices staged a rally at the end of the month, bringing their performance into positive territory, with gains of 0.38%. The declines were fuelled by ongoing concerns about supply as President Obama borrows unprecedented amounts to fund various stimulus programmes. The US sold a record USD115 billion of debt during the last week of the month. However, demand for the auctions was quite resilient, with the US Treasury selling seven-year notes at lower than forecast yields, and prices staged a late rally at month end. Investors are increasingly nervous regarding the method and timing of any exit strategies from stimulus packages. In his twice-yearly testimony to the US Congress, Bernanke sought to explain that the Federal Reserve has various tools at its disposal to eventually exit the current stimulus policies "in a smooth and timely manner".

Currencies

GBP rose 1.5% against the USD, was unchanged against EUR and fell 0.2% against the yen. Recent macro economic data is mostly still weak although consistent with a less weak second quarter than first quarter. Public sector finances are deteriorating sharply. Public sector debt hit a record high of 56.5% of GDP at the end of June, the highest since records began in 1974. 2009 consensus growth forecasts have been revised down (-4%) and although 2010 forecasts were nudged up, they are still forecast to be anaemic (0.8%).

Europe

European equity markets rallied strongly over the month outperforming many other equity markets including some in emerging markets areas. The MSCI Europe Index ended the month up 9.3%. The pick-up in investor sentiment was largely driven by the positive earnings results for 2009 second quarter earnings in the US and elsewhere. For example, more than 62% of companies within the DJ EuroStoxx 600 have so far reported better than expected earnings for the second quarter. However, earnings growth remains in sharply negative territory on a year-on-year basis. For example, Nokia's earnings are down more than 58% from a year earlier. Some news flow suggested that the economic slowdown could be stabilising, but on the whole, economic activity is still weakening. In addition, the deterioration in labour markets prompts further concerns over consumption and growth.

US

In July the MSCI USA Index gained 7.5%. Second quarter earnings announcements displayed a growing number of positive surprises which led to strong gains for equity markets. In the US, 66% of S&P500 companies have now reported and the majority of these have posted better than expected earnings across a variety of industries. For example, Intel announced a 12% increase in revenues from Q1 2009, signalling the strongest pick-up in business in more than 20 years and suggesting improving conditions in the PC industry and technology sector. Within the Financials sector, a number of players including Goldman Sachs, JP Morgan and Bank of America also reported better than expected results, with Goldman posting its best quarterly figures in the firm's history and USD3.4 billion in profits. Nevertheless, the news was not universally positive. General Electric's results showed that profit from continuing operations declined by 47% from a year earlier. In addition, within the Financials sector, JP Morgan added more reserves, painting a bleak view of future consumer and wholesale loan losses, whilst other banks like Wells Fargo or American Express are still struggling with increases in troubled loans to businesses and consumers.

Japan

Japanese equities underperformed almost every other equity market over the month. The MSCI Japan Index was up by 2.8% whilst the MSCI World gained 7.5% over the month. The weak increase resulted from a sharp correction of 6.8% in Japanese equities at the beginning of month. The drop reflected mixed US and Japanese economic data, as well as Japan's Prime Minister calling for national elections to be held on 30 August, which dampened hopes for a recovery to start in the near future. The unemployment rate rose to 5.4% in June, from 5.2% in May, further clouding the outlook for consumption. Retail trade also disappointed, down 3.0% year-on-year in June from -2.8% in May and below a consensus estimate of -2.5%. However, signs of improving macro economic data and positive earnings surprises in the US in particular led the market to surge over the second half of the month.

Asia ex Japan

According to MSCI, Asia ex-Japan markets gained 12.3% in July outperforming a number of other equity markets. The move was led by China, Taiwan and Korea, up 10.8%, 12.2% and 14.4% respectively. The strong performance was largely driven by improving economic fundamentals and the belief that Asia has a fair chance of being among the first to emerge from the crisis.

The improvements were not limited to China. Taiwanese export orders in June showed very strong improvements, albeit still negative relative to last year (-10.9% year-on-year, from -20.1% previously). In Korea, industrial production climbed 5.7% month-on-month in June from 1.6% in May, with several companies, including Samsung Electronics and Hyundai Motor, reporting profit surges for the second quarter, as exports and household spending jumped.

Emerging markets

Global emerging markets equities surged by 9.9% in July. The strong performance was largely driven by Asia ex-Japan markets, with China up 10.8% while Korea and Taiwan climbed almost 14.4% and 12.2% respectively over the month. Latin American markets however, lagged during the rally, up by only 5.9% over the month. Markets were largely driven by the positive macro economic news, essentially from China. China's GDP growth was reported at 7.9% for the second quarter of the year, 1.8% above first quarter figures. Investments, industrial production and retail sales all contributed to the higher output with retail sales expanding by 15% from a year earlier, whilst year-to-date fixed asset investments were up by 33.6% year-on-year in June.

Oil, gas and gold

The oil price fell during most of July, with the WTI spot price declining from USD 69.89 per barrel to a mid-month low of USD 59.52, before recovering to end the month at USD 69.45, representing a -0.63% decline. The most pronounced price declines were triggered by a US government report showing an unexpected gain in US supplies as imports rose and refiners cut operating rates. Stockpiles surged by 5.15 million barrels to 347.8 million in the week ended July 24, according to the Energy Department. This was the largest weekly increase since April. Supplies had been forecast to decline by 1.5 million barrels.

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.