Investment Comment June 2014

There are clouds of uncertainty from a variety of factors: continuing violence in Ukraine, Chinese liquidity concerns, military coups in Thailand, warnings about UK house price overheating or the need for European banks to increase interest rates to combat inflation.  Yet markets have remained resilient, with a 14 year high reached on 14 May for the Top UK 100 Companies of 6877, which is only exceeded by the high of 6950 at the dawn of this millennium.  Two main American indices also achieved all-time records in May: over 16,735 for the Dow Jones, and 1,902 for the S&P 500.  There is often a disparity between economic data and market performance, but at present the two seem positive in general, although the US GDP did disappoint with a drop of -1% (Q1 2014).  The IMF raised their global GDP growth forecast for 2014 by a point to 3.7%.  This positive news is already priced-in by investors:  ‘Developed Market’ stock indices have grown by 1.4% so far in 2014 (compared to 27% in 2013), whereas ‘Emerging Markets’ stock indices rose by 3% (compared to a drop of 2% in the whole of 2013).

The UK economic data was good in May.  GDP growth for Q1 2014 was 0.8%, or 3.1% annualised, which was almost back to pre-crisis levels.  Unemployment dropped to 6.8% reported for April.  The (Services) Purchasing Managers Index at 58.7 was also strong, and some of this optimism percolated to the equity markets.  There is considerable cash on company balance sheets.  Management has four choices of what to do with excess cash: retain money in the business for organic growth; pay out a dividend; buy another business; or concede that they can’t think of more imaginative ways to grow the business and announce a share buy-back.  Investors like dividends (the Top UK 100 Companies average yield is 3.5%) and to some extent share buy-backs (which enhances the average return by a further 0.8%).  Yet the market shows the greatest differentiation on the quality of ideas in the area of Capital Markets activity, which is often a lagging factor after company cash generation.  For instance, Sports Direct’s flirtation with buying some LA Fitness Clubs is a traditional example of vertical integration, and analysts reacted positively.  The British pharmaceutical specialist Astra Zeneca rebuffed Pfizer’s offers three times, demonstrating that management thinks the company is worth more than £55 a share or £69bn.  The trend clothing company, FatFace, failed to garner adequate investor demand, and pulled the IPO.  The Saga IPO was priced to go with shares at the bottom of guidance at 185p sustaining a price tag of £2bn with Saga’s holiday and insurance expertise and brand awareness among wealthy pensioners.

We are positive on the long-term attractiveness for investors of Lloyd’s Bank’s planned flotation of 25% of TSB Bank.  Unlike some other institutions, TSB seems to remember its origins as a local mutual savings fund started by the Rev. Henry Duncan of Dumfriesshire to support the poor in 1810.  We welcome the opportunities stimulated by divestment and the increase in competition resulting from such corporate restructuring and hope to see more energy released into the economy through the slimming down of corporate behemoths.  Finally, it is worth noting Bank of England expert Martin Weale’s opinion that strong domestic recovery may mean “gradual” interest rate rises and monetary tightening sooner than previously expected, although no one at this stage can predict the date.

Risk warnings
This document has been prepared based on our understanding of current UK law and HM Revenue and Customs practice, both of which may be the subject of change in the future. The opinions expressed herein are those of Cantab Asset Management Ltd and should not be construed as investment advice. Cantab Asset Management Ltd is authorised and regulated by the Financial Conduct Authority. As with all equity-based and bond-based investments, the value and the income therefrom can fall as well as rise and you may not get back all the money that you invested. The value of overseas securities will be influenced by the exchange rate used to convert these to sterling. Investments in stocks and shares should therefore be viewed as a medium to long-term investment. Past performance is not a guide to the future. It is important to note that in selecting ESG investments, a screening out process has taken place which eliminates many investments potentially providing good financial returns. By reducing the universe of possible investments, the investment performance of ESG portfolios might be less than that potentially produced by selecting from the larger unscreened universe.