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Market Bulletin
MONDAY 17 AUGUST 2010
Tel: 01437 766396
Email: mark.burch@sjpp.co.uk
Website: www.burchwealthmanagement.co.uk
This weekly Briefing Note aims to pick out some of the
key financial and economic issues touched on in the press
over recent days and from time to time includes the views
of some of our independent fund managers.
Activity picks up
After a relatively quiet first week of the year for the FTSE
100, last week saw an increase in trading activity and
market rumour. The leading UK index retreated late in the
week from its 31-month high as commodity stocks were
undermined by China‟s decision to further tighten
monetary policy, causing the index to close the week at
6002.03, still an increase of 1.7% since the start of 2011.
Elsewhere, the US and Europe also saw gains of over 1%
as, overall, equity markets concentrated on encouraging
quarterly earning reports from the likes of Intel and J.P.
Morgan, rather than less impressive economic data such as
an increase in US unemployment.
Last week also witnessed the beginnings of the first major
takeover tussle of the year, according to The Sunday
Times. One of America‟s biggest healthcare companies,
Johnson & Johnson, is understood to be examining a fresh
takeover approach for Smith & Nephew, the UK maker of
hip and knee replacements, with the US firm looking to
put together a revised bid worth at least 800p a share,
valuing the UK company at around £7 billion. Not only
has this news put the Smith & Nephew board on alert, with
it stating “we are not engaged in any discussions which
could lead to a merger or takeover involving the
company”, but this would also test the coalition
government‟s determination to scrutinise bids by foreign
companies; since after the sale of UK confectioner
Cadbury to the American foods group Kraft last year,
Vince Cable announced a review into the “short-termism”
of the City.
Johnson & Johnson, which has a market value of £109
billion, has been encouraged by market reaction to the
reports, with shares in Smith & Nephew rising to 750p on
the first trading day after the news was leaked; and with
massive cash levels of around $6.5 billion at its disposal,
the US company certainly has the financial firepower to
launch a formal bid. It remains to be seen whether a formal
offer will be forthcoming but Richard Oldfield, manager of
the St. James‟s Place High Octane
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funds, sees it as a good acquisition for the US firm. “A
company like Johnson & Johnson continues to look greatly
undervalued, and it is odd that there should be such valuation
anomalies at the larger end of the market. Within equity
markets, waves of enthusiasm and gloom sweep through
different parts at different times, but we can see with
reasonable confidence that this company will provide good
returns over several years. While by no means finalised, the
deal with Smith & Nephew would increase worldwide sales,
but if it doesn‟t go through as planned, it shouldn‟t change the
long-term prospects of the stock at all. There is no real
downside to the attempted acquisition.”
‘British’ Petroleum
On Friday, BP unveiled a $16 billion share-swap that will see
the company issue new shares equivalent to 5% of its stock, in
exchange for a 9.5% stake in Rosneft, the Russian oil giant.
The deal would potentially make the Russian company, which
is 85% controlled by the Kremlin, BP‟s largest shareholder.
The deal is part of a wider alliance between the two companies
that will see them explore for oil in the Kara Sea in the
Russian Arctic (an area the size of the North Sea), as Bob
Dudley, BP‟s chief executive, hailed it as a new model for co-
operation between publicly traded companies and government
oil companies. Looking to the future, Mr. Dudley has not ruled
out Rosneft adding to its 5% stake if the project goes well,
though it is important to remember that should everything go
to plan, production from the region would not begin for
another ten years. It is unclear how existing investors will
react to the deal, which will see their shares diluted by the
Russians‟, but the size of the issue means that no investor vote
is required. The deal has been seen initially as a coup for the
British oil company and a blow to US rivals such as
ExxonMobil, especially as it is believed that Vladimir Putin
has promised BP the “most favourable tax treatment” during
the project. The announcement brought mixed responses
globally as the share price rose 4%; but environmentalists
slammed the move into new exploration areas, while the
reaction from the US was for politicians to express concerns;
while The Sunday Times reported that Michael Burgess, a
Republican congressman from Texas, said, “The national
security implications of BP America being involved with a
Russian company requires scrutiny”.
The Sunday Telegraph opined that the planned Arctic
exploration will allow BP to regain its global prominence
following the Gulf of Mexico oil spill which saw half of the
company value lost in the space of months, although the share
price has recovered around 70% since then. The paper
reported that, nine months after the incident, this
partnership is seen as a statement that the company still
has friends in the world and does not intend to give up its
position at the forefront of deepwater drilling in the face of
US hostility. The outlook for BP in America has improved
slightly, but remains uncertain. The publication of Barack
Obama‟s oil-spill commission report savaged BP for
“failure of management”, but spread the blame among its
partners as well. The likelihood of BP having to pay out
several tens of billions in damages has diminished as a
result, but the company‟s brand in the US remains
tarnished in a market that was central to its growth plans,
and it remains unclear as to whether it will be granted new
licences in the Gulf of Mexico.
Any salvation for savers?
This week, the Office for National Statistics is due to
announce its Consumer Prices Index figure for December,
which was 3.3% for the previous month. It is fully
expected that the inflation rate will rise even higher due to
the increasing price of petrol and utility bills, with
economists believing that it will rise above 4% within
months. According to The Daily Telegraph, savings rates
are now so low that, taking these inflation figures into
account, there are only three instant access accounts
paying a real rate of return, with the average account
paying just 0.23%. However, data from the financial
markets indicated last week that interest rates could rise by
early summer, following surprise at the steep rise in
inflation. Most economists had not expected an increase
until the end of the year, and a rise in the Bank of England
base rate would end a two-year period of stability of rates
at 0.5% aimed at rebuilding the flagging UK economy.
Mortgage companies are already beginning to pull their
best fixed-rate deals, with analysts seeing this as another
sign of anticipation of a rate rise; but some leading
economists are warning that the Bank of England must
hold its nerve. According to a report in The Sunday
Times, Ernst & Young is suggesting that inflation is being
temporarily affected by rising commodity prices, and that
the Monetary Policy Committee should “keep base rates
where they are until it is clear that the economy is taking
the fiscal adjustment in its stride”.
A global problem
With inflation talk high on the agenda, The Independent
on Sunday felt it important to emphasise that this was a
global issue, and not just confined to the UK. While we are
all too aware of rising oil prices, it was also announced last
week that global food prices are now on average 32%
higher than they were six months ago. In a developed
country such as the UK, food generally accounts for
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around 15–20% of household spend, whereas in most of the
emerging world the figure reaches the heights of 50–75%;
therefore a rise in food prices is felt much harder. This is one
of the factors that has already caused civil unrest in parts of
North Africa, with several governments in the region taking
steps to control food costs. The Indian government has already
placed a ban on certain vegetable exports, China has had to cut
road tolls for food transportation, and the Korean government
has actually had to take the steps of distributing emergency
stocks of meat, fish and vegetables. There are a number of
reasons to believe this trend will continue, including a rising
global population, a global shift towards more meat-eating,
and the higher costs of fuel and fertiliser. While globally we
are highly likely to adapt to increasing the food supply, the
paper warned that with the emerging world having more
impact on global prices, food inflation may not be a short-term
trend. It is difficult to see an increase in UK interest rates as a
solution to this global phenomenon.
Global inflation concerns seem to have taken over from
worries over the eurozone in global markets, with commodity
prices rising again last week. The Financial Times reported
that several agricultural prices are now at 30-month highs and
oil is pushing back towards the $100 per barrel level once
again. Within Asia, South Korea and Thailand raised their
benchmark interest rates, while China increased its reserve
ratio requirement for banks for the fourth time in two months.
Closer to home, Jean-Claude Trichet, president of the
European Central Bank, felt the need to comment on the
inflation problems (2.2% in the eurozone), which the markets
interpreted as increasing the chances of a rise in eurozone
interest rates. This had the effect of pushing the single
currency to a one-month high and its best week for a year.
But what does this necessarily mean for equity markets,
particularly in the less developed regions of the world? Hugh
Young of Aberdeen Asia, manager of the St. James‟s Place
Far East funds, is relatively positive on the shorter-term
outlook, reporting recently, “Economic growth in Asia appears
well underpinned in the next 12 months, having rebounded
last year to pre-crisis levels. Although inflation has risen
steadily since mid-2009, it has stabilised in recent months.
However, many central banks have been slow to normalise
monetary policy and their reluctance is due partly to the huge
capital inflows into Asia that have caused regional currencies
to appreciate. Policymakers also seem doubtful about the
region's robust recovery, concerned perhaps that the US and
Western European economies remain vulnerable. To us, it
appears that Asia is decoupling from its developed
counterparts, finding its own sources of supply and demand.
Corporate sentiment is upbeat, which reflects not only the
strength of their balance sheets but also those of Asian
consumers. With corporate profits well supported and real
interest rates remaining low, the outlook for regional stock
markets appears reasonably positive.”