Interest Rates V Stockmarkets

05.11.09

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Interest rates are set to remain low for another five years. Sterling could fall further. More tax rises are inevitable. The public deficit is growing. The recession is not yet over. All in a

Interest rates are set to remain low for another five years. Sterling could fall further. More tax rises are inevitable. The public deficit is growing. The recession is not yet over. All in all, the UK economy?s tale of woe looks set to continue? and yet the FTSE 100 index is up 45% from its March lows (as at 2nd November). Cash savers and investors have experienced rather different fortunes over recent months, but what will happen next?

According to a report by Centre for Economics and Business Research (CEBR), interest rates will be kept at 0.5% until at least 2011 and will not rise above 2% until 2014. Policymakers need to keep rates low to kick start the economy and then give the recovery as much momentum as possible. But this of course means that savers will continue to receive negligible income for much longer than expected.

There?s further bad news for expatriates – the report warned that Sterling?s weak run will continue, falling to $1.40 against the US Dollar and below parity with the Euro.

The CEBR forecasts that the next government will have to make ?100 billion with tax rises and spending cuts in order to bring the UK?s massive deficit back under control.

It also said that the Bank of England would have to increase its quantitative easing programme by another ?75 billion. (On 5th November the Bank voted to add ?25 billion).

CEBR chief executive, Douglas McWilliams, said:

?We are likely to see an exciting policy mix, with the fiscal policy lever pulled right back while the monetary policy lever is fast forward. Our analysis says this ought to work. If it does so, we are likely to see a major re-rating of equities and property which in turn should stimulate economic growth after a lag.?

The report was published before the figures from the Office for National Statistics revealed that, contrary to expectations, the UK economy is still in decline. The quarterly GDP figure showed a contraction for the sixth successive quarter, making it officially the longest recession since records began in 1955.

Low interest rates and low growth are however beneficial for equities, so although some investors may get jittery and take their profits, the longer term outlook for both equity and bond investments remains encouraging.

In spite of the recession, the FTSE 100 rallied strongly since the spring, rising a very impressive 884 points over the third quarter of the year and then hitting 5,200 on 12th October.

Research by the Association of Investment Companies (AIC) released near the end of October reported a 42-month high in investor confidence. More than half (52%) of investors planned to increase their stockmarket investments, compared to 33% a year previously. When they go ahead it will push share prices higher.

Investors have been encouraged by Anthony Bolton?s ? Britain?s former most successful fund manager ? belief that the bull market could run for a ?considerable? time. Long term valuations are still attractive, and while he warned there was likely to be a correction at some stage, he said that ?the bull market will continue for some and it is not too late to invest now?.

As reported in The Telegraph on 25th October, Bolton told Fidelity?s emerging Asia portfolio managers that ?the bargain phase is over but, despite the fact that the market is well off lows, we expect the bull market to go on. It?s a multi-year bull market?.

He expects technology and consumer sectors to lead the next leg of the bull run, and also remains bullish on banks and insurers. He expects China to continue driving world economic growth.

He said that the current environment of low economic growth and low interest rates was ?good for equities?.

Bolton focuses on historical patterns of bull markets, general market sentiment and long-term valuations ? and does not focus on the economic outlook. He warned:

?If you wait for all the economic indicators to turn positive before investing you are likely to miss a significant part of the bull market?.

While the UK stockmarket may be almost 50% above its low, there is plenty of upside left. It still needs to climb almost 30% to reach its July 2007 high and a little more to get back to its December 1999 record.

Besides low interest rates, the stimulus money being poured into the economy, both in the UK and elsewhere, will eventually help boost company profits. Companies have also cut right down on costs, so any increase in sales will increase profit margins. And while many investors have already come back to equity investment, there is still a lot of money waiting to be invested which will then push share prices higher.

The low interest rates also keep stockmarket investment attractive, since if you opt for cash instead of shares, you are basically giving up the earning potential from your assets.

It does, however, depend on your investment objectives, and you should speak to a financial adviser like Blevins Franks to determine the best course of action for your money. If you have short term goals it may be advisable to leave your money in cash, but if you are looking to protect the value of your wealth for the long-term then an allocation to equities would normally be recommended, along with a mix of other investment assets, including some cash.

By Bill Blevins, Managing Director, Blevins Franks

2nd November 2009

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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