In one year and out the other…

The fiscal cliff turned out to be something of an anti-climax so we could be forgiven for thinking that nothing is different in this new year. So what is?

The days of risk on risk off which haunted last year’s politically-charged markets are likely to return during the build up to February’s debt ceiling negotiations. In the first few days of the year, however, markets are up across the board and the winners so far in 2013 replicate those in 2012. Europe remains the most obvious way to add risk to a portfolio and the best performing developed market of the year is Greece – which has now doubled from its nadir but remains 80% down from five years ago.

FTSE S&P 500

Peripheral Europe continues to make the running with Italian, Portuguese and Spanish shares amongst the best performers too. Much of this has to do with geography. Despite the wires seeming to carry no hope of a deal, the US rallied hard into New Year’s eve after Asia and Europe had shut. That suggests investors are becoming more confident that politicians are able to make the right choices when it matters. Perhaps that is why the current deal, despite lacking much substance, has been so well received by the markets: we have now seen the Republican’s surrender their fiscal demands for two New Years in a row. The Fed may have silenced the bond vigilantes (the bond market used to punish reckless fiscal or monetary policies) but it seems that Congress remains at the mercy of equity vigilantes.

UK equities are now pretty heavily overbought. Less so the US, but the S&P 500 and the FTSE 100 are up against meaningful resistance levels. The news flow and technical headwinds suggest a pause at these levels – although much will depend upon the earnings season starting properly next week. Added to which the FTSE has fallen in six of the last ten Januaries with an average loss of 1.4% (its currently up 3.2%).

The dollar has been uncharacteristically strong given the risk on mantra. Partly this is explained by a very modest vote of confidence in the United States Congress and partly by the dovish interpretation of the Federal Reserve minutes. Apparently several members thought it would probably be appropriate to slow or stop purchases before the end of 2013. This is a surprising development and one which suggests to commentators that the Fed may have reached its point of maximum dovishness. If that were so, from here on the emphasis would shift to how quickly to tighten.

It seems unlikely that there will be any meaningful tightening in 2013.

The Federal Reserve has identified a low mortgage rate as a meaningful means of stimulating the economy. As it happens tight lending restrictions have meant only a select few have been able to take advantage of the lower rate. Were anything to happen which allowed the mortgage rate to rise quickly then it would likely stifle the nascent recovery. US housing is at record levels of affordability however a more simple price to income ratio makes the case far less compelling. It is the Federal Reserve’s low mortgage rate which allows the pent up demand for housing to dissipate through the economy.

Having begun to use the yield curve as a monetary policy tool, it is unlikely that the Federal Reserve will simply abandon it to market forces overnight. Having committed to a low Fed Funds rate into 2015, and until the unemployment rate dips below 6.5%, the Fed are unlikely to allow rising bond yields to stall the recovery.

Finally last Friday saw the release of US non-farm payrolls numbers. Being pretty much bang-on estimates (155k versus estimates of 150k) it was neither too cold, suggesting further stagnation, nor too hot, suggesting withdrawal of monetary accommodation. Earnings and hours worked each rose at their fastest rate in a year, but the interesting feature from the details of this report was the construction payrolls. Whilst construction accounts for around 20% of the headline payrolls gain it is significant because new home building is labour intensive and has a high fiscal multiplier (its effects cascade through the economy). We have already seen new home starts rise in 2012 and the typical lag is around 12 months before that translates into new construction payrolls. It is therefore reassuring to see this relationship hold firm once again as new buildings construction and new residential construction payrolls each posted their largest monthly gains since 2006. Further reason for the Federal Reserve to believe all this can-kicking has been worth the shoe leather.

US Payroll Comparison

US Construction Payroll and US Housing Starts

The cliff-to-ceiling negotiations will reach their climax in February, which also delivers the Italian election. Mario Monti is set to lead a centrist coalition called With Monti for Italy. The polls have not yet taken into account the addition of Monti to the ticket but, based on the polling for the constituent parties, there appears little chance that the centrists will secure a majority or the largest share of the vote. The latter appears to be due to Pier Luigi Bersani’s Democratic Left, but they too should fall short of a majority. That seems more likely if Bersluconi’s efforts to form a new alliance with the Liga Nord come to fruition. That makes a Monti-led grand or minority coalition the most likely path which, while unsatisfactory, is probably the least-worst scenario that could be hoped for given the lie of the land in Italian politics.

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The information contained in this report represents an impartial assessment of the value or prospects of the subject matter. Graphs, performance data etc are as at the close of business on the day preceding the date of the note. The information contained in this report has been taken from sources disclosed in this presentation and is believed to be reliable and accurate but, without further investigation, cannot be warranted as to accuracy or completeness. The opinions expressed in this document are not the views held throughout Brewin Dolphin Ltd. No Director, representative or employee of Brewin Dolphin Ltd. accepts liability for any direct or consequential loss arising from the use of this document or its contents. We or a connected person may have positions in, or options on, the securities mentioned herein or may buy, sell or offer to make a purchase or sale of such securities from time to time. In addition, we reserve the right to act as principal or agent with regard to the sale or purchase of any security mentioned in this document. For further information, please refer to our conflicts policy, which is available on request or can be accessed via our website at www.brewindolphin.co.uk. The value of your investment or any income from it may fall and you may get back less than you invested. Past performance is not a guide to future performance. If you are in any doubt concerning the suitability of these investments for your portfolio you should seek the advice of a qualified investment adviser. Brewin Dolphin Ltd, a member of the London Stock Exchange, authorised and regulated by the Financial Services Authority.

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