Market Overview
The following review is for the period 1 January to 30 June 2008 and does not reflect changes in market conditions since this date.
Overview
The first half of 2008 has been characterised by financial market volatility, a relentless increase in the price of oil and mounting inflationary pressures.
Central to these developments have been a US economy in decline, slowing activity in most of the developed world and soaring demand for commodities from emerging economies. The fall-out from the US housing troubles of late last year has spread, causing a series of bank defaults and tighter lending standards throughout global financial markets.
UK
The UK economy has slowed in the wake of surging food and energy costs and a weakening housing market. Inflation hit the upper limit of the Bank of England's target range (3.3%) in May and could rise further. Coupled with contracting housing sector investment and business activity, this has led consumers to rein in their spending.
The domestic equity market, represented by the FTSE All-Share Index, has been volatile against this difficult economic backdrop. After trailing lower during the first quarter of 2008, the market received a much needed bounce in April as blue chip companies, particularly from within the resources sector, strengthened on the back of higher commodity prices. The worst performing companies have generally been within the banking sector, as concerns remain surrounding the extent of the global credit crisis.
The Bank of England reduced official interest rates by 0.25% in both February and April despite rising inflation. It has had to contend with two conflicting risks in making its monetary policy decisions - growing inflation and declining growth.Europe
According to the European Central Bank (ECB), key European economic indicators remain sound and free from major imbalances. Data continues to point to moderate but ongoing real economic growth. Nevertheless, European equity markets, represented by the FTSE World Europe ex UK Index, have been volatile. Companies within the resources, chemicals and utilities sectors have tended to strengthen in recent months while banks and financial services firms have struggled, despite making significant improvements to their balance sheets.
Exporters in the region have felt the pressure of a strengthening Euro coupled with rising costs. However, demand from emerging markets has grown during 2008, somewhat offsetting the decline from the US and Western Europe.US
The US economy has endured a gruelling first half in 2008. The economy grew at a below trend rate during the first quarter of the year. The housing sector continued to decline at an accelerating pace and the market has been rocked by a series of defaults from major banks. This rapidly reduced consumer confidence during April. To help stabilise financial markets, the Federal Reserve (the US central bank) undertook aggressive monetary policy action during the period, cutting official interest rates. Investor confidence subsequently rose to its highest level since October last year.
In recent months the best performing sectors of the US equity market, represented by the FTSE World USA Index, have been within energy and information technology. US companies have had to contend with tightening credit availability and the possibility of the economy sliding into recession. This has led financial services companies to revalue their assets.
Japan
The Japanese economy has seen a marked improvement during the first half of 2008. Signs of inflation have begun to emerge, which is positive for a country that has not seen general price rises in almost a decade. Housing and construction activity has picked up and consumer confidence is high. As a result, the outlook for Japanese equities, represented by the FTSE World Japan Index, has improved. April saw the largest inflow of foreign investment since the 1970s.
Asia
Economic growth from Asia, represented by the FTSE World Asia Pacific ex Japan Index, has generally remained strong during the first half of 2008. This has been despite China, the growth engine of the region, experiencing its worst earthquake disaster in nearly 50 years. China's government will inject an estimated RMB 500 billion into reconstruction. The biggest threat to the region remains inflation. Higher costs have put pressure on margins and revenues, and rapid economic growth continues to drive the risk of monetary policy tightening.
Fixed Interest
Due to mounting inflationary pressures, the Bank of England has stated that it is unwilling to cut interest rates to the extent it would ordinarily do to stimulate the economy. Above-target inflation has seen government bond yields rise, increasing the risk of a UK recession. In the US, Treasury yields have also moved higher as the Federal Reserve has expressed concern regarding inflation.
High Yield
High yield bonds take on more risk than government bonds in order to generate the potential for higher returns. A slowing economy and ongoing concern surrounding the credit crisis has reduced the demand for high yield bonds.
Property
Following several years of strong returns, UK commercial property has struggled in the past year. Low levels of corporate activity have hampered returns. In the first quarter of 2008 £7 billion in assets changed hands in the commercial property investment market, compared to the £10 billion quarterly average that has occurred since 2001.
The views expressed above are those of Legal & General Investment Management, who may or may not have acted upon them. The above should not be taken as an invitation to deal in Legal & General investments or any of the stated stock markets. Remember, the value of investments and any income taken may fall as well as rise, is not guaranteed and you may not get back the full amount of your original investment. Past performance is not a guide to future performance. Exchange rate changes will cause the value of any overseas investments to rise or fall.
