SPECIAL INVESTMENT BULLETIN

IC M E NO T O DA EC UP

SPECIAL INVESTMENT BULLETIN

Economic update November 2011

Events over the last few months have, once again, been dominated by Europe, in a sovereign debt crisis which has been rumbling on for the best part of two years. Greeces transformation from one of Europes fastest-growing economies to the financial debacle we see today, and its subsequent domination of global markets, is all the more remarkable given that Greece represents barely 1% of the eurozone economy, and by default a minuscule portion of the global economy. During the late 1990s, freely available credit made it possible for the Greek government to spend more than its tax and income base to improve infrastructure and social services. The deficit the government accrued was used to pay for pensions and public sector salaries, and devalued the drachma until Greece joined the euro in 2001. How it satisfied the membership criteria is a question many politicians and economists are still asking today. The strength of the single currency allowed the Greek government to access fresh finance until the financial meltdown of late 2007/early 2008 hit the nations primary industries (such as tourism) hard, making it impossible for the government to service the debt they had recklessly built up. Despite a number of bailouts (the first one in April 2010 for 45bn) and numerous crisis summits, significant risks remain, although the three-pillars of a solution announced in October does, at least, suggest that euroarea leaders are committed to keeping the European Monetary Union (EMU) together. Whilst undoubtedly a step in the right direction, the deal is not finalised and the detail remains absent. Furthermore, fiscal policy is tightening, monetary stimulus is weak, and banks are deleveraging in response to haircuts and the European Unions demand to bolster capital positions. As European leaders struggled to come up with a new bailout plan for Greece, much larger fears loomed. Interest rates soared for Italy, the continents third largest economy, to levels regarded as unsustainable. Interest rates for France also rose, whose banks hold large amounts of Italian government debt and where government finances are strained. With the continents economy teetering on the brink, a growing number of economists called for the European Central Bank (ECB) to step forward as a lender of last resort to stop the contagion; a move the bank has resisted, insisting that a political situation is the one required. Across the other side of the pond, there are indications that the US economy is improving, after stalling over the summer months. GDP data has surprised on the upside, with further expectation-beating results from employment, retail sales and durable goods, although rumours of a failure by politicians to agree on steps to reduce public debt have again rattled markets. China also appears to be avoiding a hard landing with its Q3 GDP release. It is however, the euro crisis and its possible contagion effects which has been at the forefront of investors minds and held back global markets. Despite the fall in equity markets seen in the last quarter, businesses, especially in the US, continue to hire. The US Employment Report showed an increase in payrolls of just over 100,000 and the Institute for Supply Management (ISM) index remained in expansion territory in October, registering a 2.8% increase.

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What is the ISM Index?

The index surveys more than 300 manufacturing firms, monitoring employment, production inventories, new orders, and supplier deliveries. By monitoring the index, investors are able to better understand economic conditions. When the index is increasing, equity markets may be expected to increase because of higher corporate profitability. It is also worth recognising that despite the problems being encountered in the eurozone, and the risks to the global economic recovery, equity markets, particularly in the US have proved surprisingly resilient. UK & US equity market performance year-to-date
10 10

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0 0

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-10 10
15
15 -15

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20 Jan Feb

-20 20 Jan Jan

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DowJonesIndustrialAverageTR TR FTSEAllShareTR All Share TR FTSEAllShareTR Dow Jones DowJonesIndustrialAverageTR Industrial Average FTSE

Source: Bloomberg, data from 1 January 2011 to 9 November 2011. FTSE Allshare and Dow Jones Industrial Average total return basis, rebased to sterling. Please note that past performance is not indicative of future performance.

DowJonesIndustrialAverageTR

FTSEAllShareTR

UK headline data
Gross Domestic Product (GDP)
According to figures released from the Office for National Statistics (ONS), the preliminary estimate for third quarter (Q3) GDP was growth of 0.5%. This was better than many commentators had anticipated (the consensus forecast was for growth of 0.3%), and was largely driven by output in the service sector (increasing by 0.7% compared to a smaller rise of 0.2% in the previous quarter) and production sector (increasing by 0.5% compared to a fall of 1.2% in the previous quarter). The construction sector proved to be a negative contributor, decreasing by 0.6% in Q3 after an increase of 1.1% in the previous quarter. As the chart overleaf demonstrates, whilst growth remains positive the UK economy still remains smaller than before the debt crisis of 2007/08. In their supplementary analysis, the ONS admitted that interpretation of the estimate for Q3 is complicated by the special events in Q2 (for example, the additional bank holiday in April for the royal wedding), which are likely to have depressed activity in that quarter. As such, it may be wise to look at Q2 and Q3 figures together, rather than separately; on that basis GDP has grown by 0.6% in the last two quarters and 0.5% in the past year.

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UK GDP
8.0% 8.0%

360bn 360bn

6.0% 6.0%

340bn 330bn

4.0% 4.0%

300bn 300bn

2.0% 2.0%

270bn 270bn

0.0% 0.0% 1979

240bn 240bn
1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

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210bn 210bn

- 4.0% -4.0%

180bn 180bn

-6.0% -6.0%
UK GDP, quarterly change (lhs) UK GDP, quarterly change UK GDP, annual change (lhs) UK GDP, annual change UK GDP (rhs) UK GDP (rhs)

150bn 150bn

Source: Office for National Statistics, latest data to third quarter 2011.

Whilst the figures were better than expected, economists stressed they must be treated with caution. James Knightly, of ING Financial Markets commented: While the Q3 growth rate looks respectable, it is important to remember that this follows a depressed Q2 figure. Indeed, the ONS stated that temporary one-off factors may have knocked up to 0.5% off Q2 growth. Consequently, we should have seen a big rebound. So, for the economy to have grown by only 0.5% in Q3 suggests the underlying picture remains weak. Not surprisingly, George Osborne, Chancellor of the Exchequer, was more upbeat following the release: The British economy has had a difficult journey from its debt-fuelled past. We have to take these figures one step at a time. In defiant mood, the Chancellor further added:

We are determined to continue this journey so that we have the growth and jobs we need. The economic figures are a positive step forward for the country.
Inflation
Consumer prices index (CPI) inflation stands at 5% in October, down from 5.2% in September; the beginning of what many economists are predicting will be a long trend downwards. Indeed, some economists believe the rate could fall below the Bank of Englands (BoE) 2% target level by the end of 2012. Chris Williamson of Markit commented: The rate could well fall back to target in the next 12 months. The rate had increased to 5.2% in September, but downward pressures from falls in the cost of food (due to significant and widespread discounting by supermarkets and good harvests for certain produce), air fares and petrol, contributed to the October fall. Rising utility prices prevented the rate falling further. Retail prices index (RPI) inflation (which includes mortgage interest payments and other housing components excluded from the CPI) stands at 5.4% in October, down from 5.6% in September.

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7.0% 7.0% 7.0%

6.0% 6.0% 6.0% 5.0% 5.0% 5.0%

4.0% 4.0% 4.0%

3.0% 3.0% 3.0%

2.0% 2.0% 2.0%

1.0% 1.0% 1.0%

-0.0% 0.0% 0.0%

1999 1999 2000 2000 2001 2001 2002 2002 2002 2003 2003 2003 2004 2004 2004 2005 2005 2005 2006 2006 2006 2007 2007 2007 2008 2008 2008 2009 2009 2009 2010 2010 2010

-1.0% -1.0% -1.0% -2.0% -2.0% -2.0%

UK Base Rate UK Base Rate UK Base Rate UK CPI Inflation UK CPI Inflation UK CPI Inflation UK RPI Inflation UK RPI Inflation UK RPI Inflation

Source: Office for National Statistics, latest data to October 2011.

The fall was welcome news for the BoE, as the Monetary Policy Committee (MPC) continue to resist increasing interest rates from current historic lows. Indeed, citing increasingly visible symptoms of rising stress in financial markets and the intensifying indebtedness of several euro-areas and banks the committee not only voted unanimously in favour of maintaining the bank rate at 0.5%, but also voted unanimously in favour of further quantitative easing (QE2) to the tune of 75bn (as revealed in the October minutes). The move lifts the asset purchasing programme to 275bn, and whilst the decision was not wholly unexpected, the timing was, with many commentators expecting the BoE to resist QE2 until November at the earliest, with a figure around the 50bn mark. The asset purchases will consist of nominal gilts, conducted over a four-month period, and spread evenly across residual maturities of over three years. The deterioration in the economic picture appears to have forced the Banks hand. Whilst their principal objective remains monetary stability stable prices (low inflation) and confidence in the UK currency the BoE believes its remit extends to aiding sustainable long-term economic growth; a stance not appreciated by the Banks critics, who believe they have abandoned their official goal in favour of a focus on growth and support for the coalition governments goal of eliminating the budget deficit. The view that inflation will fall sharply over the next year (as food, energy and VAT effects drop out, and core inflation finally eases) is one supported by Capital Economics, who pointed out in their UK Data Response of 18 October 2011: The headline rate also hit 5.2% back in September 2008, but was 1.1% just 12 months later. It is this ongoing belief that allows the MPC to maintain such loose monetary policy.

Employment
UK unemployment hit its highest level in 17 years, as the ONS reported that the number of people out of work jumped to 8.3%, up 0.4% on the previous quarter. This leaves the total number of people unemployed standing at 2.62 million, its highest since 1994. The unemployment rate for 16-24 year olds hit a record high and breached the symbolic one million mark; a jobless rate of 21.9%. Meanwhile, the number of people out of work and claiming benefits rose for the eighth consecutive month, by 5,300 to 1.6 million in October (source: Office for National Statistics).

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Economists were troubled by the figures; as Blerina Uruci of Barclays Capital commented: The data reaffirms the disturbing labour market picture of rising unemployment and falling real earnings growth. The figures would suggest that job creation in the private sector is not strong enough to offset cuts in the public sector, as the coalition had hoped, although on a marginally positive note, the increase in the claimant count was lower than expected by analysts (source: Office for National Statistics).

Other data
According to the Nationwide, average house prices in the UK rose by 0.4% month on month in October. The underlying three-month on three-month measure weakened slightly, falling back into negative territory by 0.2%. However, on a positive note for homeowners, house prices rose by 0.8% on an annualised basis, the first rise in seven months. It appears unlikely that the mortgage market will provide ongoing support to house prices. Both the British Bankers Association (BBA) and the BoE measures of mortgage approvals for house purchases fell, with the fall from 52,300 to 51,000 in August, the first since April. Whilst it is too early to tell whether this is the start of a downward trend, as Samuel Tombs, UK Economist at Capital Economics remarked: Recent labour market weakness and the deterioration of conditions in wholesale funding markets suggest that lending will remain subdued. More positive news came in the October release of the Balance of Payments and Economic Accounts (Q2), which indicate that the UK economy is better balanced and looking more healthy than previously thought. The current account deficit in Q1 was revised substantially lower from 9.4bn to 4.1bn, and the deficit shrunk further to 2.1bn in Q2. At just 0.5% of GDP, the deficit is now the smallest since 1998. The consensus forecast was for a widening in the Q2 deficit, however, an increase in investment income from 7.5bn to 9.7bn was the biggest contributor to the reduction.

What is the current account deficit?

A current account deficit occurs when a countrys total imports of goods, services and net investment incomes are greater than the countrys total exports of goods, services and net investment incomes. This situation makes a country a net debtor to the rest of the world. If a current account deficit is financed from long-term capital inflows this can be beneficial for an economy, as inward investment can increase the productive capacity of the economy. If the deficit gets too large, it can cause long-term financing problems for a government, particularly if global confidence in the country begins to turn, and the deficit increases due to the cost of the interest payments. A large current account deficit is often a sign of an unbalanced economy, and could be an indication of structural weakness and/or an uncompetitive manufacturing sector. The latest release of Economic Accounts showed that households have also made solid progress in repairing their balance sheets. A sharp and unexpected 1.2% quarterly rise in households real disposable income enabled them to increase the proportion of their income that they save from 5.9% to 7.4%. This increase suggests that households might be better positioned to deal with the ongoing squeeze on their incomes from persistent high inflation and the coalitions fiscal austerity measures.

Wider economy
United States
According to figures released from the Bureau of Economic Analysis (BEA), the advance estimate for Q3 GDP was the highest so far for 2011, at annualised growth of 2.5%. This was marginally higher than the consensus forecast and significantly higher than the 1.3% recorded for Q2.

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US GDP
10 10 8 8 6 6 4 4 2 2 0 0

-2 2 -4 4 -6 6 -8 8
10 -10

1992 1994 1996 1998 2000 2002 2004 1992 1994 1996 1998 2000 2002 2004 USQoQGDP Source: Bloomberg, latest data to third quarter 2011. US GDP quarter-on-quarter percentage figures.

2006 2006

2008 2008

2010 2010

The BEA confirmed that the increase stemmed mainly from a rise in personal consumption expenditures, exports, non-residential fixed investments and federal government spending. Negative contributors were a decrease in private inventory investment, and state and local government spending. The rise in GDP was seen as passing a key psychological threshold, as it edged above its previous peak, last seen way back in Q4 2007. After almost two years of recession and two years of slow recovery, economists dared to ask has the economy finally entered its expansion phase? It is evident that the figures should be treated with caution. The increase in government spending, which ultimately helped to boost Q3 GDP, coincided with the growing deficit in the US federal budget seen over the past few months. The latest release of the monthly Treasury Statement confirmed that the government deficit increased by $64.5bn in September; a decrease of $69.6bn from the $134.15bn deficit recorded in August, but still up significantly from September 2010. The current deficit in the 2011 fiscal year is now $1,298bn which, at the current rate, represents nearly 9% of the USs forecast 2011 GDP (source: Bureau of Economic Analysis). Sustaining long-term economic growth is clearly not lost on the Federal Reserve, who have continued to hold core interest rates at 0.25%, a level they have now been at since December 2008. Indeed, over the summer, the Fed committed to keeping interest rates at current record lows for at least a further two years, acknowledging that downside risks to the economic outlook have increased.

Eurozone
Eurozone GDP grew by 0.2% in Q3, driven by a rebound in activity in Germany and France, matching the Q2 figure; Germanys Q3 GDP rose by 0.5% and Frances by 0.4%. However, the figure remains sharply down from the 0.8% recorded in the first three months of the year (source: Moodys Analytics). The outlook for the eurozone has darkened, and in an attempt to respond to the continuing debt crisis, the regions leaders announced a threetiered plan following an emergency summit in late October.

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The outline was to recapitalise banks to the tune of 100bn, reduce the Greek debt burden through a 50% haircut on Greek bonds (held by private investors; banks), and to leverage the European Financial Stability Facility (EFSF) to over 1trn. However, it is far from clear that these plans will be decisive enough, and following a brief period of positive market reaction, the recent trend of uncertainty and volatility returned. Whilst it was hoped that China would contribute to the EFSF, this was looking far from certain even before George Papandreou threatened a new crisis by announcing that a referendum would be held to canvas opinion on Greeces continued membership of the eurozone; not just on the 130bn rescue plan agreed a month earlier. However, with Greece itself split on the content of any referendum, the Greek PM announced he was ready to drop the proposal, in the wake of opposition from the Finance Minister, Evangelos Venizelos. Papandreou subsequently agreed to step down, to allow the creation of a national unity government intended to secure international financing and avert a collapse of the Greek economy. After meeting with Antonis Samaras, the leader of the main opposition party, agreement was reached to form an immediate coalition government, with elections to follow after the implementation of the decisions reached at the October emergency summit. Attention in Europe has now turned to Italy and Spain, amid signs that these nations are being sucked further into the ever escalating eurozone crisis. The yield on 10 year Italian bonds rocketed up 65bps to 7.47% on 9 November, breaching the 7% level at which borrowing costs are widely regarded as unsustainable (source: Citywire, 9 November 2011). Spanish 10 year bonds also surged above 6% for the first time since August as they traded higher in line with moves in Italian debt, in spite of news that Mario Monti, a former EU Commissioner, would take the helm of a new coalition government in Rome (source: Financial Times, 14 November 2011). A new centre-right Spanish government seems to have reduced the pressure with yields on Spanish bonds subsequently falling by more than 0.5% Unemployment data in the eurozone also painted an unhappy picture, as the jobless rate rose to 10.2% in September from 10.1% in August, a rise of 188,000 (source: Moodys Analytics). The rate appears likely to remain elevated for a while yet, amidst major fiscal consolidation and public sector job cuts. The ECB surprisingly cut interest rates by 25bps to 1.25% at their November meeting; a meeting chaired by new President, Mario Draghi. Whilst a rate cut had been rumoured, it was not being priced in by the futures markets, which had indicated a cut later in 2011/early 2012, with a further 25bps reduction towards the end of Q1 2012 (source: Moodys Analytics). The new ECB President was keen to start his stewardship with a bang and make a positive statement in the central banks efforts to combat slowing growth.

Japan
The Japanese Cabinet Office confirmed that the economy grow by 1.5% in Q3, matching the market forecast, and ending the countrys technical recession following the devastating March earthquake and tsunami. On an annualised basis, the economy grew by 6% exceeding expectations of a 5.9% rise from economists. The main prop for the economy came from government spending on reconstruction, an increase in manufacturing and a rebound in trade (source: RTT News, 13 November 2011). Analysts suggest that the economy may stall again in Q4 due to persistent strength from the yen denting exports. The Japanese authorities clearly recognise the threat of the yen remaining stubbornly high, particularly against the US dollar, with the government intervening in foreign exchange markets, selling yen for dollars for the fourth time in little more than a year (source: The New York Times). A strong yen continues to be a burden for Japan, as it seeks a path to sustained recovery after the natural and nuclear disasters. While companies have been quick to rebuild factories and restore supply chains, the yen has undermined revival for the nations exporters, which drive much of its economic growth, by making their products less competitive overseas.

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A weaker yen would provide a welcome boost for Japans exporters, allowing them to gain market share (by cutting the foreign currency price of their exports) or boost margins (by keeping the foreign currency price of their exports unchanged). In addition, a weaker yen would help Japanese firms selling goods at home that compete with foreign imports. Jun Azumi, the Japanese Finance Minister, confirmed that intervention in the foreign exchange markets would continue until the government was satisfied with the results. He called the yens climb excessive, blaming speculative traders for the movements, and warning that movements did not reflect the Japanese economic reality. Mr Azumi commented further:

I have repeatedly said that we would take decisive steps against speculative moves in the market. The market has not reflected our economic position at all.
The success of these actions by the Japanese authorities will largely depend on whether investors continue to view the yen as a safe haven; if concerns persist regarding a global economic recovery, demand for the yen as a safe haven could drive prices up further.

China
Q3 2011 GDP grew by 9.1% in China, on an annualised basis, and by 2.3% on a quarterly basis, according to the National Bureau of Statistics. This was below the market expectation, although some of the underlying components are faring reasonably well. Fixed asset investment year-to-date has grown by 24.9% compared to the same period in 2010, slightly above expectation; industrial production increased by 13.8% compared to the same period last year, above expectation; and retail sales increased by 17.7%, also better than the market expected. Furthermore, the 2.3% quarterly rise was slightly faster than the 2.2% rise experienced in Q2 (source: National Bureau of Statistics). In a welcome respite for the Peoples Bank, inflation slowed to 5.5% in October, down from 6.1% in September, and a three-year high of 6.5% in July. In addition, Chinas Logistics Federation and Statistics Bureau reported that an index of manufacturers input costs fell the furthest in 17 months in October. Separate surveys by HSBC Holdings Plc and Markit Economics showed similar declines, suggesting that Premier Wen Jiabao will have more room to loosen fiscal and monetary policy in attempts to stimulate slowing economic growth (source: Trading Economics, 9 November 2011). Such a move would be welcomed by economists; as Zhu, Chief Economist at Beijing-based Citic Securities Co. Ltd. noted: Food and global oil prices have peaked and that means inflation will fall. The decline will leave more room for policy easing, such as looser credit, to help sustain growth.

Other Asia Pacific

Policymakers across emerging Asia are shifting their attention away from tackling inflation to supporting economic growth. Industrial production and exports are slowing across the major countries and the latest manufacturing purchasing managers index (PMI) suggests the outlook is poor, with a reading of less than 50 (indicating falling activity) in South Korea, Taiwan, Australia and Singapore (source: Capital Economics, Global Economic Outlook, Q4 2011). While the export-driven economies of Hong Kong and Singapore are vulnerable to a slowdown in the west, the regions economic fundamentals as a whole are in a much better state than their western counterparts. Structural factors such as catching up with income levels in the developed world, favourable demographics, and increasing urbanisation, appear likely to provide continuing support to household spending. Government investment in infrastructure and production capacity will also likely support growth.

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In addition, unlike the west, policymakers in emerging Asia have more capacity to support growth, with relatively healthy fiscal positions providing governments with the scope to introduce stimulus packages if needed. Moreover, policy rates in the region have been increased since the 2008-09 global crisis, providing central banks with room to cut interest rates once more; indeed, Indonesia has already taken this step.

Optimising investment opportunities

The world economy has continued to slow during the past few months. With this in mind, and in a slightly different format to previous Economic Updates, in this edition we turn our attention to the investment opportunities which remain in such a tough economic environment.

Equities

Intelligent investors in shares should try to take advantage of market fluctuations, and not be too concerned about them.
Benjamin Graham Making market fluctuations your friend is one of the three most important lessons Warren Buffett learned from Benjamin Graham, widely recognised as the first investment guru of our time (source: The Great Investors by Glen Arnold). The degree of volatility and fluctuation experienced in markets is not logical and, in the short term, the stock market often misprices asset values. The fear of missing out pulls investors in when markets are, or have already soared, and causes many to sell when they have already fallen. It is this type of herd mentality which often causes investors to buy and sell at precisely the wrong time. This is the scenario we potentially find ourselves in today. Investors have become fearful that there is worse to come; that the share prices of all quoted companies, irrespective of their industry sector or market share, will decline. Such market pessimism can be indiscriminate. Investors ultimately end up disposing of shares in which there are strong grounds for believing they will recover in price, and this in turn, throws up exciting and attractive investment opportunities for others. A prime example of this exists in large cap, blue-chip companies; companies in a strong and healthy position with a continuous record of generating profits and earnings during all phases of the economic cycle. Such companies have seen their prices dragged down along with all others over the summer months, as a result of high-level macro-economic circumstances outside of their control. AstraZeneca Plc is an example of one such stock. Over the period 5 July to 10 August, the share price fell by nearly 20% from 3,166.5p to 2,543.5p (source: Yahoo Finance). With a solid history of earnings generation in the pharmaceutical sector (a non-cyclical sector not wholly reliant on a buoyant economy), offering a dividend yield in excess of 5%, and on a price/earnings (p/e) ratio of 8x, the attractions are clear (AstraZeneca Plc is a stock which features in the St. Jamess Place Equity Income, Managed Growth, Strategic Managed, UK & International Income, and UK High Income funds.) As Neil Woodford of Invesco Perpetual, and Fund Manager of the St. Jamess Place UK High Income fund reaffirms: We believe that the funds exposure to the non-cyclical pharmaceutical sector should prove rewarding over the longer-term; we believe that the sector has far to go in terms of re-rating. A similar view of the sector and of the investor mentality referred to above is held by Nick Purves of RWC Partners and Fund Manager of the St. Jamess Place Equity Income fund: When uncertainty increases, investor time horizons tend to shorten and many start to focus on the macro-economic picture rather than concentrating on the longerterm outlook for individual company cash-flows and how these are likely to be affected (if at all) by the current difficulties.

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We think investors should be looking for cash generative companies with strong balance sheets and more predictable profit streams, which offer a dividend yield of at least 4%, covered by company cash-flow to give a free cash-flow yield of at least 8%. Pulling this all together, we feel that today, the best opportunities can be found in the telecom, pharmaceutical, and insurance sectors.

What is the free cash-flow yield?

Free cash-flow is a measure of how much cash a business generates after accounting for capital expenditures such as buildings or equipment. Free cash-flow can be used for business expansion, dividends, reducing debt, or other purposes. It follows that the free cash-flow yield is the free cash-flow per share, divided by the share price. In times of economic turmoil, traditionally one of the safest places to invest in equity markets is in consumer staples industries that manufacture and sell food and beverages, tobacco and household products. These are typically the last products to be removed from the household budget when disposable incomes are being squeezed, as is the situation now, due to rising inflation and wage constraints. A prime example of such a company is Unilever Plc, the worlds second largest maker of consumer products. Included in its product range are well-known names such as Bertolli, Knorr, Slim-Fast, Cif, Comfort, Domestos and Dove. Unilevers heavy presence in the growing economies of emerging Asia, Africa and Latin America has continued to propel profits (source: www.unilever.co.uk). The company is one which features in a number of the St. Jamess Place funds, including the Greater European Progressive, UK & General Progressive, International, Equity Income, Recovery, Managed Equity & Bond, Allshare Income, UK & International Income, and Balanced Managed. After the events of the past few months, investors need no reminding that equity investing can be volatile; however, history is clear; stock markets tend to rise over the longer term, despite short-term fluctuations. FTSE Allshare index performance since December 1971
4,000 4,000

3,500 3,500

Commodity & Commodity PricePrice and TMT StocksStocks Bubble Inflation Concerns TMT Inflation Concerns Burst Bubble Burst 9/11 Attacks 9/11 Attacks On US on USA

Eurozone Debt Crisis, Eurozone debt crisis and Japanese Earthquake, Japan Earthquake, US US Downgrade downgrade

3,000 3,000

Asia Currency Asia Currency Crisis Crisis

2,500 2,500

Price Level Level Price

2,000 2,000

World Trade Centre World Trade Centre Bombing Bombing Black Monday First Gulf War October 1987

LTCM and LTCM andRussian Crisis Russian Crisis

1,500 1,500

EnronEnron and and WorldComWorldCom Scandals Scandals

1,000 1,000

Rising Credit Costs, Rising Credit Costs, US Sub-Prime Mortgage, US Sub-Prime Mortgage, US Fed Interventions US Fed Interventions

ERM Crisis ERM Crisis

500 500
OPEC Oil Crisis OPEC Oil Crisis Black Monday Black Monday October 1987 October 1987

Dec 74 Dec-74

Dec 80 Dec-80

Dec 86 Dec-86

Dec 77 Dec-77

Dec 98 Dec-98

Dec 71 Dec-71

Dec 95 Dec-95

Dec 07 Dec-07

Dec 89 Dec-89

Dec 83 Dec-83

Dec 01 Dec-01

Source: Bloomberg, latest data to October 2011.

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Dec 92 Dec-92

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It is also worth referring back to a point we have mentioned previously in Economic Updates. The link between equity market returns and economic growth is surprisingly tenuous, and the two do not always go hand-in-hand, with changes in market and investor sentiment playing a major role. The early 1990s recession in the UK and US aptly demonstrates this point. UK GDP was in negative territory from Q3 1990, and did not return to consistent growth until Q3 1992 (source: The Guardian). However, over the same time period (1 July 1990 to 30 September 1992), the FTSE 100 index (representing the 100 largest companies in the UK by market capitalisation) rose by almost 21%. Similarly, GDP in the US fell by 7.8% from a peak in July 1990 to the trough as at June 1992 (source: Bureau of Economic Analysis). After steep declines in the second half of 1990, the market recovered strongly in Q1 1991, and recorded a total return of almost 12% over this recessionary period. 40 40 FTSE 100 and S&P 500 performance from 1 July 1990 to 30 September 1992
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30

30 30

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20 20

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30 Jul90 Oct90 Oct90 Jan91 Jan91 Apr91 Apr91 Jul91 Jul91 Oct91 Oct91 Jan92 Jan92 Apr92 Apr92 Jul92 Jul92

Jul90

Oct 90 Oct90

Jan 91 Jan91

Apr 91 Apr91

Jul 91 Jul91

Oct 91 Oct91

Jan 92 Jan92

Apr 92 Apr92

Jul 92 Jul92

FTSE 100 S&P 500 FTSE100TR S&P500TR S&P500TR FTSE100TR Source: Bloomberg. FTSEFTSE100TR 500 total return basis, rebased to sterling. 100 and S&P S&P500TR

Bonds
This theory of investing in inevitables (a phrase adopted by Warren Buffett to describe companies which, in his opinion, are unlikely to see a change in market share and earnings capacity over the generations) applies equally to corporate bonds. Many analysts are seeing the asset class as promising, with the recent sell-off creating an attractive entry point for investors. Exaggerated fears of mass defaults are, in the eyes of many, presenting investors with unprecedented value in high quality corporate bonds. Across the investment grade arena, borrowing levels have been reduced by up to 65% and free cash-flow to debt ratios have increased by as much as 200% (source: Financial Express Trustnet). With this in mind, the case for investment grade corporate bonds over government debt appears strong. While the former offers attractive yields (due to recent price falls) with low default risk (due to healthier balance sheets - according to Standard & Poors, in the 12 months to September only 1.9% of corporate issues defaulted), the latter offers historic low yields, with the yield on 10 year UK gilts for example, at only 2.3% (source: Bloomberg, 9 November 2011). Whilst gilts undoubtedly have a role to play as the bedrock of a conservative portfolio, they offer little prospect of generating real returns in excess of inflation over the next five to 10 years.

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Paul Read, joint Fund Manager of the St. Jamess Place Corporate Bond and Investment Grade Corporate Bond funds is seeing such a scenario in corporate credit: Weakness over the summer has left yields higher than they have been for some time. There are an increasing number of attractive opportunities across the investment universe, as sentiment towards corporate credit improves, after several months of risk aversion. He emphasised:

In general, we believe core government bonds offer limited opportunities with yields that are negative in real (inflation-adjusted) terms.

Conclusion
Investing in todays volatile markets can be emotionally taxing. Markets detest uncertainty, yet the last few months have seen nothing but that, as eurozone leaders stumble from one crisis meeting to another. With continued lack of clarity and political resolve, it seems the volatility will not end any time soon. One thing that can be said with certainty is that, despite the low growth environment we find ourselves in, investment opportunities still exist for the prudent investor. However, to find those opportunities requires the expertise of a skilled and experienced manager, one who has encountered like situations in the past, and continues to enjoy steady inflows of money into their fund. The distinctive approach of St. Jamess Place is committed to having the right man behind the wheel to maximise those opportunities. This, along with a well constructed, diversified portfolio, which is actively reviewed and de-risked where necessary, can continue to satisfy the medium to longterm investment objectives of St. Jamess Place clients.

The views and opinions of the analysts and fund managers quoted, are not necessarily those held by St. Jamess Place Wealth Management. Any reference to individual companies does not represent a specific recommendation to invest.
UK members of the St. Jamess Place Wealth Management Group are authorised and regulated by the Financial Services Authority. The St. Jamess Place Partnership and the titles Partner and Partner Practice are marketing terms used to describe St. Jamess Place representatives. St. Jamess Place UK plc Registered Office: St. Jamess Place House, 1 Tetbury Road, Cirencester, Gloucestershire, GL7 1FP, United Kingdom. Registered in England Number 2628062.

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SJP3581-VR2 (11/11)