Tanguy Le Saout, Head of European Fixed Income
Central Bankers Start Talking Again:
Whilst August is traditionally a quiet month in markets with many participants on vacation, central bankers have been quite active in trying to guide markets to their way of thinking. In the U.S., San Francisco Federal Reserve President John Williams started his August 15th Economic Letter by stating that “the time has come to critically reassess prevailing policy frameworks and consider adjustments to handle new challenges, specifically those related to a low natural rate of interest”. That’s central banker code for saying “governments need to do more on the fiscal side and we need a new way to think about monetary policy”. Shortly afterwards the minutes of the July U.S. Fed meeting were published, showing a divided committee. Some members thought that the economy was sufficiently strong to weather a rate increase, others felt that they would prefer to wait for inflation to move higher before moving. Across in Europe, the minutes of the ECB’s July meeting showed that the fall-out from the Brexit vote in the UK “has thus far been less marked than many had anticipated”. Once again, the ECB noted that they stood ready to take whatever actions were necessary to reach their 2% inflation target, but repeated their mantra that Eurozone governments needed to help as well, preferably by enacting structural reforms. In the UK, speculation is mounting that the new Prime Minister Teresa May could announce a fiscal stimulus package that, along with the Bank of England’s (BoE) recent monetary stimulus measures, might help the UK economy weather the fall-out from the Brexit vote. Finally, in Japan, Prime Minister Shinzo Abe launched a new 4.6trn Japanese Yen (U.S. $45bn) stimulus package to boost a struggling Japanese economy. All this suggests that global governments are moving closer to acknowledging that central banks and Quantitative Easing (QE) programmes alone cannot solve the world’s problems. With long-term interest rates at historically low levels, it makes sense, in our opinion, to loosen the purse strings and boost fiscal spending, financed by issuing long-dated bonds (as Japan is considering doing). In the medium-term, this could lead to higher bond yields and steeper yield curves.
Did Brexit Really Happen?
Looking at the current levels of markets in the UK, you’d be forgiven for thinking that the UK had never voted to leave the EU. UK equity markets are between 5%-10% higher than on June 22nd, and gilt yields are substantially lower. In fact, the UK 10-year gilt yield was 1.37% on June 23rd and is now 0.52%. The spread between 10-year UK yields and 10-year German yields has almost halved – from a spread of 128bps to its current level of 65bps. But the gold medal in the bond Olympics goes to the UK 30-year, which has enjoyed a total return of 35.6% since the start of the year. That begs the question – is such performance justified? The consensus post the referendum vote was that the UK would experience a significant slowing in economic growth, and possibly even fall into recession. But so far the data hasn’t been as bad as feared – UK retail sales for July were up +1.5% versus the previous month, and are +5.4% higher than this time last year. In truth, we haven’t had a lot of economic releases to indicate how economic activity fared post the Brexit vote, but what we have seen so far suggests a smaller fall-out than initially expected. The BoE did act aggressively in early August – cutting rates by 25bps and increasing their QE programme by £60bn per month for the next 6 months. The QE announcement was greeted with delight by the gilt market, and was mainly responsible for the aforementioned rally in gilt yields. However, the size of the extra QE from the BoE is smaller in flow terms relative to the size of the nominal government bond market that in Europe or Japan. Looking at it another way, UK 10-year real yields have fallen by 25bps since the BoE’s announcement, whereas U.S. 10-year real yields have risen by 5bps. The final thing to bear in mind is the substantial fall in Sterling – the trade-weighted exchange rate has fallen 21% in 2016. In our opinion that will eventually feed into higher UK inflation, making UK gilts look less attractive. We believe that a neutral duration stance in UK gilts is warranted.
European Inflation – What’s Happening?
In our last blog before the summer vacation, we noted that European inflation expectations were no longer tracking the oil price (with which they previously had a reasonably strong correlation), but now appeared to be more correlated with European bank stocks. The attached chart shows the updated relationship. Although the oil price is technically back in a bull market, having appreciated by over 20% from its lows on August 2nd, it has had little impact on Euro-area inflation expectations. The gap has been wide before (most recently in June 2016) but it does have a habit of mean-reverting, and the current gap in our opinion is wide enough to suggest that there will be convergence shortly. But the more relevant question might be why inflation expectations have not tracked the oil price recovery. One theory is that inflation-protected issuance in Europe picks up in September as sovereign issuance programmes restart after the summer break, and investors don’t wish to push the price of inflation-protected securities higher before that issuance. But more likely in our opinion is the view that investors have bought into the “low inflation forever” story, especially as economic growth is still struggling to reach the levels seen before the global financial crisis erupted in 2008. However, whilst we don’t expect to see inflation recover to target levels anytime soon, we do believe that there are grounds to expect inflation to move higher over the next 6 months or so. The falls in the oil price of 12 months ago will soon start to fall out of inflation calculations, to be replaced by more recent oil price increases, which will have the effect of automatically pushing inflation higher. In our opinion, the market isn’t priced for such an outcome, so an increased allocation to inflation-protected securities might be a good idea during the coming months.
Source: Bloomberg, Pioneer Investments. Data as of 19 August 2016.
COVID-19 and PCL property – a market on the rise?
By Alpa Bhakta, CEO of Butterfield Mortgages Limited
Over the last five years, demand for prime central London (PCL) property has been fairly inconsistent. Sudden peaks in interest from buyers could be followed by periods of stagnate price growth. Nonetheless, the advantages of PCL property investment, particularly by international investors, has remained well known.
Well-funded development and neighbourhood re-generation schemes, alongside an influx of overseas investment, has resulted in a vibrant market with a diverse range of opportunities for prospective buyers.
Nonetheless, the PCL market has not been immune to the impact of the COVID-19 pandemic. During the first half of the year, the lockdown meant physical valuations and onsite inspections could not take place. People in the UK were also discouraged from moving properties unless they found themselves in extreme circumstances.
However, as we now enter the final weeks of 2020, I believe there’re plenty of reasons to be optimistic about the future prospects of the PCL property market. Buyer demand has resulted in a new wave of activity, and this is resulting in significant house price growth. Indeed, it was recently revealed by Halifax that the average rate of house price growth in November was at a four-year high.
Obviously, there are multiple factors that have helped sustain this strong level of house price growth. Most notably, the Stamp Duty Land Tax (SDLT) holiday has succeeded in coaxing buyers back to the property market––be they seasoned buy-to-let (BTL) investors or first-time buyers––by offering up to £15,000 in tax savings on any given property purchase.
However, it’s worth considering the other factors underway in London’s property market. With the UK in a second national lockdown, many investors will be keen on hedging against future COVID-imbued market uncertainty through acquiring safe-haven assets like British property. As you’ll read below, this is having a positive impact on the PCL market.
Investors are flocking to PCL opportunities
The PCL property market has managed to be one of the most active areas of the UK’s real estate market during the whole of 2020. When discussing why this is so, we must first begin by understanding the behaviours of overseas buyers.
Given that international investors represented over half (55%) of all the PCL property purchases recorded in the second half of 2019, anything to further incentivise or dissuade such foreign actors would hugely impact PCL property transaction figures.
Earlier in the year, alongside the announcement of the aforementioned SDLT holiday, UK Chancellor Rishi Sunak indeed announced that he would be implementing 2% SDLT surcharge for non-UK based buyers of British property from April 2021 onwards.
So, for those seeking properties worth over £5 million in the UK capital, a 2% additional cost may represent a substantial amount of wealth. To avoid this, many overseas buyers who may have been contemplating a PCL property acquisition have rushed to buy such properties before this surcharge is applicable. This trend will undoubtedly continue until 1 April, 2021.
Remote working and PCL
On the topic of the PCL market’s future, many property speculators were concerned earlier this year that London’s property market would potentially collapse entirely as a result of remote working. With homeworking set to remain the norm for the foreseeable future, commentators predicted that professionals would escape the capital en-masse in favour of roomier, cheaper properties farther from their London employer’s offices.
While there have been some signs of shifting demand from urban London neighbourhoods to suburban ones, according to Rightmove statistics, there has been no recordable effect on the UK’s property market as a result.
Conversely, property specialists Savills have actually discovered that over half of all transactions including properties worth more than £5 million in the UK this year were all located in just five central London postcodes.
A busy few months
Given the performance of the PCL property sector in 2020, I only foresee this market growing stronger and stronger in the years ahead. Recent developments in the production of COVID-19 vaccine have many hoping that we may return to normality by Spring 2021, which would represent fantastic news for those involved in bricks and mortar, should it transpire.
In the coming months, I anticipate a surge in activity across the PCL market as buyers look to take advantage of the tax breaks on offer. As such, it will be important that these buyers have access to the financing needed to complete these transactions quickly. If not, there is a risk any purchase they attempt might be concluded in April 2021 when the current tax breaks in place are removed.
Overall, I cannot help but be impressed by the performance of the property market more generally during the pandemic. Having experienced slow growth in the years following the EU referendum in June 2016, it is clear that buyers are eager to take advantage of the opportunities on offer. This is particularly true when it comes to PCL property.
An outlook on equities and bonds
By Rupert Thompson, Chief Investment Officer at Kingswood
The equity market rally paused last week with global equities little changed in local currency terms. Even so, this still leaves markets up a hefty 10% so far this month with UK equities gaining as much as 14%.
The November rally started with the US election results but gathered momentum with the recent very encouraging vaccine news. This continued today with the AstraZeneca/Oxford vaccine proving to be up to 90% effective in preventing Covid infections. This is slightly below the 95% efficacy of the Pfizer and Moderna vaccines already reported but this one has the advantage of not needing to be stored at ultra-cold temperatures. One or more of these vaccines now looks very likely to start being rolled out within a few weeks.
Of course, these vaccines will do little to halt the current surge in infections. Cases may now be starting to moderate in the UK and some countries in Europe but the trend remains sharply upwards in the US. The damage lockdowns are doing to the recovery was highlighted today with the news that business confidence in the UK and Europe fell back into recessionary territory in November.
Markets, however, are likely to continue to look through this weakness to the prospect of a strong global recovery next year. While equities may have little additional upside near term, they should see further significant gains next year. Their current high valuations should be supported by the very low level of interest rates, leaving a rebound in earnings to drive markets higher.
Prospective returns over the coming year look markedly higher for equities than for bonds, where return prospects are very limited. As for the downside risks for equities, they appear much reduced with the recent vaccine news and central banks making it clear they are still intent on doing all they can to support growth.
Both factors mean we have taken the decision to increase our equity exposure. While our portfolios already have significant allocations to equities and have benefited from the rally in recent months, we are now moving our allocations into line with the levels we would expect to hold over the long term.
Our new equity allocations will be focused on the ‘value’ areas of the market. The last few weeks have seen a significant rotation out of expensive high ‘growth’ sectors such as technology into cheaper and more cyclical areas such as financials, materials and industrials. Similarly, countries and regions, such as the UK which look particularly cheap, have fared well just recently.
We think this rotation has further to run and will be adding to our UK exposure. This does not mean we have suddenly become converts to Boris’s rose-tinted post-Brexit view of the UK’s economic prospects. Instead, this more favourable backdrop for cheap markets is likely to favour the UK.
We will also be adding to US equities. Again, this does not represent a change in our longstanding caution on the US market overall due to its high valuation. Rather, we will be investing in the cheaper areas of the US which have significant catch-up potential.
We are also making a change to our Asia ex Japan equity holdings. We will be focusing some of this exposure on China which we believe deserves a specific allocation due to the strong performance of late of that economy and the sheer size of the Chinese equity market.
On the fixed income side, we will be reducing our allocation to short maturity high quality UK corporate bonds, where return prospects look particularly limited. We are also taking the opportunity to add an allocation to inflation-linked bonds in our lower risk, fixed income heavy, portfolios. These have little protection against a rise in inflation unlike our higher risk portfolios, which are protected through their equity holdings.
Optimising tax reclaim through tech: What wealth managers need to know in trying times
By Christophe Lapaire, Head Advanced Tax Services, Swiss Stock Exchange
This has been a year of trials: first, a global pandemic and, now, many countries facing the very real possibility of a recession. For investors, private banks, and wealth managers, these tumultuous times have manifested largely in asset price volatility, ultra-low interest rates and uncertainty about when things may level out, as well as questions about what can be done to safeguard portfolio performance.
The answer here lies within identifying and creating efficiencies to maximise performance and minimise cost, and while there is a slew of options as to how to do this, they are often siloed or have a single USP. Tax optimisation, on the other hand, provides benefits to all, not just in increasing returns for investors, but also in creating economies of scale across stakeholders, creating millions – if not billions – in savings for banks.
Evolving tax reclaim
The tax reclaim process used to be a tedious one banks had to manage themselves, and required detailed, industry and country-specific knowledge to stay on top of constantly shifting requirements and regulations. And when we consider that many countries – such as the UK – allow for capital gains exemptions, tax optimisation may not seem like an integral part of the process. However, this isn’t the case for all countries, and can lead to severe after-tax implications on global portfolios.
Furthermore, even if you’re able to avoid double taxation, getting the money back is not always as simple as it sounds. This, combined with the fact that countries often have contradictory taxation rules or requirements, makes navigating the tax reclaim space a challenge even for those with the right expertise and experience.
Ultimately, providing tax optimisation to investors ends up being a heavy lift for private banks and wealth managers, who often don’t have the right solutions, are relying on outdated technology and manual processes. While this is generally fine for business, it is no longer fit for the purpose when it comes to tax optimisation. To date, knowledge and expertise have been the key to protecting and maintaining profitable investments and avoiding tax leakage. However, through tax optimisation services starting to emerge, portfolio managers can now manage and reinvest easily.
Today, technology has evolved the process so that banks are able to access and submit tax reclaim – and the relevant documentation – online, leaving the tech provider to coordinate next steps with custodians and tax authorities behind the scenes. In essence, taking the legwork out of the process while assuring consistency and completeness in execution.
Simplifying tax through tech
While tax optimisation may seem like an easy choice in theory, it is not always the go-to for every private bank or wealth manager. Without the right supports and setup, including innovative technologies and automation, tax reporting must be done manually, leading to labour intensive processes and huge time wastage. Changing these processes can be overwhelming for those used to a certain way of operating.
By making tax reclaim digital, banks will be more able to optimise returns and gain efficiencies while reducing redundancies and unnecessary complexities. Cloud based solutions or platforms can offer a safe and secure solution for banks, wealth managers, and investors to access and submit any information required, processing the data automatically for conformity and completeness.
It is critical that providers who intend to offer tax services are able to do so efficiently with the right software and data processing capabilities. Not only does this drive continuity in service and efficiencies in process, but it is the only sustainable way to handle such a complex landscape sustainably without wasting time or money.
End-to-end, technologically driven tax services offer a huge number of advantages to private banks and wealth managers, the most important of which is the ability to provide continuity through tumultuous times. As we move through the end of 2020 into 2021 this will only be increasingly important as banks, managers and investors look to provide new services to clients and strengthen existing relationships in a difficult market.
As investors seek to find returns amid the global economic downturn, the demand for innovative solutions will only increase. Technology like cloud-based software, AI, and data optimisation can all serve to improve not just the tax reclaim processes, but the overall client experience within capital markets. Private banks and wealth managers are suitably equipped to provide these innovative solutions, but those who do not prepare themselves effectively and keep ahead of trends will run the risk of losing current and new clients to someone who can offer more for less.
COVID-19 and PCL property – a market on the rise?
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