Week ending 8 JANUARY 2010

With no weekly reviews having been distributed over the Christmas and New Year period, we will use this first issue of 2010 to look at asset class performances in December 2009 as well as for the calendar year. Last month’s market performance was dominated by weakness in bond markets, partly resulting from some better than expected macro data and US Dollar strength. The downgrade of Greece’s government debt also weighed on bond markets, as fears of a sovereign default grew and government bonds lost some of their allure as a safe haven. Meanwhile, most regional equity markets shrugged off any worries and capped a year of astounding performance with more positive returns.

Looking at currencies to begin with, most major currencies weakened versus the US Dollar in December. The euro and Sterling depreciated 4.4% and 1.6% respectively, whilst the biggest mover was the Japanese Yen which lost 7.5% against the greenback. Weakness in the latter has much to do with what was effectively an increase in quantitative easing announced at the beginning of the month, with the Bank of Japan initiating a 10 trillion Yen (approx USD113 billion) programme of short term loans to commercial banks. The New Zealand and Canadian currencies were exceptions to the rule in that they appreciated versus the US Dollar, as were some emerging market currencies. One reason contributing to Dollar strength over the month was a marked increase in expectations for the raising of US interest rates, following some strong economic data releases which increase the probability of an end to the Fed’s zero interest rate policy.

Against this backdrop global government bonds returned -5.0% in December, reducing their performance for 2009 to just 1.9%. This marked the biggest monthly decline in the JP Morgan Global Government Bond Index since its inception almost 25 years ago. However, whilst government bonds did produce negative returns in most regions, much of the poor performance can actually be attributed to currency effects due to approximately two thirds of the index representing non US Dollar denominated debt. The USD hedged version of the same index declined by only 1.1% in December. The general weakness in government bond markets came partly as a result of Moody’s announcing a single notch downgrade for Greece to A2, which led to fears that they may default on their debt. Combining this with concerns aroused by Dubai World’s debt repayment standstill and ever increasing levels of government debt around the world it is little surprise that yields moved higher over the month. The benchmark US 10 year Treasury began December yielding 3.20% and ended the year at 3.84%. The current steepness of the yield curve, characterized by short-term rates which are close to zero and longer term (ten years and further out) rates above 4% points to a recovery in equity markets, and may lead to further softening in bond markets as the probability of an increase in central bank short term rates increases.

Within credit, investment grade bonds also produced poor returns for the month across most regions. Much of this is explained by the increase in the yields of government bonds which corporate bonds are referenced against. Investment grade bonds have rallied hard in 2009 following their dismal performance in 2008, with US and European investment grade bond indices returning 18.7% and 15.7% respectively in local currency terms. These strong returns have come mainly through both a sharp reduction in the attached liquidity premiums as well as significantly reduced credit spreads. The end result is that investment grade spreads over government bonds are considerably lower and the instruments are more sensitive to changes in government bond yields. High yield bonds fared much better over the month with strong local currency gains of 3.3% and 2.4% in the US and Europe respectively as improving economic conditions boosted investor risk appetite. Spreads on high yield debt remain elevated relative to history, compared to investment grade debt which has gone a long way towards pricing in a sustainable recovery. Both of these asset classes have rewarded investors with extraordinary returns in 2009, especially in the context of their relatively low risk and volatility. High yield bonds returned 58.8% in the US, and 76.4% in Europe. Looking at global high yield the default rate calculated by Moody’s declined in December for the first time in almost two years, falling from a high of 12.9% in November to 12.5%. This compares to a 4.2% default rate at the beginning of 2009, and to historical default rate peaks of 12.2% and 10.4% in 1991 and 2002 respectively. Global convertible bonds, which combine bond-like protection with an option on the equity price, also produced outstanding returns in 2009. Their return of 1.6% in US Dollar terms in December brought the annual performance to 41.4%, thus outperforming even the MSCI World Developed Equity Index.

Moving on to equities December was another strong month (at least in local currency terms) and rounded off an excellent year of performance. As in other asset classes currency moves played a bit part in returns for the month and the end result was much more modest returns when viewed in US Dollar terms; global equities, as measured in US Dollars by the MSCI World Index, moved 1.8% higher. On a regional basis local currency returns were strongest in Continental Europe and Japan, with gains of 5.7% and 8.0% respectively. Despite the latter strong return Japan proved a laggard in 2009, returning just 7.6% for the year compared to the MSCI World return of 30.0%. One of the contributing factors to this has been currency strength versus the US Dollar, which was a millstone around the neck of Japan’s numerous exporting companies. In contrast recent currency weakness has benefited these companies and the overall market, as has an improvement in foreign investor activity. Across other regions, local currency returns fell within a range of approximately 25-30% for the year, although Australia was one of the developed countries that delivered stronger returns with a gain of 37.6% in local currency terms and significantly more in US Dollar terms. Meanwhile, emerging markets continued their stellar performance in 2009 returning 4.0% in December, and bringing the 2009 return for the MSCI Emerging Markets index to 78.5%. Nonetheless the index remains over 22% below its high set in October 2007.

Property securities also produced strong returns of between 1.5% and 7% in local currency terms in December, reflecting the strength in broader equity markets. These securities have enjoyed a strong run of performance through 2009 but most regions remain a long way off their liquidity fuelled highs of 2007. Commodities produced mixed performances in December, with agricultural commodities declining 1.3% whilst broad non-agricultural commodities gained 0.6%. Oil gained 2.5% for the month, bringing its annual return to a few percent shy of 100%. Meanwhile the shine came off the gold market to some extent, with a return of -4.3% for the month, but the precious metal still ended the year over 30% higher than the beginning of the year.

Our market outlook for 2010 is that we suspect this to be a year for wealth preservation as markets face high tail risks and daunting uncertainties globally. A year of high single digit returns would seem at this juncture to be a reasonable outcome and expectation, albeit with some considerable volatility on the way.

Markets were strong last week with equities, property and commodities generally gaining over 4%. Having fallen on eight out of the previous ten days, the S&P 500 Index posted gains for every day of last week and ended the week 4.6% higher. Within fixed income, government and investment grade bonds delivered flat to marginally negative returns, while high yield and convertible bonds posted healthy gains. Listed property securities produced the strongest performance at over 5% globally. Among currencies the Australian Dollar strengthened by over 4% versus the US Dollar and reached a 14 month high, prompted by the Reserve Bank of Australia becoming the first major central bank to raise interest rates since the start of the financial crisis.

Source: RMB Asset Management / Bloomberg / Lipper Hindsight. January 2010.

Returns to 08 January

Source: RMB Asset Management / Bloomberg / Lipper Hindsight. January 2010.

Important Notes

Disclaimer:
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Any opinions expressed herein are those at the date this material is issued. Data, models and other statistics are sourced from our own records, unless otherwise stated herein. We believe that the information contained is from reliable sources, but we do not guarantee the relevance, accuracy or completeness thereof.  Unless otherwise provided under UK law, Wealth management Group Ltd does not accept liability for irrelevant, inaccurate or incomplete information contained, or for the correctness of opinions expressed.

We caution that the value of investments in discretionary accounts, and the income derived, may fluctuate and it is possible that an investor may incur losses, including a loss of the principal invested.  Past performance is not generally indicative of future performance. Investors whose reference currency differs from that in which the underlying assets are invested may be subject to exchange rate movements that alter the value of their investments.

Our investment mandates in alternative strategies and hedge funds permit us to invest in unregulated funds that may be highly volatile.  Although alternative strategies funds will seek to follow a wide diversification policy, these funds may be subject to sudden and/or large falls in value.  The illiquid nature of the underlying funds is such that alternative strategies funds deal infrequently and require longer notice periods for redemptions.  These Investments are therefore not readily realisable. If an alternative strategies fund fails to perform, it may not be possible to realise the investment without further loss in value. These unregulated funds may engage in the short selling of securities or may use a greater degree of gearing than is permitted for regulated funds (including the ability to borrow for a leverage strategy). A relatively small price movement may result in a disproportionately large movement in the investment value. The purpose of gearing is to achieve higher returns associated with larger investment exposures, but has concomitant exposure to loss if positive performance is not achieved. Reliable information about the value of an investment in an alternative strategies fund may not be available (other than at the funds infrequent valuation points). 

Under our multi-management arrangements, we selectively appoint underlying sub-investment managers and funds to actively manage underlying asset holdings in the pursuit of achieving mandated performance objectives. Annual investment management fees are payable both to the multimanager and the manager of the underlying assets at rates contained in the offering documents of the relevant portfolios (and may involve performance fees where expressly indicated therein).

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Wealth Management Group 2009