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Shrinking feeling

Watching bank shares getting hammered recently was not a pretty sight as these shares have been the cornerstone of UK equity income portfolios. Now that you can receive a dividend return vastly in excess of the deposit rate offered, you have to wonder just what is going on.

HSBC has published a somewhat downbeat report on the liquidity squeeze and its implications for domestic banks. It refers to the attitude of investors being perhaps too sanguine rather than too pessimistic. Higher lending costs, particularly in mortgages, with slower growth and lower profits from structured and securitised products could mean we have to revise down our profit growth expectations for some time.

The Bank of England governor also made cautionary noises over the credit crunch. This is nothing but so much pessimism will even-tually take its toll – if it hasn’t done already.

From worrying about which bank is exposed to sub-prime risk and how much it will cost, we are now at the stage where we are concerned over whether the whole structured debt market may wither on the vine.

We also learn that Northern Rock is seeing its new mortgage book shrink rapidly. This should not be any surprise but you have to wonder what will be left for the ordinary shareholders if it cannot succeed in settling its future swiftly.

It is probably too simplistic to lay the blame for the underperformance of income funds since the start of the year at bank shares alone but some high-profile managers have had a most uncomfortable time.

Not so the Far East excluding Japan. This has been the place to be this year. Threadneedle’s recently issued China opportunity fund has nearly doubled in value in the past six months. Taken over three years, this IMA sector returned an average of 144 per cent, with all 56 funds doubling in value, save one. The best performer, from the Gartmore stable, will have delivered over 240 per cent.

But you have to wonder if a bubble is inflating. Last week saw the trebling in price of PetroChina on the back of listing on the Shanghai stock exchange, becoming world number one in market capitalisation, overtaking Exxon Mobil. Warren Buffett had already declared the company overvalued even before this latest boost. Worrying.

There are other concerns over China. Inflation is on the up and economic growth slowing. Social unrest, environmental problems and a growing shortage of many basic commodities, including water, demon-strate growth has not been without its price.

What does all this mean for investors? Nervousness, particularly over inflationary pressures, still abounds. Wall Street has seen equities dumped in favour of bonds despite the weakness of the dollar, and there, as here, financial stocks have led the way down.

These conditions will test the mettle of stockpickers.

Brian Tora (brian.tora@centaur.co.uk) is principal of The Tora Partnership

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