“It’s an ill wind that blows nobody any good”…

8 July 2016

 

would be forgiven for thinking that the travails of the open-ended commercial property funds would be accompanied by a sharp fall in all risk asset prices. And yet sterling risk assets have ended the week with little overall change after the previous week’s rather decent bounce back.

underlying rationale may not be so pretty. The current valuation of future equity cash flows hasn’t changed much, but not because investors expect them to be stable. It is because the interest rates used to “discount” them have fallen.

Mark Carney, in making it clear that he is ready to act, has provided a means for risk markets to reach a near-term equilibrium. If we expect the economy’s weakness to push earnings down, at least we should expect that he will match that fall with downward interest rate action. Equity cash flows will beat bond cash flows, whatever.

He also made it clear that banks’ cyclical buffers were there for a rainy day, and the weather forecast is for precipitation. Banks have a problem with extremely low yields across all maturities (flat yield curve) but they have a much bigger problem if the security underpinning their loans falls away. They will have welcomed his prompt response enormously, especially as the European banks have come under renewed pressure.

The BoE Governor could not be said to be engaging in a currency war though, despite the further falls in sterling. Rather, I’m sure he would say that he is not concerned about what level sterling reaches. From virtually every perspective, its fall is to be welcomed. As discussed later, the current account deficit would have needed addressing and this goes some way to do so.

This also suggests that we should not expect any great sterling rally in the near term. UK assets have not come under any sustained selling pressure, but neither is it likely that there will be a rush to hoover up “bargains”.

As for the responses elsewhere, central banks worldwide are moving easier again. Japan has shown willing and should move soon, and various ECB members have indicated a willingness to push again. Inevitably all eyes will be on the Fed in two weeks’ time. Friday’s surprisingly positive US employment report gave reasons to be optimistic about US domestic demand but there will be enormous pressure on the Fed to remain dovish during this period of growing political vacuum across Europe.

Returning to commercial property; the sudden move from “daily liquidity” to “no liquidity” is causing us (and by that I recognize it’s you!), pain, frustration, and concern. The sequestration of property assets creates many problems in managing portfolios around it. However our recent asset allocation changes, conducted just before the referendum, emphasized the risk/long-term nature of the holdings.

The same forces of lower yields supporting other equity sectors do provide fundamental support for property. Meanwhile the financial system underpinning has become more stable since 2008-10; UK banks reduced exposure to commercial property loans substantially, with insurance companies (and their greater ability to take risk and see through short term fluctuations) replacing them. Also while we should not expect massive bargain hunting from overseas investors, the fall in sterling has made UK properties that generate decent rental yields a more attractive investment.

Not the end of the world then….