Issue 80 | May 2010

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Debt contagion unsettles markets

UK Equity Market: FTSE All-Share index-last 6 months

Source: Bloomberg
The UK market: Debt contagion unsettles markets
The FTSE100 index continued its steady upward trend during the first half of April as investors moved their focus back to the
improving overall global economic outlook, and, in particular, stabilising US employment numbers. While concern over Greece’s
fiscal problems spreading to other eurozone countries refused to go away, the announcement that the European Union had
agreed to provide loans to Greece, supplemented by money from the International Monetary Fund, appeared to settle market
sentiment. Investors nevertheless remain to be convinced over Greece’s ability to resolve its dire fiscal problems given the likely
tough terms that will be forced upon it by the eurozone and IMF. However, with global economic growth forecasts being
upgraded, and US corporate results coming in at least as well as expected, equity markets continued to rise, with the FTSE100
index reaching a 22-month closing high of 5825. At that point sentiment was hurt by news that the US Securities and Exchange
Commission was charging investment bank Goldman Sachs with fraud relating to subprime mortgages, and fears over the
Greek sovereign debt crisis re-emerged, sending equity markets lower. With the situation fast deteriorating, not helped by
Standard & Poor’s downgrading of Greece, Portugal and Spain’s long-term credit rating (Greece’s to junk status), Greece was
forced to ask for emergency loans from the eurozone. Although investors’ nerves are being severely tested, as contagion from
the sovereign debt problem could undermine what had been viewed as a gradually improving economic outlook, and the
growing possibility of a hung parliament in the UK, the market remains surprisingly resilient. Nevertheless, at the end of the
month, with rising market volatility, the direction of the FTSE100 index was looking increasingly uncertain.

Sector Performance during April

Top 5 % Bottom 5 %
Electronic & Electrical Equipment + 13.1 Tobacco - 8.8
Industrial Engineering + 6.1 Mining - 8.8
General Retailers + 5.4 Mobile Telecommunications - 4.2
Industrial Transportation + 4.9 Household Goods & Home Constr. - 4.1
Chemicals + 4.2 Forestry & Paper - 4.1
Source: FTSE International Limited

FTSE 100 Company results due in May

Company Date due Type of result Company Date due Type of result
Sage Group 5 May Interim National Grid 20 May Final
Vedanta Resources 6 May Final SABMiller 20 May Final
TUI Travel 11 May Interim British Airways 21 May Final
Compass Group 12 May Interim London Stock Exchange 21 May Final
Sainsbury 13 May Final United Utilities 21 May Final
3 i’s 13 May Final Invensys 24 May Final
BT Group 14 May Final Marks & Spencer 25 May Final
British Land 18 May Final Burberry Group 26 May Final
Vodafone 18 May Final Cable & Wireless 26 May Final
Experian 19 May Final Man Group 27 May Final
ICAP 19 May Final Severn Trent 28 May Final
Land Securities 19 May Final Thomas Cook Group No date Interim
Scottish & Southern 19 May Final Lonmin No date Interim

Source : Companies

Economic Indicators due in May

Announcement Date Announcement Date
UK interest rates 6 May Monetary Policy Committee meeting notes 19 May
ECB interest rates 6 May US CPI 19 May
UK employment figures 12 May UK retail sales 20 May
UK Consumer Price Index 18 May US interest rates (FOMC) None
Eurozone Consumer Price Index 18 May
Residential property market update
According to the Halifax house price index, the decline in UK average house prices from last decade’s peak (August 2007)
to the low point (April 2009) was 22.6%. This compares to a peak to trough fall of just 13% in the last UK housing market
downturn (May 1989 to February 1993). The last cycle fall in prices was also more evenly spread across all the regions
of the UK. While the recent decline was significant, it should be viewed against a doubling of average house prices (from
£85,000 in January 2000) over the decade as a whole – a compound annual rate of growth of 9%. Despite the longer
than average period of the recession, the fall in house prices was much steeper and shorter lived than in recent previous
downturn periods. On a long-term view (since the 1980s) UK house prices have now returned to trend level.

The main influences on the sharp house price retreat in the latter part of 2007 and 2008 were the slowing rate of growth
in the economy (and a looming recession), rising unemployment levels and the sudden onset of the credit crisis. The
sharp reduction in mortgage approvals following the credit crisis, together with the rising level of unemployment, resulted
in the number of housing market transactions approximately halving from late 2007 to the end of 2008. However, the
various government initiatives designed to help homeowners in difficulties with mortgage payments, significantly
reduced the number of repossessions and forced sales compared to previous housing market downturns. Thus the
large falls in the housing indices may have been exaggerated due to the limited number of transactions in extremely
difficult market conditions. Similarly this factor may also go someway to explaining the sharp bounce in prices seen in
the second half of 2009, despite most of the adverse factors remaining in place.

Source : Nationwide

The strong recovery in house prices since the summer of 2009 has continued into 2010, although on a rolling three-monthly
basis (a better guide to trends than the often volatile monthly figures) the rate of growth peaked in September last year at
3.8% (according to the Nationwide), and is now on a clearly slowing trend with an increase of just 1.1% in the three-months
to April. Both the main indices (Halifax and Nationwide) have shown major swings in the results for the first three months of
2010, with both indices reporting rises in January, followed by falls of 1.6% and 0.8%, respectively, in February, but rises
again in March of 1.1% and 0.7%. The annual rate of change in average UK house prices remains strongly positive at plus
5.2% and 9.0%, while growth in prices from the low points in Spring last year were plus 9.1% and 11.4%, respectively.
Nationwide has just reported a rise of 1% in April, a 10.5% increase over the past year. The ending of the temporary increase
in the nil stamp duty threshold (at £175,000 compared to £125,000) in December 2009, the normal slow market at the start
of a year and the prolonged period of snowy weather, together with continuing uncertainty over the economic outlook and
upcoming general election, have combined to result in a significant drop in the level of transactions so far in 2010. Countering
these factors (as far as prices were concerned) was the continuing limited supply of properties for sale. Average price levels
have now returned those seen in 2006. Average annual house price growth in England remained higher than the overall UK
figure at 10.5%, with London again the best performing area (+15.7%) - helped by supply shortages and overseas buyers -
followed by the Outer South East and Outer Metropolitan regions (over 12%). The weakest growth was in the North region.

Following 18 months of contraction, the UK’s GDP finally returned to growth in the fourth quarter of 2009, expanding by
0.4%. The first estimate from the Office of National Statistics for the first quarter of 2010 is of 0.2% growth, a decent result
given the sluggish growth in the EU and the adverse weather conditions during that period. The general expectation from
economists is that this figure could be revised higher when more data has been analysed. While the outlook for the UK
economy appears to be reasonably positive, the latest unemployment figures showed a rise, after three months of declines,
taking the total number of jobless to 2.5m, for the three months to February (8% of the workforce – the highest level since
1996). Economists’ main concern is that the fragile growth in the economy could be a jobless recovery as many employees
accepted reduced working hours and pay as opposed to redundancy, and, therefore, companies will be able to expand
without the need to take on additional staff. There is also the fear that any new government taking office will need to achieve
substantial cuts to public spending (including redundancies) as it takes measures to reduce the large budget deficit.
 The recovery in net mortgage lending in
recent months reflects an improvement in
credit conditions, although the wholesale
money markets, previously an important
source of funding, remain largely frozen.
Nevertheless, the amount available for
lending remains substantially below levels
prior to the correction in the credit markets. In
addition to a shortage of loans, lending
criteria have been substantially tightened,
particularly as to levels of deposits for access
to the lowest rates of interest. This has been
particularly noticeable for first time buyers
and new builds. Nevertheless, the outlook is
for improving levels of mortgage lending.

On the simple basis of average house prices

to average earnings, affordability deteriorated
sharply from 2000 when it was around three
times to around six times in 2007, lower
house prices since then have somewhat
improved the picture. However, the
affordability picture changes dramatically if
the level of mortgage interest rates is taken
into account. Thus initial interest payments
are equivalent to around 13% of median
gross earnings (according to the Council of
Mortgage Lenders) down from around 20%
in 2008, but are still above the level in 2003.
On this more sophisticated basis average
house prices would appear to be currently
fairly valued. The low levels of bank rate are set to continue for some time helping affordability despite recent price rises
and relatively low earnings growth.

The question now is whether the recent recovery in the housing market is sustainable. While it looks unlikely that the level of
price rises can be maintained, the slowdown in the first few months of this year may be due to unusual circumstances – the
ending of the increased stamp duty holiday, bad weather and uncertainty surrounding the outcome of the upcoming General
Election. The main factors influencing house price growth will continue to be economic growth, employment levels and earnings
growth, availability and cost of mortgages, and supply levels of property for sale (which seem to be slowly increasing). Most of
those factors would appear to be relatively benign towards a stable to slowly appreciating housing market, provided that
uncertainty over a possible hung Parliament can be removed fairly quickly, and the outlook for first time buyers – helped by the
unexpected temporary increase in the nil stamp duty threshold – improves as mortgage terms currently remain restrictive.

First Equity Limited

Salisbury House, London Wall, London EC2M 5QQ
Tel: 020 7374 2212 Fax: 020 7374 2336
Website: www.firstequity.ltd.uk
Paul Henry
email: paul.henry@firstequity.ltd.uk

The information in the newsletter is taken from publicly available sources and the newsletter is distributed for information purposes
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