Standard & Poor’s Downgrade: an Insight

Last week the UK was in danger of losing its first-rate credit rating due to the recession. Standard & Poor’s (S&P), a global financial services company, changed its forecasts to negative for the first time. They say that government debt could reach 100% of the economy after the bank bailouts. The news that initially sent stocks, gilt plunging and sterling, brought bad news for British investors from several biggest blue-chip companies. Earlier this week Marks & Spenser announced that it would reduce its final dividend payout by a third in order to conserve cash, after BT made a similar move. British Airways cancelled dividend payouts as well, explaining it by its worst loss for over two decades. Graham Secker, an equity strategist from Morgan Stanley, said: “Companies have cut dividends this cycle by more than they have ever done before.” He anticipates that UK dividends total value will drop 10% to 15% as compared to their top value last summer. The stock market yielded around 5.5% back then. He forecasts a trough by the beginning of 2010, when the expected yield will make up about 4.75%-5%. According to his words, we are about two-thirds of the way down. Let’s take a closer look at prospects for shares, gilts and currencies. Shares The FTSE 100 lost about 3% on Thursday last week following news of the downgrade, however the index recovered the next day and ended the week at 4,365. According to the analysts, S&P’s move should not wreck the recent green shoots of stabilization in markets. Julian Jessop of Capital Economics, the research consultancy assumed that the UK or even the US are very likely to lose the AAA ratings in years to come. But the consequences for the financial markets may not be that frightening. He noticed that after the initial wobble, the markets were ready to prove yesterday’s announcement wrong. The other leading rating agencies – Fitch and Moody’s – restated their stable attitude. Graham Secker believes that markets will not fall back to March’s lows and that “the point of maximum uncertainty” is left behind. Yet analysts from Markit, financial information services company, expect more 17 UK companies to cut down dividends this year. Aviva, the insurer, and British Land, the property company, are among them. Some stock market experts advice to take a look outside the UK. Malcolm Millar, manager of the Jupiter European income fund, stated that there are three times the number of high-yielding companies on the Continent as there are in the UK. The Dow Jones Euro Stoxx index yields 5.27%, while the FTSE All Share yields 4.59%. However, Secker is pretty cautious on the point of chasing high yields in Europe. He alleges that the UK and the US have reacted to the downturn much faster than Europe did. Anglo Saxon companies have been really quick to cut their dividends, particularly in the banking sector. He added that despite today’s high yields in Europe, the UK is much further down the dividend-cutting process. Gilt Gilt prices dropped, the yields increased, caused by the S&P downgrade. Investors showed concerns that the government will have to issue more bonds to pay off their escalating debt. An increased supply of gilts is no good news for prices. Some analysts predict a further drop in gilt prices due to the government’s weakening finances. The Treasury borrowed £8.5 billion last month. This is a record figure for any April and more than four times the figure of the borrowed amount the same month last year. Advisers recommend corporate-bond over gilt funds. Nigel Walker of Torquil Clark tend towards the M&G Optimal Income fund, which is up 12.6% this year. Higher gilt yields would play into the hands of savers and those who take out an annuity. Nigel Callaghan, the adviser from Hargreaves Lansdown, claimed that in case S&P after all downgrade the UK, it would increase gilt yields and raising thus the annuities. Graham Secker recommends UK defensives with “gold- plated dividends”, such as British American Tobacco, yielding 4.1%, and Scottish and Southern Energy, yielding 5% Currencies Sterling had grown stronger from $1.36 to about $1.57, since the beginning of the year. However, the S&P downgrade held this trend back and caused pound to slightly dip. After the S&P’s announcement it dropped to about $1.55, but grew to $1.59 to end. Mike Lenhoff, chief strategist at Brewin Dolphin, sticks to his outlook concerning sterling and anticipates the pound to reach $1.65 by the end of the year. He believes that the selling of the pound is no object so far, investors will apparently try to take advantage of its somewhat weak position after last week in order to get back in.

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