In our opinion, events so far this year continue to support this, but there are three particular areas which remain open to question.
Perhaps the first of these areas relates to interest rates. In both Japan and the Eurozone, quantitative easing continues with a view to seeking to promote inflation and economic growth, so that their markets continue to be flooded with money in effect printed by their central banks. Here, interest rate increases are not on the current agenda. In China, the world’s second largest economy, interest rates have been falling in an attempt to slow down the pace of decline in the rate of growth. Here again, interest rate increases look to be off the agenda for the foreseeable future and although the Chinese economy is still growing relatively quickly, central action taken following recent extreme volatility in its stock market should serve as a reminder to investors that in this State directed economy investment risks are not the same as those that are generally associated with more liberal capital markets.
At the other end of the spectrum, in the US and the UK economies, the largest and the fifth largest respectively (World Bank figures for 2014), a return to growth looks increasingly well-established, but inflation remains low and given international developments it is hard to envisage any large short term interest rate increases this year, although there may be a small upward adjustment in both countries later this year or early in 2016. These appear likely to mark the start of a trend set to develop modestly over the next couple of years.
Taking into account all of these factors, we continue to be in an era of low interest rates by historic standards and this looks set to continue for some time. This poses something of a dilemma for fixed interest investors as at some point rates will rise which will weaken fixed interest values. It is for this reason that we remain underweight in the sector, except where high income is a definite priority for clients and where a favourable tax regime exists: such as in pension funds and ISAs.
The second area impacting markets has already been touched on briefly, namely the situation in China. There is no doubt that in the medium and longer run, the Chinese economy is capable of substantial growth but activity over the last year has demonstrated the risks associated with it. A significant and sudden slowdown in Chinese growth rates would further unsettle markets in China and elsewhere and we believe that other Asian and developing markets offer less volatile alternatives.
The third factor warranting mention is the state of the Eurozone, the durability, or otherwise, of which is of significant importance to investors in the UK as around half of our exports go to, and our imports come from, Eurozone economies. That the present mess in Greece has been allowed to develop as it has clearly represents a significant failure of Eurozone governance and by Greek politicians. However, the thought of having to send emergency aid to a European country in the 21st century appears to have concentrated minds and looks to be delivering potential for yet another bailout ‘solution’! From an investors point of view Eurozone equities look attractively priced relative to other markets at this juncture.
Summing up, we remain of the view that the outlook for company profitability on both sides of the Atlantic continues to improve in many areas, supported by still easy monetary policy, an environment that in the round remains reasonable subject to careful investment selection.
Summer Budget Commentary
In broad terms, the UK’s return to economic growth continues and the Chancellor’s aim is to reduce the budget deficit and eventually secure a surplus – this aim being achieved through a combination of overall tax increases (as well as some tax reductions) together with significant reductions in a range of state benefits, plus the introduction of what is described as a ‘National Living Wage’.
At least in part as a result of postponing the planned return to budget surplus for further year, defence spending will be maintained at 2% of national income, there will be a boost to health spending and cuts to certain other Government departments will be more limited than previously expected.
It is of course beyond the scope of this short Newsletter to provide detailed commentary on all points covered in the budget, some of which are complex, but it is worth remembering that a number of key tax rates are to be frozen by law.
Individual Savings Accounts
No major ISA changes were announced, but as from 6th April 2016, investors will be able to withdrawal and replace money in-year without the replacement counting towards their annual subscription limit. The Help to Buy ISA starting date will be the 1st December 2015.
Importantly, the tax regime for dividends within ISAs remains unchanged and is not impacted by alterations to the taxation of dividends held outside tax shelters.
Income Tax
From April 2016, the personal allowance increases to £11,000 and the higher rate threshold will be raised to £43,000. It has also been announced that in the following year, those figures will rise to £11,200 and £43,600 respectively, both these increases going some way towards meeting the Government’s pledge to raise both allowances further during this parliament.
There is to be a significant change in the taxation of dividend income from 6th April 2016. It is however important to be clear from the outset that this will have no impact on dividend income from ISAs and that collected within pensions, nor on dividends paid by VCT and EIS investments.
Essentially, the present dividend tax credit will cease and instead individuals will have an annual tax free dividend allowance of £5,000, a clear benefit for those with smaller dividend income. Dividends in excess of this allowance will be taxed at 7.5% for basic rate tax payers, 32.5% for higher rate tax payers and 38.1% for additional tax rate payers. While many will benefit from this change, those who enjoy larger dividend income will be losers.
Making full use of ISA and pension allowances in every tax year, and, where applicable, ensuring that married couples hold dividend producing investments jointly, represent potential ways of mitigating against this.
Inheritance Tax
While the current nil rate band will remain frozen at £325,000 until April 2021, from April 2017 an additional nil rate band will apply where a residence is passed on death to a direct descendant. This additional band is being set at £100,000 in 2017/18, rising in annual amounts of £25,000 to a maximum of £175,000 in 2020/21, after which will increase in line with the CPI.
The aim of this is to reduce IHT on “the family home” but only where that home passes to direct descendants on estates valued at up to £2 million, above which figure the new allowance will be tapered at the rate of £1 for every £2 over the threshold.
Capital Gains Tax
There are no changes to the previously announced rates for this year, i.e. £11,100 for individuals and £5,550 for trustees.
National Savings
No changes were announced.
Pensions
Further changes to the annual allowance for pension contributions are being introduced from April 2016. Those with incomes of up to £110,000 will retain the full £40,000 annual allowance, reducing to just £10,000 for those whose income exceeds £210,000.
In future, pension input periods are to align with tax years. The current year sees transition from the old system in this respect to the new one: those who have contributed up to £40,000 to their pension in this tax year up to the 8th July can make further contributions in the period up to 5th April 2016.
Thinking further ahead, there is to be a pension consultation, closing on 30th September, inviting views on alternatives to the current pension tax framework with a view to increasing engagement and aiding retirement planning. This may or may not lead to eventual change – in the meanwhile those building up pension funds under current rules should continue to take advantage of current tax incentives.
Business Taxes
Corporation tax is to be reduced to 19% from 2017 and 18% in 2020, for companies with annual profits of £20 million or more. The continuing reduction in corporation tax rates adds to the UK’s competitive stance in comparison with other leading economies.
Summary
As with previous post budget newsletters, our observations do not represent full coverage of all points in what was another complex budget. We do however hope that they highlight some of the key aspects from an investor’s standpoint.
Budget 2024