Market Outlook – 11 May 2009
The past month has seen a marked improvement in sentiment in world equity markets. In the UK the FTSE-100 index briefly crested 4,500 - nearly 1,000 points above the 03 March low – and broke out of the bear trend which set in last May and steepened following the Lehman/AIG debacle. This despite a Budget which brought nothing but bad news: net borrowing of £175 billion this year if you believe the figures. The Chancellor's estimates of 3.5% decline in GDP this year, 1% growth next year and 3.5% growth in 2011-12 are regarded by most independent observers, and leading institutions such as the IMF and the EU, as ‘optimistic’. That said, as we have stressed in the past, in current conditions, nobody can make sensible forecasts. The market is telling us that economic recovery could start before the end of the year and it remains to be seen how bad Government borrowing will turn out to be.

The main concern is if the Government is unable to sell enough gilts to finance its debt or that gilt yields will be driven up to levels which negate the effort to lower long-term interest rates. The worst-case scenario is that the UK’s AAA rating is downgraded. To date there has been some increase in the ten-year gilt yield from 3.1% to 3.5% but the pound has recovered slightly against both the dollar and the euro. So far, so good.

As to equities there have been several indicators that we are no longer in a bear market, but the early stages of recovery. Cyclical sectors such as general retailers, travel & leisure and mining, have been handsomely outperforming defensive sectors like utilities, pharmaceuticals, food & drug retailers and tobacco. Second, the market has shrugged off bad news (like the Budget and the outbreak of swine ‘flu) and responded well to good news. What good news have we had? The prices of oil and many commodities, along with freight rates, are rising, largely in response to recovery in China and other asian economies. Also, UK interbank rate has at last come down (to circa 1.4%) signalling an improvement in credit conditions. US and British banks have reported much improved and in some cases profitable trading (Barclays reported Q1 profits 15% ahead of last year). The recent purchasing managers’ index for UK services, while still just in negative territory, was well ahead of expectations. Finally, fund managers have large cash positions earning very poor returns. Even economic news is not all doom and gloom: the housing market is showing signs of a pick up in activity, although prices are still drifting downwards, while consumer spending power is being boosted by sharply lower mortgage interest costs, as well as lower fuel and energy bills. Finally, sometime in the months ahead there will have to be a rebuilding of inventories, which will give the economy a fillip.

We are starting to increase our equity weightings, boosting our exposure to early-cycle sectors, where dividends look safe, and we are continuing to buy investment-grade corporate bonds. The immediate trading range for the FTSE-100 index is 4050 – 4600. However the market is overbought short term: we are likely to see some profit taking, but overall we now expect equities to move higher as the market anticipates better times.

Reproduced with permission from Miles Moseley, Managing Director of Capel Court PLC