Market Outlook – 09 February 2009
The Christmas rally in the UK equity market, which carried the FTSE-100 index up to 4,638 on 06 January, has been reversed in the face of continuing bad news, but the index has remained comfortably above 4,000. Talk of wholesale nationalisation of the banking system at one point drove bank shares to new lows – Barclays lost two-thirds of its value in a week and it took an open letter from the chairman and chief executive to steady nerves and cause the share price to double in a day. The collapse in bank shares was not helped by the ending of the ban on short selling by the FSA. Sentiment was affected by a sharp fall in sterling sparked by advice from a leading US investment guru, Jim Rogers, to sell all sterling assets. There was even talk of the UK following Iceland into bankruptcy. All this struck us as classic bottom of the bear market stuff.

It is too early to be sure however that the market is bottoming. It still has to endure what is likely to be a pretty torrid results season, with dividend cuts and gloomy forecasts. But Britain is not going to go bankrupt. Indeed the pound has enjoyed quite a sharp rebound since Mr Rogers spoke against both the dollar and the euro. What does concern us is the prospect of £150 billion of gilt issuance, at a time when most other Governments are issuing huge amounts of paper. Already the ten-year gilt yield has risen from 3% to 3.75% and if it rises a lot further it will effectively negate the efforts of the Bank of England to reduce interest rates to help consumers and companies weather the recession. It will also make equities and other asset classes look relatively more expensive. The Government’s huge demand for money looks like crowding out the private sector. This is the risk Mr Brown is taking by trying to spend his way out of the recession.

Last week, as expected, base rate was cut by 50 basis points to 1%, the lowest in history. Encouragingly, the pound responded by rising sharply against the dollar and the euro. A steady pound will give foreign investors confidence to invest in Britain. Equities of strong companies offering yields - on dividends likely to be at least maintained - of over 4% continue to look attractive. Both Royal Dutch Shell and BP weighed in with record profits (admittedly with Q4 downturns) and higher dividends. Companies do not raise dividends if they see the prospect of cutting them in the near future, and these two companies now offer yields of 6.7% and 8.4% respectively. Vodafone and GlaxoSmithKline are two other giants which produced encouraging results. So while banks and real estate companies continue to languish, there are major stocks and sectors which are attracting buyers. Apart from oil majors and mobile telecoms, some construction companies, beverages, defence stocks and insurance shares are performing well. If the market as a whole can hold above 4,000 through the current results season, it will be possible to look for a better trend through the summer pointing to the start of what is likely to be a slow recovery in 2010.

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