Market Outlook – 17 August 2009
World equity markets have rallied strongly over the last month. The S&P 500 index has risen by 49% since its low point in March and the FTSE-100 by 35%. Most major indices have now completed a reverse head and shoulders formation which is one of the most reliable indicators of a further strong rise. The rule of thumb is that the distance between the top of the head and the neckline will be repeated, on a logarithmic scale. On this basis the S&P index, now 1004, would rise to 1270 and the FTSE-100, now 4650, to around 5700 in the next 12 months. This might seem improbable but technical analysis can often be the best guide to future trends. When the FTSE-100 broke through 4100 in April and we announced the end of the bear market, our view was met with some scepticism. Bears continued to view it as a bear market rally. We are now almost certainly in the early phases of a bull market.

This is not to say that it will be plain sailing. Short term the market is due for a bout of profit-taking and may well trade at or near this level until the autumn. But there are a lot of investors who have missed out on the rally whose cash is earning a derisory return, and will want to get on board on any setback. So we don’t see much downside. In the real economy there are numerous ‘green shoots’ appearing – house prices have risen for three months, LIBOR has come back sharply, purchasing managers’ indices for industry, construction and services are back in positive territory. The principal headwinds are the continuing rise in unemployment and the appalling state of the public finances. So far, thanks partly to the "quantitative easing" both here and in the United States, the 10-year bond yield has held steady at around 3.7% in both countries and the two Governments have been able to sell bonds without much trouble. However the UK has been warned that its AAA rating is under review and with a Government which appears to be in denial about the state of the public finances, there must be a danger that interest rates will have to rise to fund the borrowing, which would choke off the recovery.

The rationale for the bull case is that most of the bad corporate news, dividend cuts and earnings reductions are now out of the way. Markets are looking ahead to next spring, when earnings could be bouncing back and some dividend cuts restored. In recessions, companies shed staff, cut other costs and thereby become more ‘efficient’ and profitable. The harder hit (and cyclical) sectors have been making the running, while defensives such as utilities have not only failed to join the party but in some cases seen share price falls. We are continuing to look for stocks with further recovery potential, particularly those, like Vodafone and Marks & Spencer, which have good, sustainable, dividend yields. We also retain our overweight in investment grade corporate bonds which continue to outperform handsomely.

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