Market Outlook – 11 December 2009
The pre-budget report was something of a non-event. The numbers were much the same as in the April budget. Apart from the one-off levy on bank bonuses, there were a few tax increases – VAT will be restored to 17.5% as expected, income over £150,000 is to be more heavily taxed, also as expected, and national insurance is to be raised in 2011, but more than expected. Public expenditure will rise by £31 billion next year and again marginally the year after. The lack of any plans to cut spending is not surprising with a general election looming, but it remains to be seen whether the rating agencies and gilt and currency markets will be prepared to wait for the ‘real’ Budget, which will come shortly after the election. Greek debt was downgraded this week following Dubai World’s default and the rating agencies again issued warnings about Britain’s debt levels.

However, for the moment UK markets are in “wait and see” mode. The FTSE-100 index continues to trade between 5,200 and 5,400, the ten-year gilt yield is holding at around 3.7% and the pound is trading sideways against the dollar and the euro. The oil price seems to have topped out for the moment at just under $80 a barrel, providing some relief for the developed economies, and the gold price has come back from its peak, perhaps reflecting diminished fears of inflation, but also speculative activity. We expect this consolidation phase in the equity market to continue in the weeks ahead. The yield on the FTSE of 3.4% and PE ratio of around 17 look about right for the moment, and we believe that the market has now bounced back from its oversold position in March to a fair valuation. Given that there is still plenty of cash looking for a home and alternative asset classes are looking less attractive, we would expect the equity market to trade higher in Q1 2010 provided that there are no major shocks, with a target of 5,700 as indicated by the reverse head and shoulders pattern.

Earnings are expected to bounce back by over 30% next year as loss-making sectors like banks and housebuilders recover and other sectors benefit from this year’s cost cutting. This is probably now priced into the market. Even a tough year for the UK should not hold back the FTSE-100 as 65% of its earnings come from overseas, of which 22% from emerging markets, most of which are now growing strongly again. We expect therefore to overweight stocks and sectors such as mining, oil and pharmaceuticals. Exporters should also benefit from a combination of lower sterling and robust recovery in the world economy (growth could be as high as 4%). Britain’s biggest exporters are Rolls-Royce and BAE Systems, but many other high-tech engineering and chemical companies should benefit. We still like, as core holdings, stocks like BT and Vodafone which yield around 5% and have strong cash flows and recovery prospects. We are continuing to hold higher-yielding corporate bonds, but continue to avoid gilts, including index-linked.

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