Market Outlook – 12 February 2010
The past month has seen leading equity markets retreating – by 7.3% in the case of the FTSE-100 Index. This has been due to international, rather than domestic factors, particularly growing concern over the huge public sector deficits of the Club Med countries. Greece has been at the centre of the storm, and at one point its ten year bond yield shot up to 380 basis points above the Bund yield. Some sort of EU bail-out is likely, probably on terms which will cause a lot of pain to the Greeks. Markets are worried that the contagion might spread to other over-indebted EU countries such as Ireland, Portugal and Spain and even eventually to the UK and US. The election of a Republican senator to Ted Kennedy’s seat in Massachusetts has compelled President Obama to launch a tirade against the banks, threatening to force them to separate their commercial from their investment banking activities and imposing a levy on their income. This has added to uncertainties in financial markets.

Here in the UK the main concern for markets has been the narrowing of the Conservative lead over Labour, raising the possibility of a hung Parliament, which would be bad news for financial markets. The Bank of England has suspended quantitative easing (QE) but lowered its forecast of GDP growth this year from 2.2% to 1.6%. The Governor warned that growth could be anaemic for several years. He expects inflation to spike higher short term but then come back to below the 2% target. The gilt market continues to hold up reasonably well – the 10-year gilt yield shaded from 3.8% to 3.9% and sterling has strengthened against the euro but softened against the dollar, a trend which we expect to continue. Initial indicators suggest that the economy is showing some growth in Q1 – industrial production and exports are at last rising quite strongly and house prices continue to rise, on low but improving volume.

Against this continuing uncertain background it was not surprising that the FTSE-100 Index slipped back. The index had risen by 58% since last March with hardly a pause for breath and a bout of profit-taking was due. It is important that it holds above 5,050. If it does so over the next week or so, we believe this will mark the bottom of the trading range. The yield is over 3.5% and the trailing PE ratio around 15 (which should drop to around 11.5 on this year’s earnings). These are historically attractive ratings. True, we expect gilt yields to trend higher and domestic growth to be held back by both rising long term interest rates and likely higher taxation. But if we can escape a Government funding crisis, and if a Conservative Government is elected in the spring, we still see the FTSE-100 Index rising to perhaps 6,000 by the year end after a period of sideways trading in the immediate future. We remain heavily overweight in the major international stocks which are an investment in the world economy, rather than domestic UK, particularly oils, mining and aerospace, together with a judicious mixture of high-yielding defensive stocks such as utilities, mobile telecoms and cyclical stocks with further recovery potential.

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