Market Outlook – 9th July 2010
The past month has seen a flight to safety in financial markets. This has been prompted by some disappointing numbers coming out of America, growing concerns of the possibility of a double-dip recession (on both sides of the Atlantic), the ongoing sovereign debt situation in the Eurozone, plus fears that we might be heading for deflation, even a depression. The US 10-year bond yield has fallen below 3%, while the yield on its UK counterpart has come down from 3.53% to 3.36%. Equity markets, with the notable exception of Germany’s, have come back quite sharply – the FTSE-100 index closed at 4,806 on 1 July, down over 1,000 points from its 1 April high, though it has since bounced over 6% (300 points).

We believe these fears have been overdone. The recovery may slow down as restocking is completed, fiscal stimuli are withdrawn and deficit reduction starts to bite. The emergency budget in the UK has been well received by the bond and currency markets and the rating agencies, but greeted by the predictable raspberry from the Labour Party and the public sector unions. Trouble from the unions can be expected when more details become available on where government cuts are to fall, particularly after the spending review on 20 October. The weak euro is helping exports from the Eurozone, which should help to mitigate budget problems there, but the problems of Greece, whose 10-year bond now yields 10.3%, may prove insurmountable. The US recovery, helped by strong corporate cash flows, should continue, while growth in the emerging economies will remain strong – world economic growth is expected to exceed 4% in each of the next two years.

Following the strong bounce of the past week, we now expect the FTSE-100 index to trade between the broad range of 4,800 and 5,400 over the next few months. The more defensive sectors, particularly where high yields are available, should outperform, such as utilities and telecoms. Some very encouraging numbers are coming out of the industrial sectors, particularly those with a sizeable export business, and these too should continue to outperform. The oil and gas sector has been hit hard by BP’s oil spill – BP’s own price has halved before bouncing back and the sector is probably set for a measure of recovery. So too is the mining sector, where the Australian Government has greatly reduced its proposed ‘Mineral Resource Rent Tax’. Miners are still a play on China where we expect no more than a slowdown in growth. Retailers and UK consumer sectors face a tough period ahead and may find it hard to grow their profits. Some banks look cheap and could outperform. Outside of equities we have increased our corporate bond weighting, as interest rates now look set to remain low well into 2011. We continue to underweight commercial property.

Reproduced with permission from Miles Moseley of Balkerne Asset Management