Market Outlook – 18 March 2010
The equity market has enjoyed a very strong rally over the past month. The FTSE-100 index has risen by over 11% to circa 5,650, despite the continuing uncertainty as to both the political and economic outlook. The latest polls show little improvement in the Conservative lead over Labour at around 2%, and they still point to a hung Parliament. What is most worrying for the markets is that neither the Government nor the public seem to be fully aware just how bad the national finances are and how painful the cutbacks will have to be after the election. The EU apparently does. The Greek people are now starting to feel the pain in their country and are rioting in the streets. Our public sector deficit is similar to theirs, but with control over our interest rates and currency, and our option to resume quantitative easing, we have more weapons to deploy. Nevertheless, the Gilt market has softened over the past month, with the yield on the 10-year gilt rising from 3.9% to 4.15%, where it is higher than the yield on Italian or Spanish Bonds. The pound has slipped by 5.5% over the month against a trade-weighted basket of currencies.

Against such a background, the strength of the equity market may look surprising. But it had come back on profit taking by around 10% and the outlook for corporate profits is continuing to improve – one recent estimate is that they might improve by 34% this year. A further point to remember is that over 70% of the earnings of the FTSE-100 companies come from abroad and will be unaffected by the political and economic problems of the UK. Indeed, if sterling continues to weaken against other major currencies, the sterling value of these overseas profits will be enhanced. It may well be the case that the market is counting on a Tory victory in the May election, which would be good for the Gilt market and probably the pound as well.

Our view remains that a carefully-chosen equity portfolio is still the best investment medium in these uncertain times. Gilts continue to look vulnerable. Cash offers a derisory return. Commercial property has some attraction for its high yield, but rents continue to weaken and there is a lot of potential supply from distressed sellers (such as banks). Investment-grade corporate debt will be affected by a weak gilt market, though lower-quality, higher-yielding corporate debt is still attractive. After the strong rise of the past month the equity market may pause for breath. We basically expect it to trade sideways over the pre-election period, particularly over the next couple of weeks while it awaits the Budget. We still expect it to move higher over the second half of the year. Our emphasis continues to be on international stocks offering a stake in the recovering world economy, such as oil, gas and mining, with a mixture of cyclical stocks with unrealised upside potential and some defensive plays, preferably high-yielding, such as utilities.

Reproduced with permission from Miles Moseley of Balkerne Asset Management