Market Outlook – 13 November 2009
The UK equity market continues to move ahead against the still grim economic backdrop. Q3 saw the economy decline by a further 0.4% when everybody was expecting a return to growth. This led to the Bank of England opting for a further £25 billion of quantitative easing (QE) which has helped to keep bond yields down although the yield on the 10-year gilt has edged up from 3.45% to 3.75%. Neither of the two main political parties has come up with a credible plan to deal with the huge public sector deficit and a leading credit rating agency has again raised the question as to whether the UK’s triple A credit rating will be sustainable. Overseas the news is better – the US actually recorded growth in Q3 of 0.9% and the main Euro zone countries also achieved positive growth while China and India continued to power ahead.

The continued strength of the UK equity market might appear odd against such a backdrop. But the key points are that interest rates are set to remain very low for at least the next year, making cash unattractive; the economy appears to be turning the corner and both earnings and dividends are set to bounce back next year: finally more than 2/3rds of FTSE-100 earnings derive from international operations. Remember that in Q1 share prices were discounting Armageddon. Investors were running scared and the fall in prices was overdone. Even after rising by 50% the market is still only fairly valued on a yield of 3.45% and trailing PE ratio of around 17. There are still a number of good shares yielding 5 – 7% and on single figure PE ratios and we see no reason to revise our view that the index, now at 5,275, should not rise to the 5,700 level predicted by the reverse head and shoulders pattern traced out between July 2008 and August 2009.

Everyone is well aware that H1 2010 will be a testing period. VAT will return to 17.5% on January 1 and there are likely to be other tax rises. The March budget is bound to be tough, there will be an election by June and nobody knows what will happen when QE is ended, but it seems likely to lead to higher gilt yields. On the other hand, the retail sector is already looking to a better-than-expected Christmas. Credit markets are open for large and medium corporates and export orders to the emerging markets are up sharply. Overall, the market could be right in looking for events in 2010 to surprise on the upside.

Pending next month’s pre-budget review our strategy remains broadly unchanged. We are starting to reduce holdings of investment-grade corporate debt, as we feel that further upside is limited, and we are increasing holdings in shares of companies with a high proportion of overseas earnings, such as oils and mining. We continue to hold some cyclical stocks which have further substantial recovery potential in the housebuilding and financial sectors, along with high-yielding defensives such as BT and Vodafone.

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