Market Outlook – 12 October 2009
September is often a bad month for financial markets, but this year all the major markets apart from Japan continued to rise. The FTSE-100 index rose from around 4,800 to 5,130 and gilts were also firm – the yield on the 10-year gilt declined from 3.55% to 3.39% helped by further quantitative easing (QE). The housing market continued the recovery which started in May and other leading indicators were positive. These tend to be a reliable guide to the next three to six months, and should support our view that, perhaps after a few weeks range trading, the FTSE-100 index will move ahead towards the 5,700 level predicted by the reverse head and shoulder formation which we highlighted in our August Market Outlook. The yield on the index is now down to 3.46%, just above that on the 10-year gilt and the trailing PE ratio is up to 16.5. Given that earnings and some dividends should bounce back next year, these ratings look fair, and there are enough sectors which still have substantial upside potential to drive the overall index higher.

Bear in mind that over half the earnings of the FTSE-100 derive from overseas, so that it is an investment in the world, rather than the UK. Next year will not be an easy one for the UK economy. At some point QE will have to end and the yield on gilts will probably rise, pushing up long-term rates for all borrowing. Higher taxes are certain to be imposed by whoever wins the election. If Labour wins, or there is a hung Parliament, the UK’s credit rating could be downgraded and sterling could suffer. There will almost certainly be public sector strikes to test whoever is in power. Overseas we see strong growth in China, India and many other emerging markets but further turmoil in Eastern Europe which could affect some Eurozone countries. America should be on a course of steady recovery. It could be an interesting year for equity markets, but if the problems can be moving towards resolution, there is no reason why the equity market should not end the year higher than it started.

We believe that the market has reached a level where it is more crucial than ever to concentrate on certain sectors and stocks to outperform. We are reducing overweight positions in corporate debt (which has done very well) and increasing holdings in mining, pharmaceuticals, telecoms, certain housebuilders (for recovery potential), insurances and selected support services. We are watching the oil majors carefully, as the oil price is weakening and there is some uncertainty as to whether they will hold their dividends, but the charts have not yet given a sell signal. The banks could have huge recovery potential, but we see this as a story for next year when Barclays should resume dividend payments and Lloyds may well reduce the Government’s share stake. Commercial property may have finally bottomed and offers an attractive yield, but its illiquidity is a drawback in current conditions and any meaningful recovery will take time. We continue to regard gilts (including index-linked) as unattractive.

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