Market Outlook – 7 September 2009
UK financial markets remained firm in August, admittedly on low volume, while US markets also held up. In both countries quantitative easing continued, helping to push down the yields on Government bonds – from 3.7% to 3.3% in America and from 3.7% to 3.55% in the UK. A further £50 billion of easing has been sanctioned in the UK, taking the total to £175 billion, just matching Mr Darling’s projected public sector deficit. The Government is effectively financing its deficit by printing money, which makes sense short term but could carry dangers further down the line. Partly as a result of the quantitative easing and the resultant lower gilt yields, sterling has tended to weaken against both the dollar and the euro which should further benefit the UK economy.

The FTSE-100 index continued its recent run to within a whisker of 5,000, before turning back to around 4,800. The reverse head and shoulder formation which it traced out between last October and July (which we highlighted in last month’s market outlook) indicates a potential rise to around 5,700 in the first half of 2010. September and October tend to be bad months for equity markets and the market has had a strong run, but we do not see much downside. There is good support at around 4,640 and a substantial amount of cash earning derisory returns still waiting to get back into the market. The equity yield, at 3.7%, is still above that available on the 10-year gilt and next year should see restored a number of dividends which have been passed or cut. Similarly, next year should produce a bounce back in earnings, putting the current trailing PE ratio of 15.2 into perspective. So the market still appears fair value.

The third quarter should see the start of recovery in the UK economy. While it may be fairly sluggish at first, it should pick up next year, led by consumers and exports. The chief economist at Goldman Sachs predicts 4% growth next year for the world economy and Britain’s exporters can hardly fail to benefit. True, consumption will tend to be held back by tax increases and possibly by higher interest costs once quantitative easing has ended. Remember, in any case, that over half the earnings of the FTSE-100 index derive from overseas and the index is therefore an investment in the world economy.

Within the market we continue to overweight natural resources, both oil and mining, as plays on the global economy. Recent laggards such as pharmaceuticals and telecoms are now performing more strongly. Financials could still have substantial upside potential while retail, media, food & drug and industrial engineering are joining the party. We remain overweight in corporate bonds which continue to perform well and offer both attractive income streams and recovery potential.

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