Share Watch April 05

Tom Winnifrith considers the outlook for UK shares

Was it a pre-Easter lull? The UK certainly had its fair share of Bank Holidays during March. But there were perhaps more fundamental reasons for concern and a pullback. The oil price eased back over the month, which hit the FTSE 100 (where oil stocks account for more than a fifth of the index’s value by weighting). Retailers continued to serve up disappointing numbers with even high-street superstar Next admitting that it was feeling the pinch. And in the US the Federal Reserve not only increased base rates by 0.25 per cent (to 2.75 per cent) but, more ominously, warned that further rate rises would be needed to curb the growing threat of inflation.

The FTSE 100 ended the month 1.5 per cent down at 4,914 while the FTSE 250 index lost 1.7 per cent to hit 7,180. The FTSE Small Cap index was 1.1 per cent down on the month at 2,913, but the main casualty was the big winner of most of the previous 12 months – the FTSE AIM index. It slipped back 5 per cent to 1,092. Mounting criticism of some of the valuations ascribed to many of the oil stocks, gold miners and cash shells which these days dominate AIM is perhaps starting to sink in with private investors. Or perhaps it was just the result of some portfolio adjustments as the end of the tax year drew nigh. Incidentally, as one indicator of private investor sentiment: the ISA sales season for 2005 looks to have been one of the weakest on record.

Political indifference

Let us start with matters on an insignificant small island sandwiched between the north-west coast of mainland Europe and Ireland. At the start of March Britain’s Chancellor of the Exchequer announced his 2005 Budget plans and the world hardly noticed. Taxes will go up in 2006 and government spending is out of control. But we all knew that anyway. At the start of May Britain will elect a new government. Well in reality, barring a miracle, it will re-elect its current one and the market prices in as much. Over the next few weeks as the General Election campaign ramps up you will read acres of copy about how it may affect both your life and your finances. I make no comment on the first claim, but as far as the equity markets are concerned it really does not matter at all. Avoid the verbiage – focus on what really matters.

Some of what matters for UK equities is concerned with events on the small, damp lump of rock on which we live. Every day another retailer seems to issue a profits warning. As I write, the day’s miscreant has been Whittard of Chelsea; yesterday it was Boots. Meanwhile data continues to come in showing that the housing market, if not slum-ping as some had predicted, is far from buoyant. Prices are at best holding their own, and it is taking longer and longer for vendors to shift their properties – even the good ones. So one theme of this column in recent months continues unchanged (whatever happens on 5 May) – the consumer spendfest is over.

Somehow it has filtered through to the collective consumer brain that personal indebtedness cannot be cured simply by rising house prices and that levels of disposable income will be squeezed by the tax hikes that are in the pipeline. Consequently the level of earnings visibility for UK consumer-related stocks is poor. That may already be discounted in some fairly dull ratings, but when one can have no great confidence in earnings forecasts across sectors such as retail, the housebuilders or pubs and leisure, it would be a brave man who would buy such stocks now. At best they will be unexciting investments during 2005. At worst they will be downright bad investments if earnings start to slide sharply.

Oil shocks

Moving to economies that really matter, the March warning from the US Federal Reserve was pretty explicit – while UK base rates are probably close to their peak, US base rates will have to rise significantly from the current 2.75 per cent to cope with the emerging inflationary threats in the American economy. This explains the recent resilience of the dollar (2004’s one-way bet – down). While that trend is likely to be positive for big British-based dollar earners (the pharmaceutical stocks and Diageo for example), a tightening of US monetary policy does not provide a helpful backdrop for a re-rating of US equities. Indeed one might argue that it may be the cue for a modest de-rating, and if that happens it is hard to see British equities heading significantly higher.

Meanwhile, lurking in the background remains another potential worry: oil. Since the start of April Brent has marched steadily higher and now trades at $54 a barrel. According to Goldman Sachs, WTI oil prices could peak at $105 a barrel (implying a price of $100 a barrel for Brent) during the next 18 months. Inevitably such a spike would put a huge squeeze on margins for heavy fuel users and in the UK it would add to the squeeze on disposable incomes for consumers. I do not think we will see oil hitting such peaks but even a sustained spell at over $55 must be hurting some companies.

Despite having sounded like a born-again bear for most of this column, I am not. Most non-consumer companies are still reporting strong earnings growth and order books, and business confidence continues to improve. Although there clearly are external risks to the UK equity markets, corporate borrowings are at a relatively low level, which means that UK Plc should be able to withstand short-term external pressures. An historic price/earnings ratio of just under 15 for the FTSE 100 is not that demanding and selectively equities do offer some real value. It is not a time for indiscriminate buying, but there is equally no reason for the bears to start celebrating either.  Tom Winnifrith runs the media and IT group Rivington Street Holdings and edits the share-tipping website www.t1ps.com.