Market view
October, the bears told us would see a crash.
Well so much for history repeating itself. Instead markets
around the world continued their six-month winning streak.
The FTSE 100 ended 3 November at 4,332.57 – a gain of
1.37 per cent on the month. Had it not been for the heavily
weighted Oil & Gas sector (off 0.42 pr cent) it would
have done even better.
The FTSE 250 Index benefited from decent
exposure to the cyclical recovery plays (IT Hardware up 17.7
per cent, Software & Computer Services which gained 13.41
per cent and Mining, up 13.4 per cent as commodity prices
soared) and minimal exposure to the dull Oils. The FTSE 250
also has a decent exposure to the house builders and the Construction
& Building Materials sector was the worst performing sector
of all, losing 2.04 per cent on worries that higher base rates
will spook the housing market. But on balance the cyclicals
and recovery plays drove the FTSE 250 ahead strongly. It closed
up 3.14 per cent at 5,768.1.
But the real action was again in small caps.
There was some real silliness evident as cash shells suddenly
doubled in the space of days to trade at ludicrous premiums
to net assets and some of the flotation’s planned look…interesting.
That sentiment is running with the tiddlers is not in question.
How long it will last is. The FTSE Small Cap Index closed
3 November at 2,478.87 – a gain of 3.41 per cent. Meanwhile
the FTSE AIM Index managed to gain 3.93 per cent to close
at 787.97.
Three planks
As we entered October the case for a crash was based on three
planks. The weakest of these was that October has always been
the month for great crashes (1929 and 1987). The City is a
superstitious place and so happily ignores the fact that in
most October’s the market does not crash. So this was
a weak reason for pessimism.
The second reason to be cautious was that
valuations had somehow got ahead of themselves. On a PE of
around 18 the FTSE 100 may be more lowly rated than the Dow
and S&P 500 (25 plus) but it still trades on a rating
that discounts quite considerable earnings growth. Bears would
argue that the third-quarter results season, though on balance
upbeat, was just not good enough to justify those valuations.
For the bulls to be vindicated, earnings needed not only to
match forecasts but to beat them by a sufficient margin to
trigger upgrades to forecasts across the board.
For every two companies that beat forecasts
there was one that missed estimates, notably all the oil stocks,
Unilever, Abbey National, Boots…the list goes on and
it cuts across all sectors of the economy. Perhaps as importantly,
the chairman’s statements that accompanied those numbers
were far from universally upbeat. Words such as “difficult
climate” or “challenging trading conditions”
cropped up with a surprising regularity.
Let there be no doubt that the global economy
– led by the US, which is now growing at an annualised
rate of 7.2 per cent - is recovering. The evidence comes not
only from government and Central bank generated economic data
but also from independent indicators such as shipping freight
rates and the price of base metals. The question is whether
the rate of economic growth and – at one step removed
– the rate of corporate earnings growth is sufficient
to justify market valuations. It cannot be said that the answer
to this is a definitive yes.
But on the other hand there are clear signs
that business confidence is improving. A clear sign of that
is the re-emergence of both a raft of new issues (not all
of the highest quality) and perhaps, more importantly of mergers
and acquisitions. The past month has seen a bid for FTSE 100
member Amersham, Punch Taverns splashed out £1.2 billion
buying Pubmaster, the Granada/Carlton marriage was consummated
and a raft of smaller deals took place. If the rumour-mill
is to be believed – and it shouldn’t necessarily
– then there are a host more bids in the wings: Allied
Domecq? Smith & Nephew? Take your pick.
However, this brings us to the third reason
to be bearish – base rates. The UK has led the way in
tightening its monetary policy by increasing base rates by
0.25 to 3.75 per cent. But you can be sure that other Central
Banks will follow and also that this will not be the last
rate rise – the hot money is on UK rates hitting 5 per
cent by Christmas 2004. So just as business confidence starts
to pick up, the heavily indebted British consumer will start
to feel the purse strings tightening. Worst still, our imprudent
chancellor shows no sign of reversing any of his 60 tax rises
to date. If anything taxation is likely to continue to increase.
October was not a good month for the retailers.
Perhaps the weather was to blame? But the poor showing by
sellers of big ticket items such as MFI, DFS and Carpetright
raises the possibility that as interest rates continue to
increase the consumer spending bubble will deflate or, more
probably, burst. It may not need significant increase in base
rates for this to happen. Perhaps the shock of a couple of
hikes will be enough to remind borrowers that if they thought
that 40-year low rates could last forever, they were sadly
deluded.
If overall corporate earnings are to continue
to grow at a rate needed to justify anything like current
equity valuations then business investment and confidence
has to take on the role of engine of the economy from the
consumer who has kept it going since 2000. Will that be a
seamless transition? Is business really that confident? If
the answer is anything other than an unequivocal yes, you
have to be cautious. Valuations and the confident prevailing
mood amongst most investors cannot allow for any uncertainty
at all.
REFS is
a mine of invaluable information for the private investor.
