Market view
There had been suggestions that 2003 would
end with a bang – a big pre-Christmas rally. But as
it turned out investors were as reluctant to buy shares as
they were to spend on the high street. Thus despite the fact
that Wall Street was soaring on the back of more and more
economic data showing that the US economy is growing rapidly,
UK equities ended the month in uninspiring form.
The FTSE 100 was boosted by the strong performance
of mining and oil stocks, which in turn were boosted by the
strength of commodity prices. The blue-chip index closed 31
December at 4,475.87 – a gain of 1.52 per cent over
the month.
With less of an exposure to oil and metals
and a big exposure to the underperforming software sector
as well as to dull retail stocks, the FTSE 250 posted a rather
less impressive showing, adding just 0.85 per cent to end
the year at 5,802.28. Among the weaker sectors were pharmaceuticals
and aerospace – both big dollar earners. Gradually it
seems to be dawning on many that while a weak dollar might
boost US corporate earnings and thus US equities for UK-based
dollar earners a sliding greenback is actually earnings-depressive.
The FTSE AIM Index enjoyed another good month
and a steady stream of new issues and also fund raisings suggests
that investor’s appetite for small caps remains unfulfilled.
The index closed the year at 835.43, a gain during December
of 2.5 per cent.
Bears go long
Anyone who was ‘short’ for the last nine months
of 2003 must be heading for the poorhouse by now. I know of
only three bears who remain unrepentant and all three are
currently running ‘long’ positions – that
is to say that they are going with the trend. So is it intellectually
plausible to be bearish of equities?
The bull case rests upon the US economic
recovery. The Dow Jones jumped by 43 per cent last year and
as I write it is happily trading above 10,900. Had one suggested
a year ago that the Dow could end 2004 at 13,000 you would
have been ridiculed. Today such forecasts are commonplace.
And as each day goes by economic data and corporate earnings
announcements make it more and more difficult to argue that
the US economy is not recovering strongly. In an election
year it is hard to see how Federal Authorities will do anything
other than feed that recovery with a diet of loose monetary
and fiscal policies.
Whilst one or two bears insist that all US
data is misleading, that view is now almost impossible to
justify. So let us take it as given that the US economy is
growing strongly. That then begs two questions: Is this discounted
in equity valuations? And will that growth kick-start the
global – and specifically the UK – economy?
The answer to the first question is that,
with the Dow now trading on an historic price earnings ratio
of 23, quite a good bit of that growth is indeed discounted.
Such ratings are not normally seen at the start of a bull
run. Lehman Brothers, though bullish on global growth, argues
forcefully that US valuations look far more stretched than
ex-US valuations and it is not alone in advising investors
to be underweight America.
And then there is the issue of whether America’s
growth is exported. Inevitably some of it must be. However
it would be wrong to assume that ex-US will come anywhere
close to matching US growth rates. The three stimuli for the
current recovery seem to be: a weak dollar, low base rates
and a fiscal policy of combining huge tax cuts with a big
hike in government spending. The sliding greenback helps US
exporters while the fiscal and monetary policy encourages
indebted consumers to carry on spending and corporates to
finally implement long-delayed capital expenditure programmes.
Dollar weakness
Of course the weak US dollar is a positive disadvantage for
those companies seeking to export goods to the US –
or to compete with American companies in international markets.
Meanwhile in both Europe and the UK base rates are significantly
higher than in the US while anyone expecting tax cuts in the
old world is in line for the Nobel Prize for Optimism. British
exporters to Euroland face the added problem that –
thanks to years of following policies advocated by the Guardian
newspaper – the Continental economies will be the last
– and slowest – to recover.
Meanwhile there is evidence from the Christmas
period that confronted by vast tax increases and increasing
base rates the heavily indebted British consumer is –
unlike his or her American cousins - being more careful with
the chequebook. Should the consumer side of the economy falter
before the business cycle has turned fully back into positive
mode that could pose a real threat to overall growth assumptions.
So on that basis, even Chancellor Brown is
not foolish enough to think that UK economic growth will come
anywhere close to matching that in the US. And that suggests
that once again UK corporate earnings growth in 2004 will
lag that in the US – low double digits would be something
of a result. Yet at 4,500 the Footsie trades on an historic
price earnings ratio of around 18. Again – one can hardly
describe that as bargain basement territory. With ratings
relatively high by historic standards and with base rates
set to rise – albeit modestly – over the next
24 months there are certainly reasons to be cautious.
To suggest that the stock market rally may
be petering out is pretty much heretical these days so positive
is investor confidence. But whilst it may be over-egging the
pudding to suggest that now may be the time for the bears
to take out a few shorts, there is no compelling rush to buy
either.
Tom Winnifrith runs the free to register
share tip and market report service www.UK-Analyst.com
REFS is
a mine of invaluable information for the private investor.
