Market view

The old adage is “sell in May and go away until St Leger’s Day.” Anyone who did that this year will have been kicking themselves – it seemed almost as if we were back in the heady days of 1999. The FTSE 100 Index jumped by 4.47 per cent between 2 May and 2 June to reach 4,129.28. That it did not do better was due to the relatively heavy sector weighting of pharmaceuticals (down 3.9 per cent thanks to fat cat rows and a switching out of defensives).

The FTSE 250 Index, on the other hand, is heavily exposed to “new economy” stocks in IT (up 21.3 per cent) and electronics (up 20.51 per cent) and cyclicals such as media (ahead by 12.5 per cent) which all shot up significantly. Hence the second line Index ended the month at 4,879.95 – a mammoth 10.48 per cent gain in just over 4 weeks.

And highlighting the renewed sense of investor confidence, small cap stocks attracted sustained buying in a way that brokers have not seen for more than two years. This was not of the scale of the madness of 1999. But it was not unusual to see stocks, written off for dead in April jump by 30, 40 or even 50 per cent in May. They may still be “dead” on a fundamental basis but who cares? Momentum trading is back. The FTSE Small Cap Index jumped by 10.6 per cent during the month to close at 2055.08 while even the AIM Index managed a gain of 7.18 per cent to hit 617.3

Bear hug
How quickly the market atmosphere has changed. On 1 February I organised a conference in London for 1,000 investors. Three chartists stood up and called the FTSE 100 down to 1,500. There was a lot of nonsense spouted (mainly by the chartists) about “following Japan” into a deflationary black hole. Among the audience the mood was a mixture of “when will this all end – we cannot survive much longer” and “it is never going to end – shorting is a one-way bet.”

As I write the bears are being squeezed. Indeed amid signs of bears capitulating many share prices are being forced higher merely because bears are buying back short positions. Stockbrokers no longer have time to send silly emails, they are actually doing real business. And the rumours of bids, MBOs and contract wins are doing the rounds just as in the good old days. If it was not for the fact that the past three years had been so bloody awful one might be forgiven for feeling almost optimistic.

So what has changed? Base rates remain low across the Western world and look like they will stay low for a good while yet. Why? Because economic growth is still weak in the US and the UK while inside the Eurozone – notably in Germany – there is no growth at all.

In the US and UK base rates may not be falling – although they still might do – but the depreciation of the dollar and sterling against most currencies – but noticeably the euro – has given exporters a much needed boost. It won’t do much for exporters inside the Eurozone but then no sane person ever pretended that being in the euro was good for your wealth.

Base rates in the UK and the US may no longer be falling but they are at 40-year lows. It has always been recognised that interest rates are a fairly crude way of stimulating an economy and are a tool that can take quite some time to have an effect. Perhaps at long last there are signs that base rates are having some effect on business confidence. The evidence is not overwhelming or conclusive but some economic indicators and corporate announcements have suggested that levels of business investment are starting to recover (albeit from pretty low levels). Since most firms have spent the past two hears hacking costs right down to the bone, any improvement at the top line should flow through pretty dramatically to increased earnings. UK plc can be said to be operationally geared.

Icebergs ahead
Of course there are still some icebergs, which will need to be circumnavigated before we all get too carried away. In both the US and the UK levels of personal debt remain worryingly high. Arguably the US is helping its citizens with significant tax cuts. But in the UK taxes are going up - tax freedom day fell on 2 June in 2003, having been 26 May in 1997 and will be 9 June by 2005. That means that consumers have a lower disposable income with which to support (let alone repay) their vast debts. At some stage consumer spending must slow down and that will dent earnings growth.

And there is also the issue of valuation. When the FTSE 100 traded at 3,300 you did not need to look hard to find dozens of very solid stocks, generating cash and whose shares yielded 6 per cent plus. Buying such stocks was of course a total nil brainer except that we were all too terrified to do it!

As I write, the yield on the FTSE 100 is down to around 3.3 per cent. Dividend cover for UK companies averages a miserly 1.6 times. That might be an acceptable level of cover at the bottom of the cycle but it is not sustainable in the long run. Hence the priority for most companies over the next few years will be rebuilding dividend cover (and balance sheets) not hiking the payout. So you would be foolish to bank on significant, across the board, dividend increases. And if that is the case it is hard to see how anyone can get terribly excited about an investment yielding only 3.3 per cent. It is not one that jumps out at you screaming “bargain.”

Of course equities may go higher. Man always over-reacts and having worried about the end of capitalism four months ago it is no surprise that the same animal is now back as a momentum trader talking about “the next bull market”. Caveat Emptor: today’s valuations simply do not look an attractive base for a bull run.

Tom Winnifrith edits the internet website www.t1ps.com

FTSE 100 INDEX

3i Group Inv Tr	126.45	4	78.56	58
Abbey National	113.61	11	50.95	93
Alliance & Leicester	102.84	60	99.9	12
Alliance Unichem	108.44	30	80.06	53
Allied Domecq	99	80	76.8	62
Amersham	104.06	55	76.43	64
Amvescap	108.97	26	56.06	90
Anglo American	105.47	44	79.19	55
Associated British Foods	105.85	43	93.21	27
Astrazeneca	100.73	70	85.06	43
Aviva	101.14	68	71.35	74
BAA	101.04	69	81.84	49
BAE Systems	101.97	65	35.89	98
Barclays	99.48	76	76.47	63
BG Group	108.19	31	92.36	30
BHP Billiton	99.22	78	84.16	45
BOC Group	97.47	85	75.14	68
Boots Group	108.82	27	95.13	22
BP	107.01	37	75.21	67
Bradford & Bingley Ord	106.16	42	106.95	7
British American Tobacco	109.25	24	84.53	44
British Land	117.95	7	81	51
British Sky Broadcasting	102.24	63	90.2	32
BT Group	107.39	35	70.23	78
Bunzl	101.59	67	88.23	36
Cable & Wireless	136.21	1	51.02	92
Cadbury Schweppes	101.87	66	73.31	71
Canary Wharf Group	110.43	17	45.13	95
Capita Group	92.31	95	62.37	85
Centrica	106.92	40	87.5	38
Compass	115.97	8	80	54
Daily Mail & General TA N/Vtg
Diageo	94.38	93	78.8	57
Dixons Group	103.82	56	56.48	89
EMAP	106.48	41	99.7	14
Exel	111.5	15	77.64	61
F&C Investment Tr	104.08	54	76.31	66
Friends Provident	118.07	6	71.23	75
Gallaher Group	103.71	57	99.88	13
GKN	99.51	75	65.35	84
GlaxoSmithKline	96.75	88	88.71	35
Granada	129.67	3	68.99	80
GUS	108.65	29	101.23	10
Hanson	100.71	71	71.22	76
Hays	97.31	86	51.57	91
HBOS	97.14	87	90.3	31
Hilton Group	111.6	14	73.64	70
HSBC Hldgs	105.18	47	88.95	34
Imperial Chemical Industries	104.82	49	42.98	96
Imperial Tobacco	105.06	48	98.18	17
Johnson Matthey	105.4	45	82.21	48
Kelda Group	105.35	46	110.31	4
Kingfisher	104.6	52	73.26	72
Land Securities	107.66	33	85.69	41
Legal & General	111.29	16	60.42	88
Liberty International	110.34	19	108.11	6
Lloyds TSB Group	108.75	28	65.78	83
Man Group	118.39	5	133.82	2
Marks & Spencer	98.11	84	76.33	65
MM02	110.31	20	144.71	1
Morrison (Wm) Supermarkets	102.55	61	86.7	40
National Grid Transco	95.99	90	80.43	52
Next	102.28	62	97.68	18
Northern Rock	107.62	34	109.97	5
Old Mutual	95.37	91	85.59	42
Pearson	109.3	23	70.68	77
Provident Financial	109.49	22	93.52	26
Prudential	99.22	79	61	87
Reckitt Benckiser	107.75	32	100.45	11
Reed Elsvier	100.4	72	77.99	60
Rentokil	98.72	82	66.86	81
Reuters Group	134.44	2	42	97
REXAM	99.41	77	83.1	46
Rio Tinto (Reg)	100	73	94.97	23
Royal Bank of Scotland	96.59	89	82.32	47
Sabmiller	93.5	94	72.81	73
Safeway	98.81	81	88.19	37
Sage Group	115.93	9	92.58	28
Sainsbury (J)	114.48	10	73.93	69
Schroders	110.41	18	92.41	29
Scottish & Newcastle	106.99	39	61.39	86
Scottish & Southern Energy	98.68	83	95.93	21
Scottish Power	94.65	92	97.3	19
Severn Trent	104.62	51	102.43	9
Shell Transport & Trading (Reg)	107	38	78.55	59
Shire Pharmaceutical Group	103.11	59	66.64	82
Smith & Nephew	88.68	97	96.26	20
Smiths Group	99.7	74	78.82	56
Standard Chartered	104.66	50	94.19	24
Tesco	103.16	58	81.72	50
Tomkins	113.21	13	98.95	16
Unilever	90.16	96	89.03	33
United Utilities	102.16	64	99.17	15
Vodafone Group	107.29	36	130.15	3
Whitbread	104.44	53	102.93	8
Wolseley	109.09	25	93.84	25
WPP Group	110.05	21	69.38	79
Xstrata	80.32	98	50.45	94
Total Average (100)	105.31	100	82.18	-100