Market View

January was another disastrous month for the markets. So much for the much hoped for New Year rally. Attempting any sectoral analysis is pretty pointless as every single FTSE sector ended 4 February lower than it was on 3 January.

As a rule of thumb, those sectors that were most bombed out at the start of the year (IT Services, Other Financials, Insurance) took less of a beating than those sectors which have hitherto been regarded as relatively defensive such as Household Products, Food Producers and Beverages. Even ‘safety’ can look expensive when there is a whiff of panic in the air!

As in any big sell-off the first casualties were the most liquid stocks: the blue chips of the FTSE 100. If you are an institutional forced seller it is a lot easier to offload 10 million Vodafone shares (worth £11 million but just 0.16 per cent of the company) than to sell 22 per cent of a £50 million capitalised enterprise. Mind you when forced sellers did try to offload lines of individual small and mid caps the impact on those individual share prices was, in the absence of any buyers, horrific.

The FTSE 100 Index fell by 10.4 per cent during the month to close at 3,590.09 although it did trade down to below 3,500 at one point. The FTSE 250 Index fared marginally better, retreating by a mere 7.5 per cent to 4,047.08 by 4 February. For once, the small caps outperformed although the mood in the small cap world is grim. The FTSE Aim Index ended the month at 577.51, a fall of only 4.9 per cent!

Tip top
Once a year at the end of January around 20 stock market reporters from all the national newspapers plus a few retired market reporters (including me) gather for a lunch where we have to nominate a buy, a sell and predict where the FTSE 100 will be in a year’s time. Modesty prevents me from revealing who won, by a Country mile, a magnum of champagne for the 2002 buy of the year. But his tip this year is Centamin Egypt (CEY)!

What really fascinated me as I wandered home with my booty was the wide range for FTSE 100 forecasts: 2,500 up to 5,500: a fairly wide spread! The truth is that nobody has the faintest idea where the market is heading.
On some yardsticks the FTSE 100 might appear cheap. When compared to gilts, the yield on the FTSE 100 is more attractive than at any time since 1967. And if one strips out some of the non or minimal yielding new economy stocks (which would not have existed 35 years ago) then the yield argument starts to look really quite compelling. But before you get carried away…

There are several good reasons not to rush into the market. The first, and most obvious, is that the Occidental economies still face some quite enormous challenges. It is very hard to see how the high levels of consumer and corporate debt can be eliminated in a painless fashion. That process could quite plausibly put a hold on economic recovery and there are plenty of other potential cockroaches in the kitchen such as war in Iraq, a very weak dollar and the strength of oil prices.

Why does this matter? Because in order to fund meaningful dividend growth or indeed to sustain the dividends currently being paid, companies need to be generating enough cash from operations not only to service (and hopefully repay) their debts but also to fund the payout. If profit margins come under pressure or sales are deferred and cancelled then a good many companies will simply not have the spare cash to both repair their balance sheets and to reward shareholders.

Speak to any veteran investor and the warning is clear: analysts may be forecasting high single-digit earnings growth this year and next but those forecasts are almost as suspect as Gordon Brown’s predictions for GDP growth. And if earnings forecasts are suspect then can you really make any assumptions about yield?

Dividend policy
Warren Buffett argues that you pay a high price for certainty. Equally when no-one has any faith in forecasts – as is the case now – then there will be bargains to be had. Undoubtedly some of those companies yielding 6,7, 8 or 9 per cent plus will continue to pursue a progressive dividend policy and if you buy the stock now you will be richly rewarded. But I fear that many such companies (and indeed some enterprises whose yield is not that high) will be forced to pare their payouts. Indeed if a stock yields more than 10 per cent, arguably that is s sign that a dividend cut should be the least of shareholder’s concerns.

Even if the bulls – if there are any left - are correct in saying that the yields on offer when the FTSE 100 trades at around 3,500 offer real value that is not to say that the market may not go lower still. Human nature is always to over-react. Investors overbought the FTSE 100 at the top of its cycle in 2000. And they will oversell it at the end of the bear market.

Veterans of 1973 argue that it is not enough to see signs of investor disinterest. At the bottom of a cycle there should be more than disinterest there should be revulsion towards shares in general. And valuations should leap out at you as attractive precisely because the market has over-reacted. I cannot honestly say that we are that stage yet. If one is a long-term bull you may well be vindicated in five years time if you claim that at 3,500 the FTSE 100 offers value. But there is no guarantee that at some time between now and five years the Footsie will not start with a 2!

Investor sentiment is somewhere between extremely nervous and extremely bearish. In such circumstances, and with the potential for such nasty external shocks to the economic system, it would be a brave commentator who would argue that shares could not still have further to fall.

Tom Winnifrith edits the financial website www.t1ps.com

FTSE 100 INDEX

Stock	1 month	Rank	1 year	Rank
3i Group	88.65	63	64.96	67
Abbey National	77.61	97	40.98	92
Alliance & Leicester	93.5	20	85.35	25
Alliance Unichem	87.02	71	73.41	54
Allied Domecq	87.16	70	88.62	19
Amersham	84.53	85	72.31	58
Amvescap	83.92	88	35.53	94
Anglo American	90.03	45	73.65	53
Associated British Foods	87.41	69	108.77	2
Astrazeneca	92.57	27	64.59	68
Aviva	88.66	62	50.31	83
BAA	89.09	54	73.33	55
BAE Systems	91.73	33	34.58	95
Barclays	90.97	39	63.97	69
BG Group	87.59	67	82.71	35
BHP Billiton	85.61	79	77.36	46
BOC Group	88.68	60	80.27	38
Boots	89.08	55	83.68	31
BP	89.46	51	73.04	56
Bradford & Bingley Ord	85.52	81	85.14	26
Brambles Industry	97.7	8	46.81	88
British American Tobacco	92.67	25	97.55	12
British Land	89.99	46	84.44	28
British Sky Broadcasting	92.72	24	88.43	20
BT Group	88.97	56	79.02	42
Bunzl	90.79	41	74.99	50
Cable & Wireless	124.02	2	21.3	99
Cadbury Schweppes	85.53	80	79.47	40
Canary Wharf Group	95.54	14	61.85	72
Capita Group	82.73	91	48.53	86
Centrica	90.5	43	68.59	62
Compass	87.95	66	56.52	76
Corus Group	97.25	10	34.08	96
Daily Mail & General TA N/Vtg
Diageo	92	30	77.58	45
Dixons Group	71.21	100	47.88	87
EMAP	91.58	34	99.71	10
Exel	85.68	78	78.6	43
Friends Provident	73.08	99	45.2	89
Gallaher Group	90.76	42	118.67	1
GKN	93.15	22	71.17	60
GlaxoSmithKline	95.97	12	69.6	61
Granada	80.56	94	52.62	80
GUS	86.69	76	77.98	44
Hanson	94.93	15	59.16	75
Hays	83.29	89	41.54	91
HBOS	84.12	87	67.95	64
Hilton Group	92.81	23	74.96	51
HSBC Hldgs	91.92	31	83.03	32
Imperial Chemical Industries	86.74	74	63.09	70
Imperial Tobacco	88.06	65	103.26	5
Invensys	91	38	42.49	90
Johnson Matthey	94	19	84.84	27
Kingfisher	86.52	77	50.71	82
Land Securities	92.29	28	88.41	21
Legal & General	78.39	96	49.46	84
Lloyds TSB Group	84.98	84	52.74	79
Man Group	95.83	13	67.31	65
Marks & Spencer	94.44	18	79.77	39
MM02	104.52	3	60.26	74
Morrison (Wm) Supermarkets	73.38	98	82.15	37
National Grid Transco	86.97	72	90.13	17
Next	103.19	4	83.72	30
Northern Rock	93.18	21	94.05	15
Old Mutual	91.19	36	87.99	22
P & O Princess Cruises	91.18	37	100.33	9
Pearson	94.6	17	68.58	63
Prudential	86.73	75	53.19	78
Reckitt Benckiser	87.55	68	104.1	4
Reed Elsvier	88.72	58	82.55	36
Rentokil	89.43	52	76.39	49
Reuters Group	98.03	7	29.66	98
REXAM	85.02	83	87.21	23
Rio Tinto (Reg)	89.68	49	83	33
Rolls Royce	91.36	35	65.42	66
Royal & Sun Alliance	79.92	95	30.71	97
Royal Bank of Scotland	89.99	47	76.76	47
Sabmiller	88.79	57	85.85	24
Safeway	149.12	1	107.5	3
Sage Group	88.72	58	49.12	85
Sainsbury (J)	84.39	86	61.77	73
Schroders	86.89	73	53.46	77
Schroders Non Vtg	83.11	90	50.81	81
Scottish & Newcastle	88.67	61	74.14	52
Scottish & Southern Energy	89.26	53	102.49	7
Scottish Power	92.62	26	84.14	29
Severn Trent	99.14	6	101.02	8
Shell Transport & Trading (Reg)	90.22	44	79.24	41
Shire Pharmaceutical Group	82.58	92	39.79	93
Six Continents	102.89	5	76.54	48
Smith & Nephew	90.93	40	89.33	18
Smiths Group	91.88	32	96.7	13
Standard Chartered	88.39	64	82.86	34
Tesco	85.31	82	72.23	59
Tomkins	97.5	9	98.81	11
Unilever	89.51	50	95.12	14
United Utilities	92.07	29	102.65	6
Vodafone Group	96.25	11	72.61	57
Wolseley	94.87	16	91.38	16
WPP Group	89.78	48	62.24	71
Xstrata	80.74	93
Mean/Count	90.23	-100	72.61	-99

Source: Lipper
Figures are the result of £100 invested to 31/01/03. Returns are shown net of income tax