Market view
It was not a bad month for UK equities but
the huge weightings of oil and pharmaceuticals within the
FTSE 100 make it look as if it was only if one looks at the
headline Index.
A shock restatement of its reserves knocked
Shell (and hence the oil sector) for six while disappointing
numbers from AstraZeneca on sales of new products and the
ongoing de-rating of GlaxoSmithKline hit pharma. The net result
was that during January the FTSE 100 lost 2.94 per cent to
2nd February at 4,381.37.
The one stock sector that is Steel raced
ahead thanks to the ongoing recovery of Corus (a FTSE 250
stock) while the other winning sectors (also heavily represented
in the FTSE 250) included the cyclical TMT darlings, Media,
IT Hardware and Electronics. Consequently the FTSE 250 raced
ahead by 3.69 per cent on the month to close 2nd February
at 6,057.43.
Arguably the FTSE 250 gives a more accurate
picture of the state of the market and of investor sentiment
than, on this occasion, does the blue-chip index. With real
signs that private investors are returning to the market –
indeed with some signs of froth and silliness emerging –
the FTSE Small Cap Index jumped by 5.37 per cent to 1,725.83
while the FTSE AIM Index raced ahead by 5.9 per cent to 889.79.
Normally small caps outperform at the tail end of a bull market
or when base rates are falling. Given that monetary policy
is actually tightening this increased appetite for risk must
be of some concern.
Difficult lessons
It is not the earnings that a company reports which dictate
how its shares will react but how those earnings relate to
expectations. If you had not twigged that by now you will
have been taught a savage lesson since Christmas.
The current quarterly and full-year reporting
season on both sides of the Atlantic has been very good indeed.
A few companies (Shell, Cisco, Sainsbury’s, Parmalat)
have let the side down to varying degrees but as a whole the
earnings season has shown impressive growth across all sectors.
And not only are the numbers good but the forward-looking
statements from CEO’s and chairmen are also pretty upbeat
in tone.
But (and it is a big but) the market appears
to have discounted this already. The FTSE 100 started 2004
on an historic price earnings ratio of around 17. In the US
the S&P traded on a multiple (depending on how you view
the treatment of share options) well into the twenties. Such
ratings demanded not only very strong quarterly numbers (which
they generally got) but also statements so upbeat that analysts
just had to increase current year forecasts by a significant
margin.
It would be an untruth to suggest that forecasts
have not, in a good number of cases been increased. For some
of the highly operationally geared stocks, notably British
Airways, the increases have been truly massive. However more
often than not forecasts for 2004 already included a huge
element of bottom line recovery and at this stage of the year
analysts are not prepared to be any bolder. There may be upgrades
later in the year but not yet.
On that basis, while it may be justified
to hold a stock on a price earnings ratio of 17 in the anticipation
that there may be upgrades, it is a brave man or woman who
will actually commit fresh cash and buy. Indeed, with equities
up by a third since the lows of last year there have been
some who have decided to take a bit of cash off the table
and lock in some profits. The failure to beat already high
expectations was one of the key themes for January and it
is likely to remain a feature of the coming months.
Dollar weakness
The other feature of January was the weakness of the dollar
against all-comers: gold, the euro and sterling. Although
the Federal Reserve has indicated that base rates will increase
(from 1 per cent) sooner rather than later, in the UK rates
are already on the way up. The weakness of the dollar has,
of course, boosted US exporters and that is one factor behind
the strong US corporate earnings season and the strength of
US equities. It goes without saying that those British companies
generating revenues in dollars are – for the same reason
– already feeling the pinch. Put in constant currency
terms the outperformance of the Dow versus the Footsie is
rather less marked than the headline numbers might suggest.
Though the dollar staged a temporary revival
in late January all the indications are that the interest
rate gap with the UK will widen and also that President Bush
is printing money at a record rate – the US budget deficit
is widening to worrying proportions. And that augurs rather
badly for the dollar during the remainder of 2004.
And what of UK base rates? It seems pretty
obvious that they won’t stay at 4 per cent for too long.
Most economists reckon that they will hit 4.75 per cent by
Christmas and that the current cycle will peak at around 5.5
per cent in the middle of next year. Corporate balance sheet’s
look – as a universe – fairly strong but given
the record levels of personal debt among British consumers
and their (over) exposure to the housing market this must
be of some concern. It is hard to foresee circumstances under
which earnings for consumer-related stocks head sharply higher
over the next 24 months.
While there are all sorts of reasons to be
cautious, but not pessimistic, on fundamental grounds, even
the most bearish of commentators has to concede that investor
sentiment is clearly greatly improved. The way that small
cap stocks with little asset backing and no earnings but a
lot of hope can see their shares raced ahead on the whiff
of a story is in some ways reminiscent of the happy days of
late 1999. Whilst this has to be welcomed, sentiment is, it
should be remembered, a fickle friend.
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