The FTSE 100 ended last year with an overall drop for the first time in more than six years. The index ended just over 10% down at 6,222. Fund managers may be keen to believe that this year will be more positive, but strategists say the market will have to weather more bearish times yet.
But with a robust economy and lower interest rates in the US, there are chances that the market’s upward momentum will pick up speed later this year, they say.
Even though in the UK GDP growth is not under threat to the extent that it is in the US, the Bank of England is still likely to cut interest rates, says Deutsche Bank UK strategist David McBain. He expects to see 50 basis points cut from the cost of short-term borrowing by the middle of the year.
The central bank has room to ease because retail price inflation is running below the Monetary Policy Committee’s target, he says.
Over at US securities house Merrill Lynch, strategists expect to see a cut in UK interest rates some time in the second quarter. Khuram Chaudhry, UK strategist, says the Bank of England is probably looking for further evidence of a slowdown in the economy before cutting rates. “Bond yields are factoring in some sort of interest rate cuts in the light of the US cut,” he says.
But not all experts agree. “We’re bearish on UK interest rates,” says Geoffrey Dicks, economist at Greenwich NatWest. “We don’t think rates will come down.” Currently the securities house even has a view that rates may actually be higher by the end of the year, he says.
However, for bonds, the rates outlook differs according to maturity. “We’re very bearish on the front end of the curve, but rather less so at the longer end,” says Dicks.
The UK economy appears sound at the moment, with every consumer-based index looking sturdy, says Dicks. But he admits there is a possible danger of contagion from the US, where the speed of the trend to economic weakness has taken analysts by surprise. This would only have a knock-on effect in the UK if the US economic situation turned out to be worse than it now appears to be, he adds.
But with a general election looming, there will be no need for extra economic stimulus from the monetary side, as Chancellor of the Exchequer Gordon Brown is likely to fill any void with tax cuts, says Dicks. No date has yet officially been given for a general election, but most observers expect the poll to take place on May 1, with the pre-election budget announced on the first or second Tuesday in March.
Economists at Deutsche Bank expect to see GDP growth this year of around 2.5%. Merrill Lynch forecasts 2.7% growth this year, after 3% in 2000.
Although US GDP is still forecast to show stronger growth this year than that expected in the UK, the US market has suffered from a sharp downgrade in economists’ growth predictions since September. At that time, the consensus forecast was 3.7% but it has since been revised to just 3%. Meanwhile, predictions for UK growth have not been altered.
Deutsche’s McBain says since late last year, his team have been advising clients to buy the UK market now. “That remains the case coming into 2001,” he says.
“In the longer term we still think the UK equities market will post reasonably attractive returns in 2001. For the first time in a while, you can find a good case for overweighting equities relative to bonds and cash,” he says. Stocks still appear 10% cheap relative to bonds, he says.
Chaudhry says that while equities generally rally at the prospect of lower interest rates, their lead will be taken from the US. So the market is dependent on the pace of Fed easings.
But the market is still dogged by analysts’ downgrades in corporate earnings estimates, and this type of negative news will continue to hit the market in the next few months, say strategists. However, McBain points out there is room for downgrades, given that earnings forecasts are still in double digits. Profit growth for 2001 is likely to be around 5%, he says.
In view of the uncertainty surrounding corporate profits, in the near-term market action is likely to be volatile, he says.
Acknowledging the rash of earnings downgrades, Chaudhry says if stock prices are to make progress, this situation will have to turn around some time in the second half. However, government expenditure – currently planned at 4% of GDP this year – will give some stimulus to growth. Teaching and healthcare will be the primary beneficiaries of the spending, which will be reflected in higher wages, he says.
Pharmaceuticals will be one of the main stockmarket sectors under threat in the first half of this year, strategists say. Banks, however, should continue to find favour, says McBain.
He sees the FTSE 100 ending the year at 7,250, with this blue-chip index adopting a firmer tone by the summer as people begin to be become comfortable about the prospects for economic growth.
Chaudhry notes the FTSE 100 is currently trading at the bottom end of its fair value range of between 6,100 and 7,000. The index should end the year at around 6,600, he says.