With the FTSE 100 index poised to push up through key resistance levels, sentiment in the London equities market has brightened. But strategists are not holding their breath. Share prices in the UK are unlikely to make any lasting upside progress just yet.
The fact that prices have come off the bottom does not reflect fundamental improvements in the domestic environment, strategists say. “A lot of it has got to do with global issues rather than UK issues,” says Bob Semple, UK equity strategist at Deutsche Bank in London.
Market confidence, he says, seems to have stabilised. “But what we haven’t yet seen is any improvement in the investment side.”
Khuram Chaudhry, equity strategist at Merrill Lynch in London, also doubts the market has the ability to sustain the gains it has won. “Many people don’t actually believe this rally can last,” he says. “Every time the market rises, people are ready to close their short positions. I still think we’re in a bear market rally, so to be defensive is still quite a logical thing to do.”
High beta stocks – those with a high correlation with the market, such as cyclicals – could offer some protection in the current environment, says Chaudhry. As well as these, defensives such as tobacco and some of the retailers could be wise holdings, he says.
Factors governing market behaviour have become more positive, but in many cases, that change has been incremental. Among corporate earnings revisions, for example, there are still more downgrades than upgrades in most markets, but Semple points out that this imbalance is not as pronounced as before.
“The UK has been one of the better areas,” he says. “Forecasts haven’t changed over the last month, so there is a bit of encouragement there.”
Darren Winder, UK economist and strategist at UBS Warburg says earnings growth in 2003 is likely to be modest. “Unless we get more (upward) earnings revisions, it will be very hard to move the market from its current level”. Winder points out that well below a fifth of companies in the FTSE 100 have reported earnings that were better than expected.
Domestically, consumer spending has suffered no significant dip despite weakness elsewhere in the economic scene. Chaudhry points out that unemployment has not increased. There were concerns over the summer as house price development slowed that this would knock consumer confidence levels. But recent figures from mortgage lender Nationwide showing that house prices have shown a 2% rise have put paid to these worries for the time being.
For now, even though UK interest rates are seen as being on hold – the 50bps rate cut by the European Central Bank should provide support for the UK market, says Chaudhry.
Merrill Lynch currently has a year-end target of 4,500 for the FTSE, though Chaudhry says this may now be slightly optimistic. A range of between 4,000 and 4,500 is more likely, he says.
“Next year, if global growth improves slowly but surely, then many of the cyclicals will start to perform,” he says. “If global growth surprises on the upside, interest rates will go up first in the UK. But because there hasn’t been a consumer slowdown the concern is there are quite high debt levels held by the UK consumer. So when interest rates do go up they will have to go up further.”
If the FTSE 100 manages to break through the 4,200 barrier convincingly, Semple predicts this will spark a spirited run of another 200 points over the next month or so. But after this, there would be a pause for breath. Even if the market does manage to rise as high as 4,800 over the next few months, there are plenty of factors that will rein its potential in, he says.
By this time next year, interest rates will be going back up again, he says. And it is possible that once equities reach higher levels, some pension funds will opt to alter their strategic asset allocation in favour of bonds.
Winder says equity weightings among UK pension funds stood at just 40% as of the third quarter 2002, compared with 55% at the beginning of the 1990s. “They’ve already made quite a large shift away from equities into UK bonds and international bonds,” he says. “I would expect the trend towards international equities to increase as funds broaden their exposure.”
With UK government spending now on the increase, there will be a need for institutional investors to take up the new offerings of sovereign debt, he says. This means bond yields will head higher next year. “The outlook for bonds is not as bright going into 2003 than it was going into 2002,” he says. But any shift in asset allocation levels away from equities will be within limits, he says. Pension schemes in the UK are having to fund shortfalls in the wake of poor returns on equities in the last few years, and this will lead to at least some increase in demand for equities, he says.
The large fall in bond yields, which came about in recognition of the outlook for equities, has led to a situation where they are more closely aligned to equity yields than they have been for some time, says Winder. This alignment in yields lends support to share prices.
Looking ahead to the first half of 2003, Semple says signs of improving fundamental economic data will prove a support for the equities market. “As the economy gets better the market will take heart from it,” says Semple.

Topics