Preparing for lift-off
With the benchmark FTSE 100 Index hitting its highest levels so far this year in August, it certainly appears is if the worst is over for the UK market. At least one observer says everything is now in place for a recovery - and that the market is now “inclined to rise”.
“It’s all falling into place quite nicely,” says Chris Rodgers, head of UK equities at HSBC Asset Management. He cites a good flow of economic data in the UK and US, alongside rising confidence and continued buoyancy in consumer spending.
“The expectations for a second-half recovery are being confirmed,” he says. The recovery is not completely out of the blue as there - the difference now is that the risk of a lack of recovery is being “taken out of the equation”.
“The market is now inclined to rise rather than fall,” he says - adding that it needed a consolidation, having moved sideways since the start of the year. The driving force was mid-cap stocks as people scrambled for recovery ideas. Large-cap stocks had been lagging this recovery. “Valuations are reasonable and the news flow is positive,” he says.
Rodgers says the FTSE 100 could reach 4,500 by the end of the year. “I think the foundations for the second half are falling into place.” Rodgers likes industries which can benefit from the global recovery - such as oil companies and banks, with HSBC and Standard Chartered best positioned. Industries less well placed are “defensive” areas such as consumer goods, utilities and tobacco. “They’re clearly suffering in a relative sense.”
As for the bond market, the fears of deflation that were around earlier in the year have dissipated - with the stimulus being low interest rates, tax cuts and the dollar. “I think there is quite a lot of stimulus in place now,” says Rodgers. “There would have to be something very wrong with the world economy if it didn’t work.”
This time round, he says, the global economy needs to recover as one. “We’re all looking at the US to be the cavalry to lead us out of a troubled period. What we really need is a synchronised recovery.” He is positive, saying there is some good news starting to come out of Japan and that there have positive survey reports from Germany.
Corporate profits, Rodgers says, are recovering – due to the cost cuts companies made over the last three years. Add a little top-line growth, he says, and you could start to see double-digit profit growth.
At the macro-economic level, the UK is likely to take a small step closer to the Euro-zone economy later this year when the Bank of England adopts a new way of measuring inflation.
The move, expected to take place in November, will see the central bank adopt the so-called harmonised index of consumer prices, or HICP, as its key inflation measure. The change signals a shift away from the current retail price index measure.
There are two reasons behind the change, says David Page, an economist at Investec Bank in London. Firstly, there’s a technical reason, in that there is a change in the way the data series is constructed. And it’s the same measure used by the European Central Bank. It’s through small, incremental changes such as this that the UK economy is edging closer to its European neighbours, it seems.
Page says the new inflation measure will probably mean that there will be a new inflation target. When the current government came to power in 1997, it set an inflation target at 2.5%. Using the new measure, the Bank of England is likely to be instructed to target two percent, Page reckons.
As for the Bank’s recent quarterly inflation report, released in August, Page says the report said little that was new. “There were not too many surprises in the inflation report - it was really what we expected.” The report was “bereft of any real news”.
So if it’s steady as she goes in terms of inflation, what of unemployment? Page says recent unemployment numbers – which unexpectedly fell to a two-year low – were “very encouraging”. Under the International Labour Organisation measure, joblessness is at 5%. Page argues that the numbers point to a “fairly tight labour market”.
As minister for work Des Browne says: “We now have one of the highest employment rates in the world.” He says long-term youth unemployment has been “virtually eradicated”.
And with average earnings growth at around 3.1% - the same number as retail prices in July - there appears to be no inflationary pressure building up. “We are likely to see consumer spending fall,” Page adds. “We expect unemployment to remain low and expect to see low rates.” Investec is predicting the Bank of England will next raise rates in August next year.
Of course the UK economy is closely tied to the US. “Both economies have spare capacity,” Page says. “We should be in a period to let growth run its course.”