Recovery is definitely in the air, say UK equity strategists, but anyone hoping for fireworks this year will be disappointed. The fundamentals are in place for an upturn in economic fortunes in the UK, but indebtedness and low levels of capital spending mean the path to stronger times will be slow, they say.
And extra pressure has landed on the market in the shape of concerns over the recent collapse of US energy trader Enron. In the wake of this event, UK market participants have become worried about the way companies are being run.
Strategists at ABN Amro are expecting a recovery this year, says Theodore Valeras, European strategist at the Dutch bank. “Interest rates have dropped, but the recovery will be very slow due to weak corporate balance sheets and weak corporate investment,” he says. In its quarterly inflation report in mid-February, the Bank of England said it expected consumer expenditure moderate this year, but warned rising levels of consumer debt could prompt a sharper slowdown
For the FTSE, ABN Amro’s target for the next six months is 5,100. This is little different from current levels. The market is holding out for a pick-up in earnings in 2003. This year, however, is forecast to be a time of zero growth in earnings, says Valeras.
Deutsche Bank UK equity strategist Bob Semple predicts the FTSE will break out of its current trading range between 5,000 and 5,400. “The key will be hard evidence that we’re past the worse in the global economy – also that we’re past the worse in earnings revisions.” Internationally, there is little as yet for the UK market to take comfort from.
At Merrill Lynch, strategists are less optimistic about this year than the crowd. “We have a year-end target for the FTSE of 5,500 – that is below consensus of 5,800–5,900,” says Khuram Chaudhry, equities strategist at Merrill Lynch in London.
Explaining this, Chaudhry says his house takes the view that even though an economic recovery should take place, there are a number of sectors that have been starved of capital. There is also concern over those sectors that have been laden with debt – notably the technology and telecommunications corners of the market, he adds.
“So even if you do get some pick up in the global economy, pricing power is likely to remain weak,” he says, adding: “We need to see capacity being cut before earnings can increase.”
A question-mark still hovers over the extent to which the global economy will recover, he says. “In essence, we’re talking about a deflationary recovery… It means interest rates will be left lower for longer, and consumer will be the ultimate winner.”
RBS Financial Markets economist Geoffrey Dicks sees interest rates in the UK remaining unchanged for now. “I don’t think we’ll get a rate move from the Monetary Policy Committee of the Bank of_England over the next six months, so not a lot will happen in the bond market,” he says. In an absence of action on the domestic front, it seems likely that the UK market will take its cue from the international fixed income markets.
And the international background will be more benign than it has been, says Dicks. “In the meantime, we will see better inflation data from Europe and the US,” he says. But at the start of this year, inflation figures have shown more rapidly rising prices, due to the effect of the changeover from national currencies to the euro.
But in Europe, the currently lagging data will catch up with the benign inflationary reality, he says. By spring, inflation will have proved itself to be below the European Central Bank’s 2% ceiling, says Dicks.
In the international bond markets, the yield on 10-year US treasuries will drift down and the UK market will adopt the same trend, he says.
The fourth quarter economic data for Europe and the US have been quite promising, says Chaudhry. “But it doesn’t mean we’re out of the woods. Ultimately, it’s when profit growth returns,” he says.
“I would be looking for corporate news to start turning up by the second half. If that doesn’t happen, we may find that the market goes sideways till earnings catch up,” he says.
In terms of stock selection, ABN Amro still favours defensive shares. Those in the technology, media and telecommunications sector have lost their growth potential, says Valeras. Industrial cyclicals are also off the buy list. “We still have a consumer bias,” he says. “We like farmers and food producers.”
Merrill Lynch’s Chaudhry believes investors should be buying into value stocks. “They offer more protection because they trade at a discount to the market, so they are less exposed,” he says. “Value cyclicals in the mid-cap and small-cap sections of the market are geared towards the domestic economy, so they should benefit.”
Also, defensive stocks are a good bet, including tobacco and utilities, he says. Disregarding capital growth potential, within these areas, there are some attractive dividend yields, Chaudhry points out. While the market dividend yield is 2.5% now, it is possible to find yields on utility stocks of around 5%.
Investors should remain hesitant, however, about those areas of the market that tend to trade at a premium – telecommunications and pharmaceuticals in particular, he says.

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