Ten days after touching a near eight-year low of sub 3,300, the FTSE 100 index shot up by over 17%...
Ten days after touching a near eight-year low of sub 3,300, the FTSE 100 index shot up by over 17%. News that allied troops had finally entered Iraq was greeted by a sharp rally in stock markets worldwide. Months of uncertainty had come to an end and investors were betting on a short sharp war with a swift and positive resolution.
So was this just over-enthusiastic buying on the first gunshots of war or is the outlook really improving for equity investors?
One encouraging sign for equity markets is the behaviour of bond markets. Last September saw a major turning point in the debt markets when yield spreads in corporate bonds peaked. The improvement in spreads since then is a very positive sign. It indicates the bond markets feel we are through the worst of the deterioration in corporate balance sheets. With the continued cost-cutting efforts of companies, we are seeing ongoing repair to balance sheets and this should support investor appetite for risk. This is necessary if any rally in the equity markets is to be sustainable. The global outlook for monetary and fiscal policy stimulus is also more encouraging. The last few months have seen interest rate cuts in all the major western economies and there may be further downward moves in Europe, the UK and US.
On the negative side, there have been concerns about consumer spending. Over the last couple of years, with capital expenditure slumping, it has been left to consumers to sustain the economy, both in the US and UK. In both economies there are signs that retail spending is beginning to tail off. Certainly there is no pent up consumer demand waiting to rebound. But in the current cycle, the key rests with the corporate sector and a resumption of capital investment ' this is what is needed to underpin a profits recovery. Balance sheet improvement is setting the scene for a pick-up once confidence improves.
What then of the UK economy? The headlines are focusing on an end to the housing boom and a slump in consumer spending. In London, house prices, employment and real incomes are all falling and if this spreads across the UK, the outlook is downbeat. However, if the shake-out in London's financial services sector has run its course and the market environment is better this year, maybe the London effect will not fan out rapidly nationwide. Encouragingly, mortgage lenders continue to report robust lending figures with no deterioration in credit quality.
Furthermore, across the rest of the UK, real incomes and employment are still rising and, with any immediate increase in interest rates now highly unlikely, the housing market may well remain buoyant and supportive of consumer spending.
A prolonged Gulf war, sharp dollar weakness, further declines in UK or US consumer spending ' it is easy to be bearish for the rest of 2003, whereby further stock market weakness induces more forced selling and drives the FTSE 100 index to the chartists' bear market target of 2,900. But the extent to which investors are steeped in gloom, distrustful of rallies and positioned for a further decline, suggests a more bullish scenario may yet surprise.
Better balance sheets boost appetite for risk.
Encouraging monetary and fiscal outlook.
Incomes and employment rising.
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