October is here again and so are the stomach lurching moves in equity markets which seem to have bec...
October is here again and so are the stomach lurching moves in equity markets which seem to have become a characteristic of this time of year. With the falling of leaves comes falling equity markets.
The UK equity market continues to give back the gains that it achieved in the rally in August. Investors have now endured a third successive quarter in which the market has ended lower than where it began.
With a high level of volatility and sector rotation, those sectors deemed to have defensive cashflow and earnings characteristics continue to win the upper hand.
Investors, however, are becoming increasingly anxious about the outlook for economic growth in particularly for corporate earnings. Of particular concern has been the prospect of a classic corporate margin squeeze as input costs rise while output prices remain weak.
The respective weakness of the euro and the strength of the dollar against sterling exacerbated this threat. This has continued to hamper progress in the manufacturing sector.
Those companies which deliver profit warnings are likely to continue to be savagely treated. The technology sector has not been immune to this following profit warnings from Intel, Apple and IBM which has taken the shine off the performance of the technology, media and telecoms sector.
A slowing economy can hold back technology companies due to their leverage to capital spending. The political environment is another area that investors are watching, particularly after the Danish "no" vote on the euro and the fuel crisis in September. Uncertainty on this front is likely to continue up to the next general election and could well have a negative impact on markets.
The market will remain highly sensitive to earnings disappointments although, as has been seen, these concerns can become exaggerated. The UK remains an attractive area of investment particularly relative to gilts and other world-wide markets but selectivity will be crucial as well as ability to rapidly re-assess positions as conditions change.
There is a very good chance that the economy will slow in a way that avoids outright recession and with this scenario in mind, opportunities will present themselves.
The rise in the savings ratio, however, is likely to provide little cheer to retailers and those geared to domestic demand. However, the gloom should not be overstated and the market has already discounted shares where there is a danger of an earnings shortfall. It still looks right to be overweight those companies that are capable of delivering above average growth during a period of slowing economic activity.
We expect the oil price to drift lower in step with its usual cyclical nature. We also expect lower interest rates in due course. A low inflation environment will aid a return of confidence to investors and allow liquidity to flow back into markets.
Edward Cotterell is a fund manager at Cazenove
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