The UK economy has performed relatively well so far this year, growing at close to its long-term t...
The UK economy has performed relatively well so far this year, growing at close to its long-term trend rate. According to preliminary estimates, GDP grew by 0.6% between the second quarter and third quarter, a commendable performance considering the bleak global economic picture.
With inflation firmly under control, the Bank of England has been able to cut interest rates aggressively. Even though household spending has remained robust, the backdrop of weakening external demand has been the reasoning behind the cuts. At the moment, inflation is not a barrier to further cuts as lower oil prices are helping depress the headline inflation figure.
The outlook for the UK economy is not so rosy however, with growth forecast to weaken sharply in the fourth quarter. In September, manufacturing output suffered its biggest monthly fall for nine years, business confidence collapsed in October and now consumer confidence is starting to show signs of weakening.
In light of the deteriorating economic climate, it is interesting that equities have staged such a strong rebound recently. The question is whether we are seeing a re-run of 1998.
In 1998, business confidence and GDP growth followed equity markets down in the wake of the emerging markets crisis. But all three rebounded sharply during the first half of 1999 and central banks worldwide were forced to increase interest rates sharply during the first half of that year.
I am more cautious this time because the picture now is even tougher than then. The international environment is considerably harder with the US now technically in recession. Interestingly, business sentiment in the UK is deteriorating across a spectrum of sectors and not just manufacturing. UK consumer confidence has only recently started to weaken and with unemployment ticking up and house prices starting to drift, these two factors alone will weigh very heavily on consumers' minds.
The concern in terms of the stock market is that the recent equity market rally has been led by cyclicals such as mining, engineering, chemicals and media. The market is starting to discount a recovery in these areas next year, which may lead to bitter disappointment if it does not materialise.
An area of topical interest at the moment is the oil sector, where the major oil companies' share prices have come back significantly recently. With Opec and Russia unable to work in unison, the oil price has collapsed to $19 from the highs of $30 only a few months ago. An oil price below $15 is bad news for Opec and non-Opec producers alike and it is that price on which the stock market is currently valuing the major integrated companies at the moment. Maybe now is the time to revisit the sector because one lesson from the post-Asian recovery in 1999 was that the oil sector was among the few cyclical areas whose margins proved pro-cyclical and whose earnings actually met expectations.
The return of corporate activity in the UK shows a degree of confidence returning to the equity market. But even with further interest rates cuts ahead, there could still be more earnings disappointments to come.
Further scope for more interest rate cuts.
Increased corporate activity.
Oil sector valuations now compelling.
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