The majority of commentators remain unremittingly bearish on the market. In the latest sell-off, the...
The majority of commentators remain unremittingly bearish on the market. In the latest sell-off, the bear market has widened to include consumer staple food and drink stocks, which had previously been resilient. Only tobacco and utilities remain untouched.
It is noticeable that a high dividend yield alone is no longer offering a stock protection as fears of dividend cuts mount. The results season has begun and is not expected to offer much relief for the market.
The dominant themes are earnings downgrades due to dollar weakness and, more importantly, increased contributions to cover pension shortfalls.
As the biggest area of the UK market, the banks' results are key. With competition having intensified since the last round of mergers and the economic backdrop now weak, returns and asset quality are expected to come under increasing pressure.
In looking for positives, the valuation of the UK market based on earnings and dividends appears supportive against its own history, other markets and other asset classes. However, this argument does not reflect the structural issues overhanging the market.
Similarly, the latest relaxation of solvency rules for life assurance companies is helpful but may only be a temporary reprieve as such firms will probably want to reduce their equity exposure on any rally.
A more significant positive has been the pick-up in M&A activity at the start of the year, with the highlight being the bidding war for Safeway. This is a reminder the bear market has driven some equity valuations down to attractive levels for private equity and industrial buyers.
There is a widely-held view the key catalyst for a market rally is a quick resolution in Iraq, with the oil price falling back. However, it could be argued this has been so well flagged it should not be regarded as the key determinant of a change in market direction. Indeed, the degree of pessimism among investors could provoke a rally, as seen in October, regardless of Iraq.
This will not necessarily mean markets move into a sustainably higher trading range. Despite an easing of political uncertainty and continued low interest rates, any pick-up in corporate investment spending will be more muted than after the previous Gulf war. This is because of the high debt levels built up in the capex boom in the late 1990s, which will act as a drag on a corporate earnings recovery.
World authorities are clearly determined to stave off the deflation threat and stimulate economic growth through a combination of aggressive fiscal expansionary packages and sustained loose monetary policy.
We remain cautious because this will store up problems in terms of the large US current account deficit and budgetary deficits in the US and UK, as well as high corporate and household debt burdens. For example, the recent surprise interest rate cut by the Bank of England is unlikely to benefit the manufacturing sector and stimulate investment, when interest rates are already so low. It could encourage still more consumer borrowing, which may lead to a sharper fall in consumption next year and a longer period of weak economic growth.
Earnings downgrades and cuts could surprise.
Continued hedging of equity exposure.
Valuations will attract more M&A activity.
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