After spending much of the year in negative territory and trading between 6,000 and 6,600, in the sp...
After spending much of the year in negative territory and trading between 6,000 and 6,600, in the space of five days the FTSE 100 rose by 3.2% and recently was close to 6,800.
The rise in the blue chip index has much to do with the sudden return to favour of technology and telecoms stocks. It is too early to say this is sustainable. Some commentators point to the catalyst as being the return of holidaymakers with cash in their pockets, eager to get back into the market. The fact the Nasdaq Index has also risen strongly in the past few weeks has helped investor sentiment in the UK.
A more fundamental reason is the US economy appears to be heading for a soft landing, thus reducing the need for higher US interest rates. The general view on the UK economy is similar to that on the US, namely that growth should slow down to a more moderate pace and inflationary pressures wane. Therefore, there is a growing opinion among market participants that UK base rates may have peaked at 6%.
The evidence that the UK economy is slowing rests with activity in the manufacturing sector and surveys that indicate consumers are spending less in the high street. Offsetting this is that activity in the services sector has remained buoyant. The slowdown in house price inflation has contributed to a more optimistic outlook on consumer prices.
Competitive pressures among producers and retailers also point to inflation being contained. The chief threats to inflation appear to lie in a still strong labour market and the increase in government spending.
In the past when interest rates in the UK have peaked, it has invariably been positive for the stock market. The recent rise in the market may be reflecting growing optimism that rates have indeed peaked.
The other good news for the UK market is the outlook for profits growth. The slowdown in growth is not expected to be so severe that profits will actually fall. Some commentators worry that profits will be hurt by the strength of sterling against the euro.
However, sterling's weakness against the US dollar should help to boost profits, about 40% of UK quoted companies' overseas profits are earned in the US. The biggest beneficiaries are pharmaceuticals and media companies. Profits are expected to grow by 14% this year.
The broadening in the UK market has benefited those investors with a bias outside the large cap stocks.
Smaller and medium-sized companies have performed strongly this year while larger companies have lagged behind. Much of the weakness in large companies has been due to the performance of telecom services companies, down 17% year to date. In contrast, sectors such as specialty and other financials, personal care, tobacco, distributors and even property stocks have performed well.
If more liquidity flows into the market over the coming months, the gap between the performance of large and smaller companies may narrow. Nevertheless, we believe better value still lies outside the market leaders.
John Ross is a senior portfolio strategist at Fidelity Investments
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