I write this after Alan Greenspan and the US Federal Reserve moved to halt the slide in the US econo...
I write this after Alan Greenspan and the US Federal Reserve moved to halt the slide in the US economy with a surprise half-point cut in interest rates with the promise of more to follow. US monetary policy is arguably the leading indicator and most important variable for the UK equity market. Given that this is the first 'unscheduled' cut between official meetings since the Asian Financial crisis in 1998, and considering the size of the cut, there are some who are speculating that Greenspan knows something we don't.
There has certainly been evidence of economic slowdown and declining consumer confidence but, in my view, the Fed was right to act now, recognising that a further tumble of activity and confidence was pending. One interest rate cut is unlikely to swing the economy back into growth mode but a series of cuts should help to eventually stabilise the world's most important economy and equity market. History supports the equity markets at this time. After the last five initial interest rate cuts, for example, the US Market has always risen.
The change in direction of US interest rates, although largely anticipated, will have a supportive impact for all markets. Falling US interest rates are also very similarly good for UK equities. There is great speculation that our own Monetary Policy Committee will cut rates this month which seems unlikely at this stage. Out of all of the major world's economies, the UK appears to be among those in the best of shape. This is likely to stall our own interest rate cut but unlikely to have a major negative bearing on UK equities.
The UK equity market is currently at very attractive levels versus the bond market, even if one accepts that part of the bond yield fall has been technically induced (demand and supply factors). In addition, the UK market is towards the bottom end of its two-year trading range.
Profit expectations in the UK remain too high, however, and fail to factor in this year's global slowdown. Nevertheless the 'cheapness' of the market can partially insulate share prices. Cash levels have been rising and equity supply is likely to be limited. Having been neutrally positioned towards defensives, we now target a slightly underweight position on the expectation of further global interest rate cuts. We predict a soft landing and that inflation will be contained enough to allow a relaxation of both monetary and fiscal policy.
We target increased exposure towards financials where we are already overweight and consumer cyclicals. We have increased other cyclical positions only slightly, recognising further deterioration in trading performance. We recognise that as the year goes on the market's risk appetite will begin to return but we are very unlikely to see the same speculative excesses in the tech area of the market for some time.
Peter Reid is chief investment officer at Britannic Asset Management
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