The late summer rally in UK equities was nipped in the bud when the sharp rise in oil prices and pro...
The late summer rally in UK equities was nipped in the bud when the sharp rise in oil prices and profit warnings from technology, media and telecommunications companies saw August's gains more than dissipated in September and October.
However, conditions are intact for a year-end rally that could take the FTSE 100 over the 7,000 mark. But Vodafone remains plagued by earnings growth doubts and the two oil majors may have topped out with the oil price. Together they exert a powerful influence on the index.
On the economic front, growth is likely to remain modest but good enough to sustain corporate earnings growth of around 12% for this year and perhaps a shade below for 2001. Most earnings downgrades have so far been for technology and media companies and these contribute minimally to aggregate corporate earnings. Bottom-up estimates tend to be higher and may prove closer to the mark given the concentration of downgrades over a few sectors notably those close to consumers as well as the technology-related areas.
Underscoring the benefits of steady economic growth are a comfortable level of inflation, the virtual certainty that interest rates will hold through into the spring and an easing rather than weakening of sterling in the forex markets: almost a classic description of the ideal background for equity investment. Throw in the fact that valuations are by no means stretched other than among a handful of the technology stocks and that the market is sitting smack in the middle of its two-years trading range and the case is made for a FTSE 100 level of 7,200 before any danger arises of a substantial correction.
Any strategic risk is extraneous. A soft landing for the US economy seems assured but not guaranteed. A sudden growth pick-up could push interest rates. On the other hand the gentle and welcome slowdown may gain momentum and bring pressure on US company earnings.
Either would bring equities down smartly, with other markets following. World technology markets have not decoupled from Nasdaq and this probably means a high level of volatility in new economy stocks until Nasdaq bottoms out. Recent volume increases suggest it may do so before long but Nasdaq is not a market noted for behaving according to traditional rules.
The fourth quarter equity rally may be starting a bit later than most fund managers expected but recent strength in the banking sector (M&A driven but backed by interest rate outlook) and in established old economy stocks (Unilever and Smith & Nephew) suggest it is underway, though we are still a far cry from seeing any marked support for the retail sector.
A steadier influence from Nasdaq would give UK indices added stimulus without new outbreaks of technology fever. Now is the time for funds to get cash surpluses back in the market.
Douglas Thomson is head of UK Equities, Murray Johnstone
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