By Stuart Fowler, head of UK equities at Axa Investments Despite nearly a year of interest rate cu...
Despite nearly a year of interest rate cuts, the global economy entered 2002 with few clear signs of recovery in sight. Although the UK scene is somewhat brighter, thanks to a pick-up in Government expenditure and the ongoing strength of the consumer, the troubled US economy still has a substantial influence on the profits of UK-listed companies.
Indications are emerging that trading conditions in the US have bottomed but sentiment is clearly still fragile. For investors to be optimistic about a favourable US economic background in 2002, they must have faith, as we do, that lower interest rates will eventually have an impact.
Absence of an upturn in the early months of the year will, we expect, result in a continuation of last year's trend, which saw interest rates cut dramatically around the world.
Despite a spike in the oil price, the cycle of rate cuts seen in 2001 ended with inflation at low levels. As such, central banks will feel free to continue to cut interest rates should the need arise.
The recent fall in the oil price should in itself be stimulatory, increasing spending power for consumers and boosting profit margins for energy users.
As investors become more attuned to the notion that a recovery is on the horizon, we expect markets to bounce strongly.
However, we do not expect such a move to herald a bull market of the strength or longevity we have become used to in the 1980s and 1990s, as there is neither scope for a re-rating of markets nor the prospect of dramatic top-line growth for most companies.
A strong market rally in the UK is likely to be met with selling by pension funds, which are continuing to re-balance their portfolios away from equities in favour of bonds.
Although, we are taking an optimistic stance overall, it may be that the FTSE 100 Index makes only moderate progress in 2002.
The UK market is highly concentrated, with the largest five stocks accounting for nearly 35% of the whole market.
These companies have fared relatively well during the bear market and are unlikely to move ahead sharply as economic conditions improve.
Smaller, more economically sensitive stocks are more likely to drive the market's performance in 2002. We expect the FTSE to approach the 6,000 level but not to exceed it.
Where are the potential surprises likely to come from in 2002? If the spectre of further terrorist action continues to undermine confidence, leading to a rise in the oil price, the economic impact could be severe.
Another wild card could be a pick-up in corporate activity. Takeover activity in 2001 was muted but if a clearer picture develops for the economy, increasing numbers of companies are likely to develop confidence in their ability to make successful acquisitions.
Going forward, with profits growth hard to come by, the cost-cutting opportunities presented by mergers are likely to be too hard for many companies to resist.
Monetary and fiscal policy to boost growth.
Fall in oil price will stimulate economy.
Takeover activity could resume.
Stock market to remain vulnerable to bad news.
Profit forecasts for 2002 remian too high.
Pension funds still sellers of equities.
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