Context is everything. November interest rate increases by central banks in the UK, US and Europe ha...
Context is everything. November interest rate increases by central banks in the UK, US and Europe have been greeted with near unanimous approval.
Despite the continuing prospect of strong economic growth (reflecting in the UK by the recent upward revisions from the Treasury) current inflation data remains benign. This is the most fortuitous combination for financial markets and clearly underpins both the current rally in bond prices and the enthusiasm for growth stocks.
With investor sentiment turning more bullish the FTSE All-Share Index is mounting a strong challenge to its previous all time peak (3073.5 on 6 July 1999), in turn tempting those of a more pessimistic disposition to reverse their hitherto cautious stance.
Until the end of October the main obstacle cited by strategists to further strength in share prices was the increasing disparity between bond and equity valuations. Rising bond yields were pricing in much greater increases in short term interest rates and initial moves from June onwards were only regarded as the first shots in a protracted campaign to restrain economies and thereby pre-empt a resurgence in inflation. The predominant view at present is that the authorities are 'ahead of the curve' and that, with inflation set to remain low, there is little need for further monetary tightening.
Of course, the prevailing bubble of optimism could be punctured by an adverse turn of events. Many pundits still distrust the ability of the British economy to sustain above trend growth without generating inflationary pressures.
Above all, any recurrence of concerns over the new economic paradigm in the US, which prompted the Fed to renew its monetary tightening after the expected millennium pause, would rapidly be transmitted to global financial markets. This potential threat has diminished but not to point where it can be safely disregarded.
There is a powerful momentum behind the meteoric performance of growth sectors, especially telecoms and information technology, which is compounded by take-over activity and the underweight position of some UK fund managers.
According to most calculations a successful offer by Vodafone for Mannesmann would give the combined entity a weighting of more than 10% in the FTSE All-Share Index, forcing index trackers to make good any shortfall. On the other hand, some fund managers are buying on an indiscriminate basis, while the market squeeze is placing a value on many growth stocks which only super optimistic assumptions would justify.
Even profits warnings are brushed aside on the basis that future growth is all that matters. As always swings in the pendulum always move to excess. The advance of the main stock market indices, both in the UK and the US, has been unusually narrowly based. A two tier equity market reflects a similar view prevailing on the underlying economy. Bulls are not deterred by the current price earnings ratios of 50 times on pharmaceuticals, while ratings of over 70 times on both information technology and telecoms are scarcely regarded in the rush to gain exposure to the 'economy of tomorrow'.
Meanwhile large swathes of the market lie unwanted and neglected, despite valuations which appear extremely depressed by historic standards. Who wants shares in lowly rated but troubled sectors like food producers, general retailing and water?
A similar view was widely held 12 months ago about cyclical industrials and smaller companies, shortly before the catalyst of faster economic growth brought them back to favour. Where is the catalyst to unlock value in these neglected areas?
John Hatherly is head of research at M&G Group
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