The FTSE 350 index reached an all-time high in early February, while the FTSE 100 climbed to its hig...
The FTSE 350 index reached an all-time high in early February, while the FTSE 100 climbed to its highest level for six years.
Growth has been remarkable in the last two years with stocks outperforming the housing market in both 2005 and 2006. Last year the UK share market returned 17% capital growth, plus dividends, while UK house prices rose just 10%. But early indications suggest that the future is looking less promising for the UK economy, not least because of the increasingly aggressive actions of the Bank of England. The economy is going through difficult times. The shock interest rate increase in January became understandable when inflation was revealed to have reached 3%, an adjusted 16-year high. The Bank of England clearly had no option but to act. The UK's GDP growth in 2006 was ahead of forecast while the money supply is still growing in double digits. But higher interest rates will impact on the nation's purses and wallets and household spending will be cut, leading to lower revenues for retailers and other domestic stocks. That may not be the only bad news.
The Bank of England's determination to fight inflation could lead to recession, warns Barings. Andrew Cole, director of Barings' asset allocation group, says: "While we expect a healthy UK economy, we are worried that the determination of the Bank to reduce UK economic activity poses a risk and increases the chance of a recession occurring if interest rate rises are too aggressive."
He adds: "Although the pound will initially be supported by this activist central bank, it will come under pressure later as and when the economy finally slows." However, the Bank's decision not to increase rates again in February may have lessened the pressure.
On the share indices, there is a key reason why the performance of the smaller cap index is more important, according to Philip Haworth, investment manager - UK Equities at Aegon Asset Management. He believes it's an indication that buyout fever is a main driver in pushing markets forward. "In 2006, the hottest sector was utilities, bouyed by the predatory interest of private equity looking to gear up low but predictable returns," he says. "However, Citigroup Global Markets recently estimated that an annualised $350bn of private equity capital had been raised by the end of the third quarter of 2006. That is above the 2000 levels and the majority is earmarked for buyouts. The fact that a disproportionate value of acquisitions has occurred within the mid-cap arena is a key reason why the FTSE 250 total return in 2006 was twice that of the FTSE 100." Haworth is staying overweight in mining and underweight in oil. "Diversified mining stocks generate higher free cashflow yields than the large integrated oil companies, while providing better organic production growth and longer reserve lives," he says. "Arguably the outlook for metals is better than that for oil."
Meanwhile, Britain's businesses are remaining upbeat. More than half of firms are optimistic about prospects, according to the latest Business Barometer from Lloyds TSB Capital Markets. Trevor Williams, chief economist at the bank, says: "The continued recovery in manufacturing, strong retail sales growth and robust earnings and employment conditions have knitted together to provide a bedrock of optimism for UK firms."
"Firms in all sectors think the economic outlook for the UK has improved but, within the sectors, the distribution trade has seen a fall in confidence."
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