The strength of the UK equity market in the first four months of 2006 has taken most sector particip...
The strength of the UK equity market in the first four months of 2006 has taken most sector participants by surprise. What is particularly surprising though, is the fact the market is up and continues to offer reasonable value.
For example, the FTSE 100 index was up to 5,618.80 points on 5 June, compared to 4,999.40 points a year ago. While the FTSE 250 index was trading at 8,794.3 points on 5 June, compared to 7,204.8 a year ago.
However, there are various issues that could cloud the horizon for the UK equity market during 2006. For instance, the stand-off between the US and Iran over the latter's nuclear ambitions and the potential impact this could have on oil prices has yet to be fully played out.
Nearer home, investors should be wary of the fortunes for the UK consumer. The slowdown in discretionary consumer spending will continue to feature during most of 2006 as consumers, already burdened with high levels of personal debt, see their disposable income further eroded by rising fuel and utility bills.
The UK nationwide spending index has fallen five points over the past year and was trading at 107 points in April 2006 compared to 112 points in April 2005.
Unsurprisingly, the retail sector will bear the brunt of the slowdown as householders rein in their spending.
Aside from concerns over geopolitical risks and the UK consumer, investors should also be mindful of the relationship between equities and bonds.
It is possible anything could undermine the structure of the value relationship between bonds and equities. For example, a significant re-emergence of inflation, would be a cause for concern.
Furthermore, the feature of the last decade or so has been the decline in bond yields, as investors become more confident about the outlook for inflation and the potency of the Bank of England.
Having said this, without a doubt mergers and acquisitions (M&A) activity has provided a tremendous boost to equities in 2006, with stocks on a daily basis coming into focus as possible recipients of M&A activity.
However, one area where M&A activity has been particularly strong is in mid-caps, which has been gradually feeding through into the large-cap sector. For example, Spanish-based Grupo Ferrovial's successful bid for airport operator BAA and US Nasdaq's bid for the London Stock Exchange.
The bout of M&A activity witnessed so far in 2006 has been partly driven by the discrepancy between the valuation on equities and the cost of borrowing, as well as the fact companies around the world are looking for growth.
In this context, some UK companies look attractive. While the earnings yield available on equities is still about 7% and the yield available on other kinds of financial assets is significantly lower, the market should remain supported.
Although the scenario for the UK economy in 2006 is not expected to greatly boost UK corporate earnings, investors should not expect UK corporate earnings to collapse either.
In this context, the long-term rating of the market appears to be good value and investors should still be of the opinion that equities will continue to make good absolute returns.
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From 6 April 2019