Following the market lows in early March 2009, there was a strong rally in UK equities as confidence grew throughout last year over the increasing signs of a recovery despite the economy struggling to leave recession.
UK equities, alongside other developed markets, ended 2009 with strong gains even when allowing for the poor start to the year.
By contrast to the end of 2009, there has seen a more mixed start to this year. Initially, the positive feeling continued from last year into January with UK equities rising in the first couple of weeks. However, this situation reversed following President Obama’s statement regarding a crackdown on risk-taking by banks. Unsurprisingly, this saw financials lead other sectors lower while other international newsflow, such as China’s move to tighten monetary conditions, ensured UK markets had a weak start to the New Year.
The negative mood continued into early-February, particularly as attention focused on the financial sustainability of Greece and the potential for these issues to spread to other heavily indebted countries such as Spain, Portugal and Ireland. There has been a further reversal in sentiment as investors took heart from the European Union’s apparent promise to provide assistance to Greece without specifying how this will be delivered.
The question now is what will be the short-term direction of UK equities? There appears to be little doubt that the apparent one way upwards movement of 2009 has now passed and that there is now more of a two-way pull on UK equities.
It is likely that the news regarding the UK economy will continue to affect shares and this could have either a positive or negative impact on prices. It was announced in January that the UK economy had managed to limp out of recession in the fourth quarter of last year and investors will be looking for further evidence of a sustainable recovery, albeit it is likely to a subdued one.
As a result of the global recession, equities have benefited from a period of extensive monetary and fiscal stimulus with low interest rates and a weak sterling providing particular benefits. However, markets will be keeping a close eye on the timing and method of withdrawal of this stimulus and will be nervous of any moves that could upset a sustained recovery.
Inflation has been a recent popular topic in the press with the recent rise in Consumer Price Inflation to 3.5%, well above the Bank of England target of 2%. While inflation at this level would normally prompt action from the Bank of England Monetary Policy Committee the rate is expected to fall later this year. Consequently, unless inflation remains unexpectedly at a high level, equities should continue to benefit from the relaxed monetary conditions in the short-term.
The markets will also have an eye on the forthcoming General Election. The result last year had appeared to be a foregone conclusion, but the prospects of a hung parliament have increased this year. While it is unlikely that there will be any significant fiscal tightening this year, this does need to take place in 2011 in order to address the very high level of government debt.
Markets dislike uncertainty and a hung parliament is likely to create this, particularly as it could restrict any needed tightening. However, a majority win should allow markets to move forward owing to increased hope that the incoming government will tackle the debt crisis.
Richard Wallis is head of research and investment at Origen
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