Business Analysis: The FTSE 100's back over 5,000 - but exuberance is in short supply

Concerns about the levels of consumer debt still overshadow a healthier stock market
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The Independent Online

So farewell, 5,000. The stock market's current bull run pushed the FTSE 100 past that milestone last week and it has held its gains, closing yesterday up another 17.1 points to 5,058.9. How long, then, before other hurdles are jumped and - it is almost too tantalising to ask - how long before the UK's blue-chip index surpasses its Millennium Eve record of 6,930.2?

So farewell, 5,000. The stock market's current bull run pushed the FTSE 100 past that milestone last week and it has held its gains, closing yesterday up another 17.1 points to 5,058.9. How long, then, before other hurdles are jumped and - it is almost too tantalising to ask - how long before the UK's blue-chip index surpasses its Millennium Eve record of 6,930.2?

At its current cracking pace, up 18 per cent since last August, the FTSE 100 will hit a new all-time high barely a year from now. But you would be hard pressed to find anyone in the City who thinks that is likely. Why so mean-spirited?

Three main reasons: that 6,930 was a ridiculously inflated level, the product of a technology bubble which rightly went pop; the economic prospects for the UK and for the globe are questionable; and already investors' excitement at the prospects of merger and acquisition activity has run ahead of itself.

Gerard Lane, an investment strategist for the fund managers Morley, cautions that investors should keep in mind the long view. He says: "When equities hit their peak, they were dramatically overvalued. The historical trend for post-bubble corrections - such as after 1929 and the late 1960s - is for extended periods of flat markets, taking more than a decade to get back to previous peaks."

Mr Lane also wonders whether the economy will perform well enough to propel equities higher, faster, and even whether the UK can avoid a consumer recession.

It is a theme taken up by many, who worry that the trillion pounds of consumer debt racked up in this country will hold back the stock market. Ian Richards, a UK equity strategist at ABN Amro, said: "Consumers will need to spend an increasing proportion of their income servicing and repaying debt. Given how important the UK consumer is to the economy, you can make a strong case for below-trend economic growth, which will act as a drag on the market for some time."

The consensus is that the stock market's current pace cannot be sustained even for the rest of this year. The current range of year-end forecasts for the FTSE 100 runs from 4,000 to 5,600. As for next year, even the most bullish investment bank is only predicting the index will end 2006 at 5,686. The peak level is far over the horizon.

Mr Richards says: "Fund managers came into the year sitting on hefty amounts of cash. There is also a real influx of private-equity money. But I am reluctant to get caught up in the current euphoria. We have to be realistic as to what we can expect on earnings growth. We have come a long way very quickly, but to go much further we need a leg up in the number and size of mergers and acquisitions."

But might not that "leg up" be possible? In the US, it has been the busiest period of merger and acquisition activity since 2000. In the telecoms sector since the start of this month, SBC Communications has agreed to buy AT&T for $16bn, while Verizon Communications is taking over MCI for $6.75bn. And, in one of the biggest deals of all-time, Procter & Gamble said in January that it would pay $52.4bn for its consumer goods peer Gillette. In the UK, a frenzy of bid speculation has drawn in seemingly a quarter of the FTSE 100, pushing up shares in Shell, Gallaher, Cadbury Schweppes, AstraZeneca, Allied Domecq, Reckitt Benckiser, ITV, Barclays, GUS, J Sainsbury, Marks & Spencer, Smith & Nephew and others.

Edward Bonham Carter, the chief executive of Jupiter Asset Management, expects that the FTSE 100 will take years to recover its previous high, but that M&A activity will help it on the way.

"It is becoming increasingly difficult for companies to produce organic growth as the UK is a mature economy with low inflation and low growth. And if you can't get growth organically, the next logical step is to buy it from your competitors," Mr Bonham Carter said.

"I would expect M&A activity to emerge in a variety of sectors - pretty much in any industry that is fragmented and has companies in it that are not enjoying significant organic growth. On this basis you are likely to find takeover targets among pharmaceuticals, energy, resources, financials, tobacco, food producers, media and retail sectors."

A Goldman Sachs study yesterday found that US corporate cash flows are already being redirected from the share buy-backs and dividend rises of recent years into capital investment and merger and acquisition activity. The confidence of American chief executives has returned, as has that of investors, and the UK could be less than a year behind.

David Kostin, the managing director of global investment research at Goldman Sachs, said of the US: "The belief that the market still favours the return of cash for shareholders rather than investment is wrong. We expect investors to reward smart growth. Balance sheets are healthy, cash flow remains robust, interest rates are low, the economy is growing, leaving investors (and us) to ask, if not now, when?"

Goldman Sachs suggests the beneficiaries of the investment upturn will be industrial sectors, information technology and energy, none of which figure especially highly in the FTSE 100. The UK's index of biggest companies is dominated by the banks, where dividend yields of more than 4 per cent suggest they are undervalued, but not hugely so. Other heavyweight sectors include pharmaceuticals, where margins on their drugs are likely to be squeezed by governments across the globe, and telecoms, where the massive Vodafone needs to double in value to return to its Millennial peak.

The only other sector to account for more than 10 per cent of the FTSE 100 is oil, which has performed poorly since the start of the bear market, down some 5 per cent. This industry is throwing off more cash than it can find opportunities to spend, and long-term investors are choosing, in the main, to concentrate on the trouble BP and Shell are having in replacing their reserves rather than on the cash they are returning to shareholders.

So few are willing to predict the FTSE 100 will return to its all-time highs much before the end of this decade, suggesting a modest annual gain of 7 per cent. And others are more bearish even than that. "It's not going there," says Khuram Chaudhry, a strategist at Merrill Lynch. "My concern is that, because of low interest rates promoting liquidity, no asset class - equities, bonds or property - has been starved of cash. Worse, in equities, sentiment is already very bullish, with no one wanting to miss out on the next takeover. Asset classes tend to do well only after they have been unloved."

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