City: Shares maintain their supremacy

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The Independent Online
LONDON share prices as measured by the FT-SE 100 index closed at a record high. The FT Government Securities Index, which is supposed to be a yardstick of performance in the gilts market, also reached its highest level since 1955 - the implication being that gilt prices generally are at a near 40- year peak. For the dog days of August and with the economy still struggling to pull out of recession, this is a pretty remarkable coincidence of events. What is driving both these markets is the hope that with the demise of the ERM, interest rates can now fall across Europe; France, Germany, Belgium and Denmark may be dragging their heels, but once enough time has elapsed to deprive the speculators of their currency gains, there's little doubt the authorities will take the necessary action. As far as the markets are concerned, things are moving strongly in the right direction.

The FT Government Securities Index in fact gives a slightly misleading picture of what's happening in the gilts market. With the development of more sophisticated and specific gilt market indices, few fund managers follow it any longer. According to Stephen Lewis of London Bond Broking Company, a veteran observer of the vicissitudes of the gilt-edged market, gilt prices have been higher on a number of occasions since 1955 than they are now. Both in value and yield terms, they were in July 1967.

None of this should disguise the fact, however, that since Black Wednesday there has been a sustained bull market in gilts that comes close to matching that in equities. Go further back and you'll find a pan-European bull market in bonds dating from as long ago as 1990. With interest rates falling from 10 to 6 per cent and expected to go lower, the total return on gilts since Britain came out of the ERM last September has been a little over 20 per cent.

On equities, it's been higher still - more like 25 per cent - ensuring that shares continue to enjoy their traditional investment premium over bonds. Among fund managers, the 'cult of equity' - the belief that over the long term, equities will always outperform bonds - remains essentially intact despite the recession. The gospel was first preached by George Ross Goobey of the Imperial Tobacco pension fund in the late 1940s, and it has remained virtually unchallenged ever since. True, there have been one or two moments of doubt - most notably during the great crash of 1974, when gilts appeared a better investment because it seemed that at least there was some prospect of getting repaid. Then again, about this time last year when Britain appeared forever doomed to be locked into the ERM's high interest rate/high exchange rate straitjacket, there was a small but growing minority who viewed gilts as the better long-term bet. Britain's enforced ERM exit put paid to them and the cult of equity is now back with a vengeance. Mr Lewis believes it's caused as much by vested interest as anything else; there are now many, many more equity managers, traders and analysts in the City than bond managers, traders and analysts. But in truth, he cannot be too unhappy with the way things are going. Though equity is still king, the gilts market has undergone a renaissance. Overseas, if not yet in Britain, perceptions of our economic performance and outlook have been transformed. US investors have come flooding back into British Government bonds, helping to drive the bull market. That in turn should make all those stories earlier this year about the likelihood of a government funding crisis look like so much poppycock.