Comment: Investors' sentiments are changing

The London equity market continued its run of ill temper yesterday, with the fall on Wall Street following the US interest rate cut giving a nasty twist to what was already a glum day. All this is a far cry from the post-election euphoria of a few weeks ago. Has anything really changed?

Well, sentiment has certainly changed, making the enthusiasm of the broking community of the early part of the year look a little absurd. Clients were told that with a Conservative election victory they should be looking for the FT-100 index to stand at 2,900 to 3,000 by spring 1993, with some of the more optimistic talking of 3,000 by the end of this year.

Institutions caught the mood, typically running an 80-20 balance in favour of equities in their UK portfolios.

The year still has half way to run and a lot can happen in the next six months. But the fact remains that so far both gilts and cash have given a better overall return than equities. The majority view, as usual, has been wrong.

One response to this is to say that nothing - aside from the shift in sentiment - really has changed, that the sound intellectual reasons for favouring equities (and in particular the value offered by British share prices compared with US or Japanese) remain. All that has gone wrong is that half a dozen things have combined to depress prices at the moment, and once these are out of the way the market will recover.

These psychological depressants might include contagion from the US, the spate of new issues here, the potential demand for funds from a government needing to finance its deficit, the uneven nature of the UK recovery, post-Horton worries about dividends, the scale of negative equity in the UK housing market and so on.

Nothing new

Anyone could easily add a couple more to that list. The problem with this 'round up the usual suspects' approach is that there is nothing new in them, nothing to explain why UK share prices are sitting 10 per cent off their peak.

The anaemic nature of the US recovery has been evident for months, as has the likely response of the Fed in making another discount rate cut. On 15 May this column noted that the more extreme US analysts expected the Fed to ease policy three more times this year, including a cut in the discount rate to 3 per cent.

The British new issue queue has existed for months and, if anything, the fact that a consumption-sensitive company like MFI can fly at a time like this shows how mature the British institutions are. At the appropriate price they are happy to help an issue away.

The government deficit and the delayed recovery? Nothing new here. Growth may be a shade worse, but if anything the funding programme has been going better than many people expected.

BZW estimates that so far this fiscal year pounds 15.6bn gross of gilts have been issued. While analysts have been downgrading their forecasts for the UK economy this year - BZW and Kleinwort Benson now expect zero growth, Morgan Grenfell minus 0.3 per cent - and that increases the PSBR, the fact that funding is going well suggests that any such increase can be handled.

Besides, the longer we have to wait for the recovery the sharper it is likely to be. Most forecasters still expect rapid growth in 1993.

Dividends? There has undoubtedly been a shift of mood within the corporate sector, and indeed within the institutions, for cutting a dividend if there are not the profits to cover it.

This can now be recognised as prudent and wise rather than selfish and short- sighted. The whole process where companies paid dividends they could not afford and then raised rights issues to shore up their balance sheet is now seen to be disreputable, and not before time.

But, while a few companies may find it more acceptable to cut dividends, there has been no fundamental change of corporate policy since early spring. Besides, some companies are still raising their dividends - the net flow of funds is stable.

And the housing market? As each month goes by with either a small fall in prices or a flat market, the prospect for a consumer-driven recovery slips one month back too. But it was pretty naive to expect a housing boom this year, or next, or the year after.

There will be some people whose mortgages are greater than the value of their houses for another five years. This debt burden will overhang the housing market until the late 1990s, but there is very little that can be done about this.

Relative merits

Calls for a devaluation of sterling overlook that fact that this would increase long-term interest rates and might well depress the housing market further.

So a rise in consumption will have to wait on a rebuilding of savings. Once these are rebuilt, spending will creep up. But, again, this is not new information.

What, then, is new? I suspect that we are in the early stages of a big shift in perception by the investment community of the relative merits of bonds and equities. Whereas since the middle 1970s nine times out of 10 equities outperformed fixed-interest, in the years ahead they will outperform perhaps five times out of 10.

To get performance in the past, it was almost always right to be heavily weighted in equities. From now on it will often be right to do so, but not always. In a low-inflation environment bonds can frequently give a higher overall yield than equities, and with very much less risk. Look at the way two 'blue chips', British Aerospace and BP, have plunged in the past month.

So some fund managers are quietly seeking to rebalance their portfolios, perhaps to 70-30, maybe 60-40, between equities and fixed-interest.

Any such adjustment will naturally be facilitated by a ready supply of gilts to fund the PSBR. So we are not seeing a buyers' strike, more the fact that the flow of funds into the institutions is being mopped up by the new issues - including the further tranches of BT - and by gilt purchases.

So there is a change of sentiment taking place, but it is not towards the factors that normally affect equities. Rather it is a change of atitude to equities in general. It is not: 'I won't buy equities because I think the economy is going down the pan.' Rather it is: 'I won't buy equities because I think I can probably do better with gilts.'