Politics cloud the shares feast
Saturday 18 March 1995
Technical factors remain relentlessly positive. On fundamental valuation, the relationship with gilts, the outlook for corporate profits and the state of institutional equity, shares look cheap. The cloud on the horizon is the dwindling prospects for the present government surviving beyond the next election.
Oddly, professional investors remain sanguine about the threat of a Labour government. Steve Hall, fund manager at the small, private client broker Pilling in Manchester, concedes that the only bugbear facing the UK market is the political aspect. But he avers that "whatever [Labour] might say, I don't think they are going to be that extreme at all".
Governments now cannot rely on ideology the way they used to. They must now "plough a middle ground" if they are going to raise the revenues to push forward ambitious plans for education and health, he argues.
Ian Harnett, equity strategist at brokers Socit Gnrale Strauss Turnbull, agrees that the political risk has been overdone. "We can actually measure what the political risk of having a Labour government is, because in 1992 we were actually one day away from having a Labour government."
The relief when John Major, against the odds, went back to 10 Downing Street saw the market bounce 250 to 300 points, Mr Harnett pointed out. With the market already on alert for a socialist administration, "it is hard to say that some of the political risk is not already in there. And secondly, this [potential] Labour government is not as red as the previous one was going to be".
The bounce on a return of the Conservatives might be as much as 400 to 600 points on the index, he estimated. "If investors see returns being over twice the size of the downside risk, then it is beginning to look quite a safe bet."
He believes that at the fundamental level, the market is quite cheap, citing the collapse in price/earnings ratios over the past year. From more than 24 in early 1994, the historic p/e for the UK's top 100 companies has slumped to 14.5 now and the prospective is just 11.5.
Others highlight the juicy yields available from the share market. Matthew Orr, a partner in private client stockbroker Killik & Co, said equities were yielding a lot more than their historic average against gilts.
The so-called gilt-equity yield ratio has been in the 1.7 to 2.0 range recently, against a long-term average of around 2.1. So to return to its long-run average, the current prospective yield of 5 per cent on shares should be nearer 4.25 or 4.5 per cent.
Mr Orr believes the market is undervalued by 5 per cent, moving out to 15 per cent a year hence. It will need to move higher to catch up, he said, and "that could be quite spiky when it does happen. It might be quite difficult for investors to get back in".
The outlook for corporate liquidity also favours further strength in the market. Previous high points in 1978 and 1987 saw the equity market rise close to 40 per cent in the period following, as money flowed back to the personal sector.
The fundamentals make Ian Harnett "emphatically bullish" about the outlook for the rest of the year. The next key chart barriers are 3,120 and then 3,150, he said, but beyond that, the Footsie could end 1995 anywhere between 3,500 and 3,700.
Trevor Laugharne of Kleinwort Benson Securities is not expecting much action beyond 3,100 in the short term, but he too believes that 3,500 is a realistic target for the year-end. He warns that what happens in the US remains crucial. Treasury bonds there were in the unusual position of yielding less than their German equivalents. "The worry is there could be a flip-over in that relationship," he said, while the possibility that the Federal Reserve might again raise rates added to that uncertainty.
There was also a threat that US and other overseas investors might start repatriating funds. "When there are shaky markets, people prefer to be in cash and at home".
Perhaps the biggest question mark over the market is what the Chancellor will do in the November Budget. Robert Kerr at Nikko Securities said the economy was being led by investment and exports. Kenneth Clarke could spoil that party. "If we are going to see him putting money back into people's pockets . . . it won't do inflation pressures any favours".
Reflecting that caution, he sees equities ending the year no higher than 3,150 to 3,200.
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