Market Report: Broker brings out the bears around BAE

BAE Systems was among the laggards as the FTSE 100 turned lower yesterday and slipped back below the 4,900-point mark last night.

The defence group eased back by 2.4 per cent, or 8.1p, to 324p after Goldman Sachs reiterated its "sell" stance on the back of three fresh pieces of news, starting with the US budget deficit. Using the White House's most recent projections, the deficit is set to be nearly $2trn higher over the next 10 years than was previously expected. Given that defence accounts for 60 per cent of federal discretional spending, the broker said it was almost certain that the American defence budget would be cut heavily.

The prospect of an early withdrawal of US troops from Iraq, and the chance of cuts in British defence spending, also weighed against the investment case, Goldman said. It highlighted the recent leaked UK government report on defence procurement which was highly critical of the amount spent on "poor decisions". "In our view, this criticism could make it easier to cut the UK defence budget," Goldman said.

Overall, the market paused for breath with the FTSE 100, down 26.22 points at 4,890.58, ending a six-session winning streak. The mid-cap FTSE 250 index was also unsettled, relaxing to 8,783.21, down 77.6 points.

The banking sector was the focus of a circular from Mike Trippitt, an analyst at Oriel Securities, who moved his rating on Lloyds, which climbed 0.64p to 108.47p, from "add" to "reduce". "The operating outlook is beginning to improve for [the group] and we forecast a strong trading surplus performance for 2010, underpinned by favourable revenue and cost trends," he said. "However, a base case core tier 1 ratio of sub-5 per cent in 2011 suggests that life without the Government Asset Protection Scheme (Gaps) or an alternative capital raising is not tenable."

Mr Trippitt was keener on Lloyds's state-backed peer, Royal Bank of Scotland, which climbed 5.3 per cent, or 2.85p, to 56.6p – further ahead of the average 50.5p price that the Government paid for its stake. He upgraded the stock from "reduce" to '"add", with its target price revised from 40p to 60p, and quoted the RBS chief executive Stephen Hester as he said: "There is greater clarity, if not certainty."

"A post-Gaps tangible net asset value per share of 53p in 2010 provides a floor for the shares," Mr Trippitt added. "We forecast relatively rapid elimination of losses at RBS, which provides some resilience to the core tier 1 ratio and to tangible net asset value per share.'

Elsewhere, the profit-taking trend persisted across the mining sector, proving a drag on the likes of Rio Tinto, which fell 4 per cent, or 99p, to 2381.5p, Xstrata, down 4.1 per cent, or 35.5p, at 825.5p, and Lonmin, down 3.1 per cent, or 47p, at 1471p. Anglo American was also weak, retreating by 2.3 per cent, or 47.5p, to 2003p.

Back on the upside, Diageo gained 3 per cent, or 25p, to close at 996.5p as investors looked ahead to its final results, due this morning. The shares traded up amid renewed speculation that the drinks group might use the occasion to announce a deal to acquire the wine and spirits division of the French luxury brands group LVMH.

There was also vague talk of a possible joint venture with LVMH. The rumour was that instead of buying the wine and spirits division, Diageo might acquire a stake.

On the second tier, the housebuilder Redrow rallied to 240.5p, an increase of 5.3 per cent, or 12.2p, thanks to UBS, which switched its stance on the stock from "sell" to "neutral" in a sector review.

The broker also reiterated its "buy" rating on Bovis and its "neutral" stance on Persimmon. Both remained weak: Bovis closed a penny lower at 555p while Persimmon retreated to 491.8p – a fall of almost 4 per cent or 19.7p – as traders cited signs of profit-taking on the back of their results.

"Trading updates from Bovis and Persimmon point to the stabilisation of trends in the UK housing sector," the broker said.

"We believe prices have now bottomed at around 20 per cent from the peak and, with continued up-tick in mortgage approvals, this trend should persist as well as provide some growth to volumes."

Further afield, Punch Taverns rose by almost 4 per cent, or 5.2p, to 136.1p as traders highlighted a new Bank of America-Merrill Lynch circular about the pubs group. Reiterating its "buy" stance, with Punch's target price revised from 120p to 200p, the broker suggested that "the recent equity raising and disposal proceeds have provided enough headroom for the company to trade through this recession".

"Punch currently trades at a 62 per cent discount to its net asset value per share of 330p per share," Merrill said in a note. "This suggests that either the market believes that Punch will not survive, or its property portfolio is drastically overvalued. Our analysis suggests neither of these to be the case."

Among the smaller companies on the index, Trinity Mirror surged by 8.2 per cent, or 10.5p, to 138p after Panmure Gordon weighed in and raised its target price for the newspaper group's shares to 110p from 48p.

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