Stock market week: Bonds and shares battle for investors' attention

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The Independent Online
EQUITIES AND bonds are like two spoilt brats competing for their parents' attention.

The two have a habit of roaming around the markets showing off their latest party tricks in an attempt to monopolise investors' imagination and grab a slice of their funds.

But unlike adults at a crowded party, international money people cannot just smile benevolently and pat both kids on the head. Their main interest is to maximise their investments by putting cash into the asset that promises the highest return. In order to do that, fund managers must keep a constant watch on bonds and stocks and are extremely sensitive to changes in their relative valuations.

This eternal battle between bonds and equities has far-reaching implications on the stock market's movements. A shift of funds from shares into fixed- income instruments is one of the equity markets' greatest bogeymen since it has often heralded sharp corrections.

This week will be a key test of investors' nerve. After months in the doldrums, there are signs that US bond yields are on the rise, fuelled by growing fears of a rate hike later this month. Last week, as the Dow plummeted, the yield on the long-dated US Treasury bond jumped to over 5.8 per cent, compared to below 5 per cent in late 1998.

In the UK, gilts yields have followed a similar pattern, edging up from January's sub-4.5 per cent level to the current 5 per cent. On Friday, the all-important United States employment numbers could add further impetus to this bond yield rally by providing a key insight into the near-term direction of US rates.

But what do rampant bond yields mean for the UK stockmarket?

The short answer is: bad news. The increasing appeal of fixed-income options makes equities look expensive and increases investors' fears that the market is overvalued.

The rationale for this theory lies in the love-hate relationship between bonds and shares. Despite the recent falls in the FTSE 100, the market's price/earnings ratio is still around its all-time high, which means that the earnings yield level is at an all-time low.

This means that investors are paying more and more for their shares just when the rewards they reap from them - both in terms of earnings and dividends - are shrinking. At the same time, the returns earned on gilts and US bonds have been steadily rising, turning fixed-income instruments into a tempting alternative to overvalued stocks.

The comparison between UK equities and bonds make worrying reading for the former. On some measures, shares are now more expensive than they were before the 1987 plunge and before last October's correction.

However, this does not necessarily mean that we are heading for a crash or even for a sharp fall.

Many bullish analysts believe that traditional valuation methods are useless when there is so much money sloshing around the market. According to the "Wall of Money" school of thought, investors are awash with cash and, in a low-interest rate environment, they have nowhere to put it but in equities .

The theory has been proven right so far, but a degree of caution is advisable, especially because, as one expert says, with rates edging upwards, "investors could simply take their Wall of Money out of stocks and put it somewhere else".

Bulls and bears will have the chance to test their theories in the market this week as a handful of blue chips unveil results.

J Sainsbury should provide most of the excitement on Wednesday. The figures themselves will be no surprise, as the supermarket chain pointed to a final profit of pounds 750m - up from pounds 739m last year - in its April trading statement.

However, the market is keenly awaiting the "framework for shareholder value" promised by chief executive Dino Adriano.

Analysts believe that Sainsbury cannot rely on a trading upturn to regain the ground lost to arch-rival Tesco and needs radical structural changes. Cutting costs is a clear priority and some expect Mr Adriano to announce more than 1,000 job losses among store staff, on top of the recent 500 redundancies among middle managers. Boosting sales is another must and the chief executive will be quizzed on how he plans to spend his pounds 80m marketing budget.

On the plus side, Homebase and the US business Shaw's should confirm the recent progress.

The market will also want to know whether rumours of a sale of the Sainsbury family stake and of a mega-merger with Marks & Spencer are completely unfounded.

Fellow retailer Boots will report a modest rise in profits on Thursday. According to the estimate service IBES, the pretax number will be pounds 558m compared with pounds 553m in 1998, before a pounds 322m exceptional loss on the sale of its DIY chain, Do It All. A weak third quarter sparked worries over the chemist's trading and Boots will have to dispel fears that it has been hit by the merging of giants Asda and Kingfisher, the owner of Superdrug.

Numbers aside, there is a chance that the retailer could return more cash to investors.

The other talking point will be the successor to executive chairman Lord Blyth. The respected Boots boss is due to retire next year and the joint managing directors, David Thompson and Stephen Russell, are believed to be neck-and-neck in the race to replace him.

On Wednesday Invensys, the old BTR Siebe, unveils its first final results since the merger of the two engineering giants.

Profits should come in at around pounds 1.1bn, down from a pro-forma pounds 1.5bn last year. The dividend, expected at between 18p and 21p, will represent a big rise for Siebe shareholders but a sharp cut for BTR investors.

The market talk will be dominated by an expected update on the troubled sale of the group's automotive division and a progress report on the pounds 250m- a-year cost savings promised after the November merger.

The media giant Emap will post a rise of some 13 per cent in 1999 profits to around pounds 160m. Progress at the recently acquired US publisher Petersen will be closely watched, as will the level of advertising growth in the UK and overseas.

BAA should have benefited from another good year of traffic growth at its airports. The first contribution from the airport retailer World Duty Free, bought in 1997, should also help to push profits some 6 per cent higher to around pounds 510m.

Looking forward, the imminent abolition of duty free shopping will hit profits this year, although fierce competition between airlines and the possible construction of an extra terminal at Heathrow should pave the way to future growth.

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