Stocks continue victory march

UK stocks are seen marching higher for a fourth year in 1998, lifted by subdued inflation, takeover talk and the countdown to EMU. Banks such as Lloyds TSB are poised to lead.

1997 was a bounty year for the FT-SE 100 Index which jumped 24 per cent to 5040, against expectations of 5 to 7 per cent. Five interest rate increases, a strong pound and the first Labour government in 18 years failed to halt the advance. The high point was on 2 October when the index peaked at 5367.3, 31 per cent higher than on 1 January.

According to 12 strategists, the index is expected to gain an average of about 450 points by the end of 1998, with some strategists expecting a 1,000-point gain. Bank and drug stocks are again on top of many lists. "A move like that has to come from the leaders," said John Ainsworth, head of equities at Hill Samuel Asset Management.

Analysts think interest rates probably won't rise much further from the current 7.25 per cent and may even begin to fall in 1998, thanks to the cumulative effects of this year's rate increases and the strength of the pound.

Asia's economic slide may hurt companies such as Inchape, which distributes Japanese cars. Some banks with loan exposure in Asia may be at risk. Royal Bank of Scotland is estimated to have the largest lending exposure with loans equal to about 55 per cent of the bank's capital. Share prices in banks which are vulnerable have been heavily hit in the final quarter and are unlikely to share in the expected gains.

Some investors are more optimistic about the effect of Asia as the economic problems there means western banks will have less of a reason to put up rates.

"What seems to be driving the market is good news on interest rates," said Joe Hall, director of European equities at Deutsche Morgan Grenfell. "People are saying that there's not going to be an inflation problem."

Some analysts think the prospect of slower domestic and overseas growth may hurt British profits. "Profits are under pressure from sterling, rising domestic pay costs, slower growth and a slowing down of the economy," said Gareth Williams, a strategist at ABN Amro.

Speculation that more companies will merge should push shares higher. Many companies are also seen buying back some of their shares, including Asda. While the Government has opted out of joining countries that are introducing the single currency in 1999, the drive towards a single market is encouraging companies to join forces.

Railtrack was the biggest percentage gainer on the FT-SE 100 this year and it remains on analysts' preferred stock lists, including UBS and Merrill Lynch. Bank of Scotland and Lloyds were the second and third biggest gainers. Amvescap was in the top ten biggest percentage gainers.

Manufacturers, particularly textiles, were among the worst performers in 1997, and are set to miss out again as the pound is seen holding most of its gains.

"Sterling is still the biggest risk - the wild card in the whole equation," said Rupert Carnegie, director of investment research at Henderson Investors.