View from City Road: Bond markets may be misleading equities

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The Independent Online
On a day when the most significant piece of company news was a profits warning from Courtaulds Textiles, the stock market soared by 40.1 points to close at yet another peak.

The explanation lay not in any good economic news but in the success of yesterday's gilts auction. Long bond yields have fallen about 30 basis points to 6.7 per cent since the Budget alone, underpinning the 4.5 per cent rise in the FT-SE 100 in the past seven days.

Such aggressive bidding in the auction is not, perhaps, surprising, given the widely held bull view that another 0.5-point cut in interest rates to 5 per cent is not too far away, maybe after the next inflation figures on 15 December.

As has been the case for most of this year, the bond markets are leading equity markets higher. The more bullish forecasts of 3,600 for the FT-SE 100 are based not on increases in earnings estimates - the trend here is still down, albeit less sharply - but on the belief that last week's Budget made the prospect of low inflation, lower interest rates, and stable growth that much more certain. As that appeals to bond markets, equities will follow in their wake.

Back in the real world, however, life still looks gloomy and there is a danger that equity valuations are running ahead of what companies can sensibly deliver. Courtaulds is only the latest in a long line of big names to issue profit warnings in recent months.

Companies like GEC have gone out of their way to tell analysts that their forecasts are much too high. Other well-regarded companies like Siebe and Chubb have seen their prices fall sharply, despite results in line with expectations.

Good news has been in short supply and continuing European recession has been a common thread. Yet a 1994 multiple for UK industrial companies of almost 15 times forecast earnings is discounting a lot of good news. It is hardly surprising that chief executives are so nervous.