View from City Road: US 'wall of money' boosts UK equities

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The Independent Online
The US cavalry is coming to the aid of Britain's bulls. US mutual funds have recently diverted almost half of their cash flows - themselves swollen by the low interest rates available to savers - out of Wall Street and into world stock markets.

As a result markets around the world have hit levels not seen for several years, or ever before in the case of Germany and the UK over the summer. The US funds argument is clear enough. All that can have been done by monetary means to boost the US recovery has been done, leaving a highly valued Wall Street exposed to a patchy upturn.

Latin America and the newly industrialised countries are favoured candidates for US money looking for growth, but opportunities across the Atlantic are not to be ignored. Europe, the argument goes, is where the US was 18 months ago. Fiscal policy is in a tight grip as governments seek to reassert control over their finances. But monetary policy is about to be relaxed significantly, boosting returns in European financial markets.

Some analysts, particularly those at Nomura Securities, have put a lot of faith in a 'wall of money,' albeit one emanating from Japan and not from the US. However, the effect is the same, even if the source is not. US buying helps to explain the remarkable resilience of the UK equity market despite a raft of unpalatable news.

In the recent half-yearly results reporting season, cautionary remarks about the strength of recovery came thick and fast from a clutch of top companies like BTR, Williams Holdings and P&O. Profit warnings are becoming a regular feature, particularly among the less well researched companies.

Yesterday the Governor of the Bank of Scotland, Bruce Patullo, provided a lender's perspective. He warned that the UK economic recovery had lost momentum even if corporate finances had been improved by pounds 10bn of rights issues this year.

There is scope, however, for expectations to be lowered. Dividend yields may have shrunk this summer while growth in payments will be limited in the short term by the need to rebuild corporate dividend cover.

But, according to James Capel, UK earnings yields, which are more important than dividend yields for the longer term, are as high, relative to three-month interest rates, as they were in the aftermath of the 1987 crash or at any time since the late 1970s.

This suggests that earnings yields are unlikely to rise or share prices to fall. If there are more short-term interest rate cuts - a fair bet for Budget time - earnings yields will ease as well, driving share prices higher.

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