View from City Road: Why shareholders should want a boring recovery

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The Independent Online
There is an interesting tension building up between the spate of good news on the economy and the resolute determination of the stock market to be entirely unimpressed by it. The usual explanation - that the market had already assumed that a strong recovery was under way - does not quite wash. After all, the CBI quarterly industrial trends survey is all of a piece with the other economic data since the Budget on 16 March. It points to a stronger recovery than the consensus was previously expecting.

Manufacturing is likely to continue to grow, albeit at a more leisurely rate than the spike of January and February. The other main indicators - GDP, unemployment, manufacturing output, retail sales volumes and house prices - have all exceeded market expectations, implying not merely a recovery, but a robust bounce.

The economists will soon be revising upwards their consensus forecast of 1.2 per cent growth this year. This stronger-than-expected upturn ought to mean stronger corporate earnings growth, and some buoyancy in share prices. Instead, the FT-SE 100 peaked this year at 2,957 on 8 March and is now down by about 5 per cent.

This apparent discrepancy between share prices and the real world is not as silly as it looks. Above all, it reflects the nature of the debate between bears and bulls, which is not primarily about the strength of the recovery or the rise in earnings. Everyone expects a strong recovery of earnings. The real point at issue is the valuation of those earnings in the market. The bears (such as Mark Brown of UBS) see the price/earnings multiple declining from the present 20 to 14 in 1994. The bulls see higher multiples - say, 18 - being sustained.

Ironically, the one scenario that could undermine the sort of super- bull case put by Nick Knight of Nomura is an unexpectedly strong recovery, leading to higher inflationary pressures and an earlier- than-expected rise in bank base rates. A bull trend in first-line stocks depends on a solid, sustainable and unexciting recovery - and on the low inflation and interest rates that will drive people into equities because the returns on other investments look so unattractive.