Where there's brass there's an index rise
Sunday 22 February 1998
SM: The FT-SE has hit eight records so far this year already. What is driving the index up?
MG: Primarily it is liquidity in the market. There are a lot of UK funds under pressure to reduce their cash positions; from holding as much as 8 per cent cash to around 5 per cent, according to a survey by Merrill Lynch. So it's weight of money that's behind the rise.
SM: Why are fund managers choosing stocks in favour of other investments, and why UK stocks in particular?
MG: There has been some re-evaluation of the effects of the Asian turmoil. We have seen domestic funds moving into sectors like pharmaceuticals, banking and property where you can get good earnings growth and which are insulated from the downturn in Asia. In addition, people have found fourth-quarter figures from companies with Asian interests have not been disappointing, as expected. So people are feeling more optimistic there.
SM: The market has already been pushed along by a lot of merger talk, and some actual mergers. Will this continue?
MG: Yes. We had numbers from SmithKline Beecham last week, which were quite robust on their own, but if they combine with Glaxo Wellcome the research and development budgets of the two groups together will be phenomenal in size: $2.5bn (pounds 1.47bn). The options that would give the merged company for development in genomics and combinatorial chemistry and new drugs mean that other companies in the industry will be forced to respond in order for them to be able to compete in future.
In the financial sector there is also pressure for further consolidation despite the dashed hopes last week of a merger between Barclays and NatWest. The banks all have very high levels of cash; the Woolwich, for instance, has just announced the payment of a special dividend which sent the shares soaring and that is a sign of the pressure for consolidation.
SM: Are the earnings good enough in themselves to justify the share prices?
MG: The results from Lloyds TSB were phenomenal - the growth has largely been driven by a reduction in the cost/income ratio. Barclays figures disappointed the market, and the shares suffered a setback, because the results were knocked back by the closure costs of BZW and by disappointment on the merger story. Looking beneath the headlines the figures from personal banking and business banking were reasonable.
SM: Can we break the euphoria in UK stocks?
MG: You might see some profit-taking in the short term. But IBES estimates show that the UK does not look particularly expensive on a 12 to 18-month view, compared with other European markets. UK shares did not do so well compared with rest of Europe last year. People are also looking to stories on share buy-backs and restructuring, both of which will be big drivers of the market in the months to come.
SM: What sectors are you looking to invest in?
MG: We are very conservative and unoriginal. We like property stocks - British Land, where you will get operational gearing uplift; pharmaceuticals such as SmithKline Beecham and Glaxo; also retail banks, where Lloyds is the big favourite.
We think people are going to look at food retailing in due course. Those four sectors are going to see consolidation.
You could argue that the valuations on these groups look stretched already, but recent work by Schroders showed a lot of UK funds have been underweight in these sectors that have outperformed in the last year. The funds that have lost money in engineering and diversified industrials will be under pressure to bite the bullet at some point, take the losses in industrials, and switch to more momentum-oriented shares.
SM: Are we looking at another increase in interest rates this year?
MG: This is a very tough call in the sense that the manufacturing economic data is not particularly robust while labour market pressure is building up, which could push up earnings. The consumer side also is still reasonably strong. But, on balance, I don't see a rise in rates in the near term.
SM: Will we see a cut in rates this year?
MG: I think rates will stay on hold for the foreseeable future.
Copyright: IOS & Bloomberg
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