Market bubbly expected to start losing its fizz
Financial Times
By Kate Burgess
Published: April 25 2003 13:02 | Last Updated: April 25 2003 13:02
The short and successful war in Iraq has been greeted with relief by investors, and
stock markets have bounced back to levels last seen in January.
But is this just a "champagne rally" which will be followed swiftly by a heavy hangover
and a sharp lesson in economic reality?
"It is a sugar rush based on an adrenalin kick," says Gary Jenkins, head of credit
research at Barclays Capital. "In a month or so markets will go back to the same old
fundamentals."
Volatility, one gauge of the level of investor fear, has been at records since last
October, but has dropped sharply in the last couple of weeks. So, too, have the prices
of traditional safe haven investments such as gold and the Swiss franc.
A survey by investment house State Street and the International Monetary Fund shows
that investors' appetite for risk has returned to levels last seen in 1998.
Freddie Tulloch at IG Index, a spread betting firm, says there has been a mood swing
among private investors. Whereas a month ago they were betting that the FTSE 100
would fall below 2,700, many are now gambling on the index rising above 4,600 by the
end of the year.
Consumers continue to fund their spending by borrowing more and topping up their
mortgages. Household debt in the UK has reached 127 per cent of disposable
income - higher even than during the economic boom of the late 1980s, when it
reached 112 per cent.
Fund managers have been on a spree, too, picking up shares in emerging markets,
junk bonds and high yielding stocks. The UK market is also being fuelled by an
upsurge in merger and acquisition activity. Target companies include Chubb, the
securities group, the Somerfield supermarket chain and Amey, the support services
group.
IG Index says private investors are also being drawn into the market by speculation
surrounding companies such as My Travel, London Stock Exchange and Pace Micro
Technology. Cantor Index, a rival spread betting firm, says others are betting on
stocks that are heavily geared to market rallies, such as banks and insurance
companies.
But there is widespread uncertainty about whether the market rally will be sustained.
"We are concerned that it may be difficult for risk appetite to maintain such lofty levels,"
says State Street.
The pull between the bulls and the bears has rarely been so even, says John
Chatfeild-Roberts, Jupiter Asset Management's fund-of-hedge-funds manager. "Even
the hedge funds lack conviction", he says. "Many have taken profits, de-geared and
are now sitting on high proportions of cash," he says.
Some investment houses, such as Lehman Brothers, reckon the rally is being
underpinned by a strategic asset shift from bonds to equities. Others disagree. Peter
Oppenheimer, equity strategist at Goldman Sachs, says there has been little sign of a
wholesale shift in asset allocation to shares or a sell-off in bonds.
World-weary market sages are concerned that the euphoria will vanish as the victory
in the war recedes, leaving investors to face shaky economies and over-valued stock
markets.
"The market has been captivated by emotion since the outbreak of the conflict," says
James Montier, global equity strategist at Dresdner Kleinwort Wasserstein. He
argues that investors are mistaking sentiment-based indicators such as consumer
confidence for underlying fundamentals such as revenue and earnings growth.
The warning signals are already visible. Housing markets are showing signs of strain
in the US and UK. The Royal Institution of Chartered Surveyors says house prices in
the UK have fallen in the past three months. A persistent fall would hit consumer
confidence hard.
The US causes analysts most concern. The country's current account deficit is
expected to reach a massive $600bn this year - 5 per cent of gross domestic product,
according to the IMF. It has been fed by US demand for imports. A recent IMF report on
the world economic outlook said it was "patently unsustainable".
Up to now the outflow has been funded by foreign investment, particularly from the
European Union, which in turn has bolstered the dollar. But many economists think
this is unlikely to continue as yields on EU assets rise and foreign investors back their
domestic markets.
Some analysts are pinning their hopes on further falls in the oil price to boost the US
economy. Others have been heartened by the first set of first quarter results in the US,
though some think the consensus forecast for earnings growth close to 20 per cent in
the fourth quarter is too high.
More fundamentally, Montier argues that the equity risk premium - the extra return
investors get from equities for taking on greater risk - implied by current prices is too
low. He says that prices at close to 26 times earnings are too high against their
long-term averages.
Continental Europe, where markets have rallied most strongly, is also causing
concern. Analys ts are watching anxiously as Germany and even France appear to
head towards deflation.
One area of hope is Asia. Many analysts see China taking on the US role as the
engine for world growth. But the outbreak of Severe Acute Respiratory Syndrome
(Sars) has put paid to that in the short term, at least.
With all this uncertainty abroad, many analysts say the best bet for UK investors may
be UK shares. "The implied equity risk premium is around 5.5 per cent, which
suggests a real return of 7.5 per cent," says Montier.
That may not be much for private investors weaned on the double-digit returns of the
past decade, but it is more than they are likely to get elsewhere.
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