Market commentary April 2006

We have covered the lack of exuberance in the UK stockmarket in prior months.  Although such a long period (3 years) without the stockmarket suffering at least a 10% correction is unprecedented since the 1950’s, and suggests we must be close to the point of such a correction, we should not expect any correction to be too severe (so nearer 10% than 25%). Plus any short term correction should be seen in the context of multi-year growth potential, and as being the necessary spring board for the next upward run in the UK stockmarket (the one in which we are now having run for 3 years).

For those of you that like to look at the numbers, the FTSE 100 index, now clinging to 6,000, is still less than 10% above the 200 day moving average, and we shouldn’t be unduly concerned until this gap is at least 15%.  Since 2003 strong support has been found at the 200 day moving average, currently at 5,500, though more obvious support exists at 5,150, nearly 15% below the index at 6,000.

Valuations for the UK stockmarket also highlight fair value.  Though the index is up 80% since March 2003, the price/earnings ratio is lower, because earnings have grown more quickly than share prices.  This is very healthy, but nonetheless does not insulate the UK from global weaknesses.

The global seeds for a UK stockmarket correction might be being sown now.  The zero interest rate policy in Japan provided near-free cash to banks and hedge funds around the world to enable them to speculate in a range of asset classes.  The Bank Of Japan has signalled that this policy is at an end, and we could see Japanese interest rates go up in the Autumn, at which point rates could also be heading higher in the U.S. and Europe, an unpleasant mix for those that have borrowed to invest into some of the worlds more exotic regions and asset classes.

The impact is already being seen in some of the more distant financial outposts. The Icelandic Krona and New Zealand dollar have collapsed, and NZ interest rates are in excess of 7%.  The Saudi stockmarket has fallen 28% in 3 weeks, and the Dubai index has lost 53% since last November.  Clearly some investors are already taking bets off the table, and the key question is whether the risk aversion (which means “selling” to you and me) will become more widespread as 2006 unfolds.

New Zealand provides an interesting example of the risks in the US later in 2006.  The NZ economy is contracting, and it also has a large current account deficit (i.e. they are importing a lot more than they are exporting).  NZ interest rates need to be cut to stimulate the economy, but need to go higher to support the currency.  In the second half of 2006 the US, and the Federal Reserve, could encounter the same conundrum, at which point risk aversion could spread to the global mainstream – and perhaps the UK stockmarket can then get its overdue correction out of the way.

All of this is simply to give you a sense of the ebbs and flows that lie ahead, so that you won’t be surpised.  The uncertainty of the timing is such that there is no point trying to anticipate such weakness (and selling with view to repurchasing), as our experience is that most people (including highly paid fund managers) get this fine-tuning badly wrong most of the time.