SUMMARY. It has been a very positive month for stock markets, both in the UK and globally. In the short term the UK market might go a touch further, perhaps 4800-5000, but you should not be surprised if it falls back a bit, before resuming the assault on 5000.
A positive month indeed, although not for each of the trinity of troubles (house prices, unemployment, and debt). Newsflow has been very encouraging on US and UK house prices, as surveys suggested stabilisation. In the US prices rose (albeit slightly) for the first time in three years. Unemployment is still a dark spot, yet high unemployment itself does not preclude a recovery – in the second half of the 1980s a booming UK economy was not held back by 10% unemployment.
There is still schizophrenia around debt. The UK Government worries because banks aren’t piling more debt on businesses (let’s not glorify it by giving it the soubriquet of “credit”), and the rest of us applaud because consumers and businesses are increasing savings and cutting debt. Since 1950, in the US borrowing has tended to decline slightly in the first year of recovery – which makes perfect sense at a time when confidence will be at a low ebb.
As such we certainly sympathise with Tim Bond when he says “pessimistic expectations are likely to collide with the economic reality of a strong recovery”. But it would be wrong to cast caution aside, which is the message from the markets.
After drifting through May and June, with 4500 as a glass ceiling, the FTSE 100 index is working hard to hold above 4600. As mentioned in June, while a sub-par recovery might justify 4800, excess liquidity, and associated exuberance, might push footsie to test 5000. This is encouraging, yet we must recall that the stock market is a discounting mechanism, and the market recovery since March has already largely priced in recent improvements in economic conditions.
As well as a number of technical indicators suggesting that the main indices are beginning to lose momentum, the recent new high for the footsie has not been matched by similar action in small caps, which are still struggling to break up through the peak of early May. And yields on 10 year gilts would be higher, nearer 4.5%, if they believed that the economic recovery was in the bag.
As discussed previously, clearly there remain a wide range of possible outcomes, in the economy and markets. If, as experience suggests is often the case, the truth lies in the middle ground, there is little to worry about – in which case don’t be surprised by the FTSE 100 index coming back to around 4100 before resuming its assault on 5000 and above. But we all need to remain vigilant, just in case.
