Robert Tyerman assesses how global markets will adjust to a new set of financial rules

We have been waiting for some time for the big shock that would signal the beginning
of a sustained stock market upturn. After such aperitifs as Northern Rock, Bradford & Bingley and HBOS, it has seemed to many that the near collapse of world capitalism might provide just such a turning point.

The commanding heights of the British banking system have been part nationalised with £37 billion of taxpayers’ money, and £400 billion of support has been pledged by the British government as part of a £1.5 trillion Europe-wide effort. Orthodoxy seems to have been consigned to the scrapheap in an effort to keep the show on the road.

A sense of relief

Battered stock markets reacted with intense relief when the lame-duck Bush Administration in the US strengthened its US$700 billion (£470 billon) rescue plan by committing $250 billion of it to ‘recapitalising’ tottering money lenders in a similar neo-nationalisation.

On Wall Street, the Dow Jones Industrial Average chalked up record daily gains. The FTSE 100 Share Index, after plunging towards 3,900, rebounded strongly above 4,400 points before wobbling again back towards 4,000.

As sales of safes and strong boxes soar, brokers say retail clients are still selling in droves, traditionally a harbinger of market improvement. The question is whether the bounce prompted by relief that financial Armageddon seems to have been averted
can turn into a sustained recovery, even as companies report a succession of poor results, retrenchments and lay-offs.  

The odds remain that it could take a long time for the market to regain anything like its former ebullience, although bids and special situations could provide some bright spots as consolidation gathers pace in parts of the economy. Some shares, notably those with a utility flavour, such as water and electricity provider United Utilities at 641p, National Grid at 657.5p and Severn Trent at £12.97, have recently been in demand.

A long way still to go

The FTSE Index is still 34 per cent off its 52-week high. Whatever recovery prospects beckon in the long term, investors must brace themselves for a succession of corporate setbacks and worse on the way, as the after-effects of the credit crunch and general
caution on the part of fearful companies and consumers continue to work their damage.

The market is likely to find efforts to stimulate flagging economies – where cash-strapped governments feel they still have scope to take them – more to its liking than measures to combat inflation, which suddenly has become less of a priority. Even as measured by the flattering Consumer Price Index (CPI), UK inflation reached a 16-year high of 5.2 per cent in September, with electricity prices up 30 per cent and food up 12.75 per cent, but somehow that now matters less.

The fall in the oil price below $80 a barrel (nearly $60 below recent peaks) and the weakening of commodity prices, coupled with collapsing consumer confidence, have encouraged economists to predict a significant reduction in inflation from now on.
 

A raft of uncertainties

Even if that pressure is set to abate, reflationary measures, of course, depend on governments feeling they still have adequate scope to take them. Public finances here and elsewhere are soon to come under pressure from the latest bail-out binge and impending increases in unemployment and social security payments, which governments must meet by raising taxes and/or printing money.

The housing market remains dire and on the economy the only debate is about how long and deep the recession will be, how many companies will collapse and how high unemployment will rise. The jobless total is headed towards two million by Christmas and some forecasters predict three million out of work before the recession has run its course.   

Even the banks, for all the public assistance heaped upon them, have been, perhaps understandably, slow to regain confidence and trust in each other. The sterling three-month London InterBank Offered Rate (LIBOR) was recently stubbornly above
six per cent and its dollar equivalent was at 4.75 per cent, down from previously, but well up from 2.8 per cent in September.

Doomsters point out that the 1929 Wall Street crash was followed by years of stock market stagnation. More recent collapses, such as 1974 and 1987, were followed by more brisk recoveries, although this time it is clear that the unilateral, nation-by-nation fixes of those days will not necessarily avail in today’s global economy.

Co-ordination between governments has been called for and at least partially achieved, despite the early breaking of ranks over banking support by Germany’s Chancellor Merkel and the Irish government. Faced with the conflicting pressures of price rises and a potential economic slump, the Bank of England’s latest 0.5 per cent interest rate cut struck many in business and the City as inadequate. But if inflation really is set to fall there are grounds for believing there will be scope for further reductions in the months ahead.


House of cards

House builder Bellway saw annual profits plummet 85 per cent to £35 million after savage write-downs. The company, whose shares at 480p have fallen from nearly £17.00 last year, was recently selling only one home per active site per month.

Hotel and restaurant group Whitbread has hardly added much cheer by warning
of a likely intensificaiton of pressures on consumer spending in the second half of
the year. The Premier Inn-to-Costa Coffee combine achieved a respectable
24 per cent interim pre-tax profit increase to £123.3 million, but its shares, although
up from 892p to 957.5p since last month, remain almost £10.00 below 2007’s peak.

In the arguably defensive food and confectionery sector, Cadbury has declared it will axe nearly 600 more jobs on top of the 7,000 already cut under its ‘Vision Into Action’ programme, in a bid to improve its profit margins. At 503.5p, its shares are down by a comparatively modest 36 per cent from last year’s high. 

After problems at Russian joint venture and elsewhere, oil giant BP has been banging the drum about its solid dividend prospects. However, at 446p, doubters still question the company’s long-term growth prospects.

Sector view: banks

If it is not bust, it is a bargain. That is a plausible reaction to the implosion of the financial system and governments’ decisions to commit billions of taxpayers’ money to nationalising, underwriting, guaranteeing and otherwise picking up the pieces left by the greed and hubris of recent years.

The tricky part is to work out exactly who is bust and who is a bargain and how long
it will take for the bargains to show their potential worth in the uncharted waters of post-bail-out markets. Nothing can be taken for granted.

Among the banks, at 851p, HSBC, with its presence in (hitherto) fast-growing parts of the world, and seen as relatively less exposed to the horrors afflicting its rivals, is closer to its 12-month high than its low. It was, after all, able to pump the £750 million required by the government into its UK banking subsidiary without outside help.

Contrasting fortunes

Standard Chartered, at almost £13.00, has risen nearly 30 per cent from its October nadir, boasting a similar geographic spread and also funding itself without state aid. By contrast, Royal Bank of Scotland, with the Treasury taking a controlling stake by underwriting its £20 billion fundraising and faced with a contentious dividend ban and other operational curbs, is looking at an altogether more circumscribed future. At 64.7p, it has lost 90 per cent of its value since March last year, although it still might tempt some brave speculators prepared to take a risk and wait several years, if not longer.

At 236.25p, Barclays, needing ‘only’ £6.5 billion to pass muster and at the outset minded to seek it without passing the hat to Whitehall, remains nearly 70 per cent off its early 2007 high. Presumably, the shares will move higher one day after the funding – unless the crisis does have another, even nastier, phase to run.

Robert Tyerman is news editor of Growth Company Investor, the UK’s leading magazine for AIM and small cap analysis.