Droughts, food price hikes, retail woes and questions over the durability of the commodities boom are keeping markets guessing.

With the FTSE 100 hovering below 5,800 points despite attempts to push it back above 6,000, a selective approach remains crucial, as investors weigh conflicting macroeconomic data and corporate news. This is proving to be a tricky business as many companies are faring better than expected and fund managers still see value in the market.
As domestic food price rises head towards 4.9 per cent and energy bill rises edge in the direction of 20 per cent, the Bank of England has indicated that it expects inflation, even as measured by the flattering Consumer Price Index (CPI), could hit 5 per cent in the second half of this year, against the official target of 2 per cent.

Stock markets can live happily with some measure of inflation, but the steps taken to curb rising prices, notably interest rate increases, are usually unwelcome to businesses and investors alike.
Markets would rather have a modest interest rate increase out of the way fairly soon, rather than wait in suspense for gathering ‘stagflation’ to make a larger hike unavoidable later on.

The MPC’s decision to hold interest rates for the 27th month in a row – and the subsequent reaction – has further justified our earlier caution on the near-term outlook for the stock market. An immediate surge gave way to selling, and a later, more robust, climate proved short-lived.

The International Monetary Fund may have given its blessing to chancellor George Osborne’s deficit-cutting strategy, strengthening his hand against the 50 economists calling for a ‘Plan B’. However, April’s unexpected 1.7 per cent fall in industrial production shows how the pressure is building.

That said, for a market now so heavily influenced by international resource companies, the Chinese Central Bank strategy for coping with high inflation can have almost as much influence on sentiment.

Against the background of the financial woes of Spain, Greece and other weaker Eurozone countries, the European Central Bank has signalled that an interest rate rise is likely soon. 

Commodities
Investors’ willingness to put £1 billion into ex-BP chief Tony Hayward’s new Vallares oil and gas fund, launched with financier Nat Rothschild, and, albeit grudgingly, to absorb idiosyncratic commodities trader Glencore’s multibillion float, shows that the resources sector has not yet run out of steam, even though prospects may not be as glittering as they once were.

BP itself remains lacklustre at 449p after oligarchs thwarted its original cooperation plan with Russia’s Rosneft energy giant.

An Aladdin’s cave of resource prospects in central Asia has not saved Eurasian Natural Resources Corporation from losing a third of its value to 774p this year, as non-executive directors quit over its oligarchic management style. Some argue it is essentially a private company in public company clothes, a criticism occasionally levelled in milder form at Glencore.

Financials
Banks taking the axe to staffing levels have won cautious approval, though concern over the extent of any further loan write-downs, especially in property, has not entirely evaporated.

State-backed Lloyds Banking Group, at 47.5p, is still 40 per cent off its 12-month high (to say nothing of its all-time peak), Royal Bank of Scotland, similarly state-backed and job cutting, at 41.25p, is 20 per cent down from its year’s high.

Hard-pressed Bank of Ireland has been languishing at 13 cents (10.8p), down 85 per cent from its year’s high, on potential challenges to the terms of its £3.7 billion refinancing plan.    

Retail and consumer
Among retailers, Morrison has not been favoured at 294.5p as a contender to buy the Iceland group to expand its presence in the South East, but remains well within sight of its 12-month high.

Far worse has been the experience of Home Retail Group, a third off its peak at 168.8p, after a 9.6 per cent first-quarter sales drop to £817 million at its key Argos division, which is 12.5 per cent less than two years ago and reflects the weakness of consumer electronics, television and video games.

In the same sector, JD Sports has been friendless at 877p on news of further sales deterioration, though analysts say this is in line with previous management warnings. 

Meanwhile, care home catastrophe Southern Cross, which wants to cut its rents and is to surrender control of more than 130 homes as part of its survival plan, is nearly 90 per cent down on the year.

It trades at less than 1 per cent of the price at which former prime movers in the company sold major chunks of their holdings before the first problems with covenants were revealed.

More interest is focusing on hitherto underperforming recruitment group Hays, firm at 109.9p. Suggestions of a possible Swiss bid have brought some colour to its cheeks.

Robert Tyerman is news editor of Growth Company Investor, the UK’s leading magazine for AIM and small-cap analysis. Visit www.growthcompany.co.uk

First published:
What Investment

Date of publication:
1 July 2011

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