I Say, a Bit of a Sticky Market
British investors, eager to give their assent to the taxing and spending plans included in the Labor Party’s first budget in a generation, drove share prices to their best one-day gain in five years on June 30, reacting to rumors and news leaks about the budget the day before it was announced.
The next morning, the actual budget arrived.
The London stock exchange’s benchmark FTSE-100 index fell nearly 80 points, about 1.7%, as the budget was unveiled in a speech to Parliament by Gordon Brown, the chancellor of the Exchequer. But by the end of the day it was up 80 points at 4,831.7, a record high. The market then slipped back for a while, only to surge again on Monday, with the index hitting a new record of 4,857.4.
Although the British market has trailed the U.S. market this year, it is nonetheless up substantially--almost 18% as of Monday, compared with 24% for the Standard & Poor’s 500.
Britain, whose revitalized economy has led Europe most of the decade, has also enjoyed a strong stock market. But the consensus of analysts is that the market is not going any higher soon--especially now that the zooming pound has reached 3 German marks, a six-year high against the German currency.
British consumer spending is racing ahead, analysts point out, and that is putting pressure on the Bank of England to aggressively raise interest rates to cool what is the healthiest major economy in Europe. Indeed, the central bank raised its official base lending rate a quarter point to 6.75% on Thursday, the third rise in three months.
“You’d have to be a brave man to think the Footsie [FTSE-100] is going to rally from here,” said Ciaran Barr, an economist at Deutsche Morgan Grenfell. “Buoyancy in overseas markets may underpin it, but the Footsie is very expensive and very vulnerable. I would be surprised if at the end of the year it’s above current levels given the interest-rate outlook.”
Barr forecasts a drop to between 4,500 and 4,600 as the central bank’s benchmark short-term rate climbs to 7.25% by year’s end, on its way to 8% next year.
Mike Dicks, an economist at Lehman Bros., agreed that “what’s priced in [to stocks] for rates now is not aggressive enough.” He expects a rise to “8% or higher” and foresees little change in the stock market for the rest of the year.
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Even Goldman, Sachs & Co., whose chief international economist, Gavyn Davies, is a key policy advisor to Labor, declared in a research report that “the U.K. appears closer to overheating than any other economy in the industrialized world.”
What makes them all so uneasy is the fact that Brown let British consumers off lightly by choosing in his budget not to appreciably boost their tax burden to slow economic growth. Instead, he left it to the central bank to do the dirty work by raising interest rates.
“The bottom line is that while Brown has persuaded everybody that this is a tight budget, you could argue that it’s expansionary,” Barr said. “Labor won the election by promising not to raise taxes, at least not very much, so to a great extent Brown’s hands were tied.”
But he had an amazing amount of freedom, even so. Under British law and custom, the budget announcement is a singularly important political and economic event. Unlike the American system, in which fiscal policy is made over months or even years, the chancellor has virtually complete control over the treasury. Once he and his civil service mandarins devise a plan, it becomes law.
If interest rates do keep going up, it could damage the stock market in three ways: Corporate borrowing costs would rise; higher yields would make bonds a relatively more attractive investment; and, perhaps worst of all, the rise in the pound would be exacerbated as foreigners piled in to buy bonds at higher yields.
A stronger pound makes British industry less competitive abroad and reduces the sterling value of repatriated foreign earnings.
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Owning British stocks has become quite simple for Americans in recent years: The New York Stock Exchange lists 48 of Britain’s largest companies, including British Telecom; British Petroleum; the drug makers Glaxo Wellcome and Zeneca; most of the big banks; several utilities; and British Sky Broadcasting, a satellite-television concern controlled by Rupert Murdoch’s News Corp., parent of the Fox TV network.
The top British stock sector has recently been its privatized utilities, which, odd though it may seem, were the target of Brown’s biggest revenue raiser, a $35.2-billion one-time tax on so-called excess profits.
The reason for the bounce was that the tax had been loudly heralded and was not as bad as feared, so shares of many utilities shot 5% to 10% higher.
“They are all up, and up quite strongly,” a portfolio manager at a large European fund company noted. “The tax was more than discounted. These companies are not expensive compared to other stocks in the U.K., and I would expect them to keep going up.”
In addition to British Telecom, British utilities traded on the NYSE include the two large British electricity generators, National Power and PowerGen.
The total raised from the utility tax was in line with forecasts, but Dicks of Lehman Bros. said that several companies “got off light. Some of the effects were different from what was expected.” British Telecom, for instance, will be hit for only half the amount that some analysts had predicted.
“BT didn’t get hurt,” he said. But reflecting his general pessimism for the market, he added: “But I’m not sure I’d say it was a winner.”
Dicks is rather sure about prospects for export-oriented manufacturers--that they are not good. With a stronger pound and higher interest rates in store, “they are clobbering the sector that doesn’t need clobbering. Export-sensitive stocks are going to be hurt because currency strength will have an impact on demand.”
Like many of his colleagues, Andrew Green, who runs a fund targeting British equities for Global Asset Management, has doubts about the market, especially blue chips. Only 4% of GAM’s portfolios are invested in Britain, barely one-third of benchmark global-stock-index weightings.
The companies Green does favor are small- and medium-sized businesses in industries that will benefit from continued economic strength, notably building materials, real estate and energy.
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Jeremy Batstone, head of research at NatWest Stockbrokers, also likes companies with strong domestic operations, including food retailers, retail banks and property developers.
Most of the big banks--including Barclays, National Westminster, Abbey National, Royal Bank of Scotland and Midland--have common or preferred issues listed in New York.
Domestic-oriented companies can best take advantage of the sudden profligacy of British consumers, who make their purchases with the almighty pound. By contrast, exporters and multinationals should be resisted at this point, Batstone advised.
“There is a lot of sectoral switching” by investors reacting to the budget, he said. “They’re switching from overseas [-oriented companies] to domestic, income to growth, and out of manufacturing and cyclicals. There are certainly winners and losers.”
And some of the losers will only be discovered, he warned, “when [companies] suddenly come out with profit warnings and analysts have to lower their expectations” because of rising interest rates and the muscle-bound pound.
Conrad de Aenlle is a London-based freelance writer.
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Defying Gravity?
Many analysts are downbeat on the British stock market for the near future, but key issues still are at or near record highs. A sampling of New York Stock Exchange-traded shares:
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Ticker 52-week Mon. close Stock symbol high-low and change Barclays BCS $86.00/$47.75 $82.25/-$0.50 British Airways BAB 125.13/78.00 117.50/+0.06 British Petroleum BP 80.13/54.25 79.75/unch. British Sky Bdcst. BSY 66.75/42.00 45.81/+0.81 British Steel BST 30.88/21.88 26.25/+0.13 British Telecom BTY 83.25/54.13 78.50/+2.19 Glaxo Wellcome GLX 45.13/26.63 46.44/+1.75 National Power NP 39.00/23.75 37.31/+0.31 Natl. Westminster NW 89.50/57.00 86.56/-1.06 PowerGen PWG 52.88/30.00 53.13/+1.25 U.K. Fund UKM 15.50/12.00 13.75/unch. Zeneca ZEN 106.00-64.25 108.81/+3.25
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Note: 52-week high prices don’t include Monday’s trading.
Source: Reuters
