Raging Bull

Iain Dey, David Smith, Danny Fortson

Simon Murphy, a fund manager at Old Mutual Asset Managers, is confused. The stock market is soaring but not many in the City are happy about it.

“I’ve never known a period where the market has bounced so much in such a short space of time yet everyone is miserable,” said Murphy, who runs the UK Select Equity fund at Old Mutual. “Nobody was positioned for it. We were one of the few.”

Since its low point in March, the FTSE 100 has climbed by more than 30%, closing on Friday at a 10-month high of 4,732. In the past month alone it has soared 14%.

It’s not just equities that are on a roll. Commodities such as sugar, copper, iron ore and oil are all on the boil, with prices rising at a speed reminiscent of the last bull market, which ran out of steam only 18 months ago.

It all seems at odds with what is happening at grassroots level for UK businesses. With consumers counting the cost of the credit crunch, the banking system still on its knees and the Bank of England ready to pump £50 billion more into the economy for fear of stagnation, many investors refuse to trust the market’s rapid rise.

The doubters say the leap in share prices has been driven by a mixture of rampant over-enthusiasm and some market technicalities.

Frances Hudson, a strategist at Standard Life Investments, is one of a number of experts who believe the rally has been amplified by low trading volumes.

The London Stock Exchange last week revealed that the number of shares being bought and sold in July was 30% lower than last year. The value of those trades was down by more than 50%. When fewer trades are taking place, markets can be moved up or down more easily.

“We don’t see any evidence to suggest that everyone has started to pile in to the market and we are at the start of a new bull market,” said Hudson.

More bullish investors, however, point to the “green shoots” appearing every day. Companies in America and Britain have made bigger profits in the first six months of the year than anyone expected and the global economy, led by China (see panel below), is beginning to grind back into action. Even house prices have stabilised.

The latest lift came on Friday with the publication of better-than-expected American job figures that showed the US unemployment rate had dropped from 9.5% to 9.4%, its first fall since April last year.

The figures helped the markets, which had started weakly on Friday, rebound sharply. The Dow Jones industrial average closed up 1.2% at 9370.7.

For the optimists, the rally of the past few weeks heralds the beginning of the next great bull market.

“Do I believe that we are in a new earnings cycle, a new economic cycle? Yes,” said Nick Nelson, a UBS strategist. “So do I believe this is the start of a new bull market? Yes, I do.”

IT is the rapid rise in commodities that has surprised most. In India, the rise in the price of sugar is front-page news; government agents have raided warehouses to confiscate illegally-hoarded stockpiles and last week the market regulator banned sugar futures trading until the new year (last week they set a record of $19.73 per pound, breaking the previous high set in 1981).

The sugar rush is one small part of the sharp rise in the price of nearly every basic material that underpins the world economy, be it oil or iron ore, wheat or orange juice.

When the recession began, it turned a near-decade-long boom in commodities into one of the most dramatic routs in history. That has been reversed in fantastic fashion in the past few months.

The boom in commodity prices has a big impact on the FTSE 100 — more than 30% of the share index’s value comes from oil and mining companies.

Jim Rogers, the famed commodities bull, expects the current trend to continue. Long-term and intractable supply problems mean commodities, and the companies that produce them — oil firms, steel makers, farming groups — are set for more gains.

“Commodities are the only big sector I know of in which the fundamentals have actually got better, and by that I mean constraint on supply and increase in demand,” he said.

“These past few months haven’t changed anything. They haven’t changed the fact that there hasn’t been a new large oilfield found in more than 40 years or that the last lead smelter built in the US was built in 1969. Inventories remain at historical lows.”

Rogers is not alone. Last week Merrill Lynch increased its target prices for copper, aluminium, lead, nickel and zinc. Since the start of July, the FTSE 100 mining index has climbed about 30% on the back of the new boom in commodities — roughly twice as fast as the rest of the index.

Around the world, credit-crunched companies are starting to see their share prices bounce back. AIG, the giant insurer bailed out by American taxpayers, saw its stock climb 67% in just two days last week. Nonetheless, the shares are still 95% down on a year ago.

Britain’s battered bank stocks have also galloped higher, as investors have decided that the situation is not quite as bad as they feared. FTSE 100 bank stocks have gained more than 25% since the start of July.

So only those investors who were willing to gamble on bank shares and the commodity cycle have felt the full benefit of the recent rally.

Some, like Hudson, have not been willing to gamble. “I don’t think any of us here would describe ourselves as overly bearish,” she said. “Realistic is the word.”

Standard Life Investments, one of Britain’s most influential fund managers, with more than £120 billion of assets under management, has kept most of its money in corporate bonds and ultra-defensive stocks such as utility groups. Although companies have been reporting better-than-expected profits, they have been doing it thanks to cost-cutting exercises that they won’t be able to repeat, said Hudson.

The latest data from the closely watched Merrill Lynch fund manager survey revealed that the majority of the world’s most influential investors started July by moving into defensive stocks and putting more of their holdings into cash.

According to Robert Parkes, equity strategist at HSBC, there is more than $3.6 trillion (£2.2 billion) in American money-market funds — a safe-haven investment where institutional investors park their cash in times of trouble.

Parkes believes this wall of money will begin to flow back to equities, giving markets another boost. However, not everyone is convinced that this cash will be put to work.

Some analysts believe that in the new age of austerity being ushered in by the world’s financial regulators, companies will make less money. Banks will have less money to lend, so businesses will have to make every pound of earnings work harder. As a result, shares could start to trade on lower multiples of their profits.

Worse than that, the full cost of the credit crunch has still to be paid by governments around the world. Taxes will have to rise and current low interest rates cannot be sustained for ever. Against that backdrop, it is hard to see why shares should get anywhere near their previous highs.

“There is a real danger that this could yet turn out to be a bear market rally,” said Bob Swarup, director of Pension Corporation. “Let’s not forget the case of Japan, where you have had several rallies of more than 50% since 1990 — all proved to be false dawns.”

Last Thursday at noon, dealers turned to their screens for the monthly announcement from the Bank of England, expecting very little. Instead, while leaving Bank rate unchanged at 0.5%, the monetary policy committee (MPC) announced that it was embarking on a further £50 billion of “quantitative easing” — creating money by buying gilts and corporate assets from the private sector.

It was the second month in a row that the Bank had surprised the markets. In July it paused its easing programme, having been confidently expected to continue with it. This time it pressed the button on more — seeking permission from Alistair Darling, the chancellor — despite a clutch of data pointing to recovery in manufacturing, the service sector and the housing market.

The decision gave another spur to the markets, instantly pushing the FTSE 100 1.7% higher. The extra stimulus was viewed as a means of sealing in recovery.

“Recent positive developments in the economy do not guarantee a recovery that will be sustainable, and the productive sector is still very fragile,” said David Kern, chief economist at the British Chambers of Commerce.

“Signs of confidence must be nurtured as there are still dangers of a relapse. The risks of not persevering with an aggressive policy stimulus are much bigger than the risks of extending the programme.”

The Bank’s move, while intended to boost recovery prospects, had the paradoxical effect of making analysts question some of the upbeat evidence that has emerged in recent days, in Britain and elsewhere in the world.

The long slump in UK house prices appears to be over for now. In America, figures last week pointed to a pick-up in housing activity and purchasing managers’ surveys, which measure business-to-business activity, have been on the up almost everywhere, particularly in Britain.

“It now seems that the MPC is relying much more on the official data,” said Ben Broadbent, an economist with Goldman Sachs. “The committee suggests that the recession appears to have been deeper than previously thought — this is only true in the official data and is clearly at odds with the very strong rise in business surveys.”

The debate will continue and the Bank will say more in its quarterly inflation report this week. By pumping in extra money, it has done more to ensure the recovery happens, which has cheered the markets. The Bank has also signalled it does not think inflation will be a problem any time soon.

However, the Bank’s move was also a reminder that the the banking system is still in the emergency room, and recovery is likely to be fragile. Some of that has been forgotten in the stock-market euphoria of recent weeks.

China in a bubble after banks open the taps

A wave of state-directed bank lending, intended to stave off the global financial crisis, has flowed into Chinese stock markets and property this year, bringing astonishing gains, writes Michael Sheridan from Shanghai.

The cash has also spurred Chinese companies to look for overseas acquisitions, and buying agencies are reported to be amassing stockpiles of copper and other commodities, helping to revive prices.

Apparently taken aback by the effects of its policy, the government signalled last week that it would aim to “stabilise” markets but would not intervene.

Nonetheless, several big state-owned banks have said they will cut their lending after going on the biggest credit spree in the nation’s modern history. They opened the taps on the orders of the political leadership last winter after China’s exports collapsed by 25% and at least 20m people lost their jobs. Banks have made more than $1 trillion (£600 billion) in loans.

Most analysts predict the government will achieve its target of 8% growth this year.

It has even revived the stagnant property market, with buyers returning in the big cities where prices had stalled and transactions all but stopped.

As the government prepares to declare victory — probably around the 60th anniversary in October of the founding of the People’s Republic — a growing number of economists are worried that the Chinese remedy could be worse than the crisis itself.

“Chinese asset markets have become a giant Ponzi scheme,” said Andy Xie, an economist in Shanghai. “They are a big bubble.”

Xie said many loans had not been spent on real economic activities but had been diverted to speculation.

Company earnings do not reflect the valuations on the Shanghai and Shenzhen stock exchanges, he added, and severe oversupply continues to be the reality in the property market.

Share prices in Shanghai are up more than 75% since the beginning of the year, although brief sell-offs in the past fortnight showed that investors were getting nervous.

Statistics on property transactions are inexact but anecdotal evidence suggests that prices have surged, to popular amazement, in Beijing, Shanghai and other urban centres.

Economists at Credit Suisse predicted it would be difficult to stop a “huge and damaging bubble” caused by excess liquidity.

There is evidence from across China that loans intended to be spent on infrastructure have been spent on shares and property.

Foreign bankers say the percentage of bad loans at Chinese banks remains within acceptable limits but they expect the credit splurge to result in a slew of bad debts.

That is a price the Communist party appears ready to pay to preserve political stability. It recapitalised the entire banking system in the 1990s and appears confident it can manage matters now.

However, economists caution that there is no evidence of a revival in China’s main export markets and some say the authorities have lost an opportunity to rebalance the economy towards consumption at home.

“The market frenzy won’t last long now,” said Xie. “The correction may happen in the fourth quarter.” (Iain Dey, David Smith, Danny Fortson, The Sunday Times) http://business.timesonline.co.uk/tol/business/article6788554.ece

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