Comment: Enjoy equity highs but don’t get carried away

Martin Flanagan
Martin Flanagan
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BRITAIN’s blue-chip FTSE 100 index broke its 15-year intra-day and closing highs of 6,950 and 6,930 respectively last week. Where now? It is a finely balanced question. The financial fundamentals and broad economic backdrop would suggest further equity gains.

But geo-political clouds and gradually rising interest rates are part of the countervailing argument for a possible retreat from current levels. Bearish investors won’t need reminding that the Footsie’s last high-water mark was followed by three years of falls between 2000 and 2002, the index ultimately hitting a low of 3,609 in September 2002.

At that stage, the earlier highs felt an aeon away. But there was a key difference between that collapse and where we are now.

The dizzying highs of equities as we headed into the new millennium were built on the sand of the first internet business bubble. Dot.com companies with virtually no real earnings potential were propping the FTSE-100 up on little more than Emperor’s New Clothes bull, jargon and “dress down Fridays”.

Corporate profitability was a quaint olden days concept in that deluded dot.com dawn. It was an accident waiting to happen and it did. By contrast, the equity thresholds breached last week are largely because corporate earnings are immeasurably stronger than they were back then.

Companies are leaner and more hard-headedly realistic, on the front foot now because many balance sheets were rebuilt over several years following the financial crash and 2008-9 recession.

The UK’s economic recovery, even according to independent experts such as the Organisation for Economic Co-operation and Development, has been pretty remarkable.

Central banks have played a bit of a blinder by keeping interest rates very low and pumping trillions of dollars into the global economy to stimulate growth.

Taken as a whole, why shouldn’t blue-chip stocks make further gains? Some analysts are predicting the Footsie could close north of 7,500 in 2015. It is certainly not a fanciful possibility.

Here we need to draw breath, however. One of the reasons equities are popular again with investors is that chronically low interest rates worldwide, from America and the UK to the Eurozone and Japan, mean that decent yields on other assets, mainly cash but also ISAs and bonds, are almost impossible to find.

Interest rates will have to rise gradually, and when that happens equities will have a stronger rival in investors’ minds. What one asset class gains, the other must lose.

The Eurozone is also not out of danger, important for UK stock market sentiment given that the European Union takes 40 per cent of our exports and is a major contributor to our corporate earnings.

And, more important than a potential Greek exit from the single currency, is whether, if the Tories win the general election, Britain votes in a referendum to pull out of the EU. If that happens, all bets would be off as to where the Footsie would head.

A worsening of the standoff between Russia and the west in Ukraine also has potential to destabilise equities. In short, enjoy the highs while we can. There may be more to come … or possibly not.

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