London Stalling

11/16/2009 12:01 am EST


John Snowden

Contributor, The IRS Report

The UK stock market is in for a rude awakening, one that could be aggravated by excessive debt, writes John Snowden in The IRS Report.

It’s official—the recession is still on, according to the latest statistics. Initial third-quarter gross domestic product (GDP) figures for the UK were much worse than consensus forecasts, sending sterling into another mini-dive as dealers anticipated near-zero interest rates persisting for many more months.

The bull run is beginning to struggle—and about time, too. I admit my bearishness over the last few months has been wrong, and good money has been made by the bulls, but I make no apology. The few stocks I have reviewed in recent months have generally outperformed the [FTSE 100 index,] and investors should still have plenty of liquidity to take advantage of the next leg of the W.

I believe we are just about at the midpoint of the W, and any Christmas and New Year rally will see the top of both the US and the UK markets. I would put some of the recent market strength down to the weakness of the dollar and sterling as longer-term investment funds have been trying to find a haven in commercial companies with major business interests overseas, since these offer some currency protection.

Investors would be wise to take note of the recent broadside from the Governor of the Bank of England, when official figures revealed the borrowing had hit £77.3 billion. Each day the government is taking on £40 of extra debt for every household in the land. The Governor does not like it and is also at odds with the government over banking reform, since he would prefer banks to be made small enough to fail by breaking them up. In the old days, a Governor and Chancellor at odds would spell disaster, and even today could fray a few nerves.

The bankers have not reformed. They are using taxpayer-guaranteed funds that are supposedly for lending to replenish their own coffers and are starting to pay bonuses again. The International Monetary Fund also hovers on the sidelines and if estimates of debts rising to £1 trillion by the end of next year are correct, we can be sure of some kind of intervention before then. Iceland and Ireland showed us what can happen to countries whose financial sector debts get out of whack with their economies. The UK is still a member of this club.

For those investors and financial advisers who are telling their clients to get stuck into the market as corporate figures are improving—I think you need to ask whether companies are making bigger profits through expansion or whether the improved results are due to destocking and cost cutting. In fact, a large part of the “profits recovery” in the UK and US is down to savage cost cuts, which have contributed to making the recession so steep.

But unless you can be confident of growth in revenues, you should be reluctant to pay high multiples for corporate earnings. On that issue, I remain resolutely bearish, since as far as I can see, the only firms able to achieve those revenue gains will be ones with big interests in the emerging economies.

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