Global outlook may be our saviour

Uncertain times may lie ahead, but there are still reasons to be positive about the future as the global nature of the British economy allows investors to exploit new trends and markets.

Uncertain times may lie ahead, but there are still reasons to be positive about the future as the global nature of the British economy allows investors to exploit new trends and markets.The influence of the global economy on the British market has been increasing for some time – more than one-fifth of FTSE 100 companies derive at least 90% of their sales outside Britain.

Rarely, however, has the evidence of these global forces been as strong as in the past few months. Over this time, markets around the world have been pushed and pulled by record high commodity prices and a weakened financial system. So the prominence of banks, oil and gas and resources in the British market has been hugely influential. Together, these sectors account for almost half of the value of the market.

The past few months have seen many investors behaving more like weather forecasters, attempting to second-guess the path and strength of each front as it rolls in from overseas. This has led to a volatile period, characterised by a strong rotation from one sector to another. The period can be dissected into three distinct parts: a severe decline, followed by a tentative rally, ending in another short, sharp decline.

From a recent peak in mid May at 6,376, the FTSE 100 fell by 19% over the next 42 days to 5,150. At the same time, oil was rising to its highest-ever price and peaked within days of the equity low in mid July. The perilous position of America’s mortgage giants, Fannie Mae and Freddie Mac, highlighted continuing concern for the whole financial system and the companies that operate within it.

Combined with this, the rise in commodity prices, especially oil, stoked fears of rising inflation. Those fears were realised by a stream of data confirming an increase in input, factory gate and consumer prices. This depressed sentiment drove share prices lower. Even the oil and gas sectors, which would be the obvious benefactors of high oil prices, fell in this period.

Economic data here and across the world provided grim reading and pointed to a slowdown. The British economy officially ground to a halt, with the Office for National Statistics confirming no economic expansion at all in the second quarter, and inflation now more than double the government’s 2% target, and rising. This left the Bank of England with a dilemma. Because it only has the responsibility to manage inflation, the pressure to cut rates and stimulate the economy has been ignored. Rates therefore remained unchanged.

The second of the three stages of this period began with oil’s peak and the equity trough in mid July. This proved to be a turning point and sparked a bank-led rally that saw the FTSE 100 return to 5,636, a bounce of 9.4%. The rally provided some cheer to the few investors that remained in a rain-soaked square mile at the peak of the holiday season.

The short-lived rally gave way to the third stage of the period, dominated by concerns about the economy as slowing growth and the fear of recession overcame the previous worries about inflation. At this point, defensive sectors began to attract attention. The contrasting fortunes of different sectors were a major factor in the performance of the market. Rotation to oil and gas from banks and then into healthcare accounted for much investor activity, with the desire to avoid a loss as strong as the wish to hunt for profit.

The sector rotation was apparent in the biggest gainers and fallers over the period. Ferrexpo, a Ukrainian iron-ore miner, joined the FTSE 100 in June. Its rise to blue-chip status followed the soaring price of iron ore. It is also a perfect example of the international nature of the British market. But since the summer peak, the shares have lost more then half their value, and the company is set to be demoted to the FTSE 250 after just three months. The biggest blue-chip riser was Astrazeneca, one of just 13 companies posting a positive return, gaining 17%. Investors’ move to the defensive healthcare sector was clear – all four blue-chip healthcare companies were among the 13 risers.

The outlook for the coming months remains uncertain, particularly in light of events on the other side of the Atlantic. As the season turns to autumn, the prospect of Britain and other economies cooling further will dominate. There is likely to be worse economic news before any good begins to filter through. Although commodity prices have fallen, the impact of this is yet to travel far enough downstream into shop prices. Inflation is therefore some way off its peak and there is little immediate prospect of the Bank easing its policy.

The British consumer is in a precarious position. With house prices falling, high levels of personal debt, rising inflation and a weakening economy making headlines, confidence is low and disposable income is coming under pressure. Companies with a high exposure to the British consumer may find the coming months difficult.

The outlook for banks in Britain remains a challenge. Until their recent problems, they had enjoyed excellent profit margins for a sustained period. Much of that foundation has been shaken or disappeared, which will limit their ability to grow earnings over the next couple of years.

There are, however, reasons to be cheerful about the future. It is precisely the global nature of the British market that allows investors to exploit positive themes that will not be hampered by a fragile outlook. The British stockmarket and the British economy are different things.

Although some commodity prices have fallen from extended highs in recent weeks, it is unlikely they will collapse to the levels of five years ago. Support for their rising prices remains in the massive growth in consumer demand and infrastructure in emerging markets.

The copper price, for example, is still supported by strong demand and tight supply. Strong and desirable British brands are also likely to benefit from growth in emerging markets. Diageo, for example, sells many well known whisky brands and is expanding sales in emerging markets.

While the outlook for the coming months is uncertain, companies that survive may thrive. Growing businesses still exist in Britain’s international equity market.