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Volatility...but value too in UK

by Hamish McRae hamish.mcrae@mailonsunday.co.uk

OH DEAR. Every time UK share prices manage to reach a new high, something comes along and clonks them on the head. So the FTSE100 index, having pushed up to 8,047 in intraday trading last month, dipped to 7,336 before closing at 7,405 on Friday.

That trading bottom was a fall of just under 9 per cent from the peak, so not quite a technical ‘correction’, the word used to describe a 10 per cent decline. But it is a nasty reaction to continuing fears about the stability of the global banking system, and there may be more trouble to come.

For once, though, the gloom is imported. Several US banks have been in trouble, including Silicon Valley Bank. Credit Suisse has been rescued in a somewhat controversial manner by its rival UBS.

The shares of Deutsche Bank were under pressure, at one stage down by 14 per cent before recovering a bit. UK bank shares unsurprisingly have fallen too, but I really cannot see any major British bank in serious trouble. Deposits are flooding back into the UK end of SVB, following its rescue by the mighty HSBC earlier this month. In tough times there is something to be said for having banks that are well-capitalised, profitable, conservatively run – and big.

However, you don’t get a sudden slump in share prices without there being fundamental concerns about the global economy, and the companies in the Footsie get three-quarters of their earnings from outside the UK. So the real question is to what extent those concerns are valid. Let’s try to unpack them.

First and foremost, there is the worry that the central banks are moving interest rates up too far, or at least too swiftly, and that will put grave pressure on the banking system in ways that cannot be fully foreseen. Having made the mistake of failing to take the inflation threat seriously and delaying action, they are now overcompensating.

There is something in that. Rates in the US and UK are probably high enough now to pull inflation back to an acceptable level by the end of this year.

The increases last week of 0.25 per cent by both the Federal Reserve and the Bank of England may have been a mistake. There are always two considerations facing a would-be borrower: what is the interest rate and can you get the loan anyway? If it is tough to borrow the money, and credit conditions are certainly tightening as banks get worried, you don’t need higher rates to choke off demand.

But even if those increases were a mistake, it seems odd to agonise about a 0.25 per cent increase. The central banks can always reverse policy. That rise in the consumer prices index here to 10.4 per cent will, I think, turn out to be an outlier. If inflation comes down even faster through the autumn than the Bank of England expects, then we could be back to, say, a 3 per cent Bank rate by Christmas. The second group of worries is that behind the loss of confidence in some of the weaker banks is a fear that too many of their customers are in trouble.

There will be corporate bankruptcies, and history tells us that this always happens at a time of rising interest rates. Unfortunately history does not tell us which enterprises will go belly up and which will scramble through, bloody but unbowed. At this stage of the cycle there are always nasty surprises.

The third concern is more general. It is that there will indeed be some sort of global recession, and that this will undermine corporate earnings. As far as the UK is concerned, the clouds have lifted a bit in recent weeks – actually as I expected they would. Andrew Bailey, Governor of the Bank of England, now thinks that we will escape recession this year. The latest retail sales figures are quite strong, and the purchasing manager indices project some growth, led by services.

All this comes on top of a solid reporting season from the biggest Footsie companies, several of which have increased dividends and/or announced share buy-back schemes. You don’t increase your dividend if you are not confident about earnings in the year ahead.

But there is at least a possibility the turmoil in US banking will push the American economy into recession. Brett Nelson, asset allocation guru at Goldman Sachs, put it this way: ‘We see the arguments in favour of a recession being about as compelling as those against one.’

Umm. My view is that while the ‘correction’ may have some way to go, you can never get timing right. The UK market does at least offer decent value, indeed better value than the much larger US one.

Clouds have lifted here and we may avoid recession

Financial

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2023-03-26T07:00:00.0000000Z

2023-03-26T07:00:00.0000000Z

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