Why UK equities are poised to go higher

The UK equity market appears poised to climb higher. The FTSE 100 Share Index the week before last reached a five year high, although this index is still below the peak seen in 2000, while the FTSE 250 has again recorded a new all-time high. Nevertheless the market is in our view reasonably rated with the average estimated P/E for 2006 at around 13 x. Strangely this is the earnings rating of the UK equity market at the time of its low point in March 2003. In other words, companies have since then achieved significant increases in profits but their shares are no more highly rated than three years ago. The overvaluation equities experienced near the end of the last bull market are not yet in sight.

The first quarter statements, expected shortly, will provide a confirmation that our expectation of about 8% earnings growth in 2006 is feasible. Many UK companies possess large international operations and world economic growth could, according to the IMF, reach 4.9% this year.

Since 2000 the supply of UK equities has, through takeovers and share buybacks, diminished. This trend is continuing - rights issues are a rarity and only a limited number of companies are joining the Official List. Although rumours of takeovers still abound, company managements are now in some cases mounting successful resistance - attempted bids for the London Stock Exchange, House of Fraser, Kesa, Prudential and ITV have failed. BAA, the airports operator, may well repulse Ferrovial of Spain's hostile bid. Nevertheless we confidently expect more takeovers, ideally for cash, taking place; private equity funds could yet mount a successful bid for a FTSE 100 company. There is no doubt that a successful major cash bid for a large UK company would drive the UK equity market into new higher ground. The majority of current bids are for cash and this is giving institutional and other investors the ammunition to invest further in the equity market.

MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Interest rates are rising in the US and the Eurozone and may in the early autumn head higher in Japan. This has led to weakness in bond markets. Growth in the UK is slowing, the consumer remains under pressure and the recent brighter news from the housing market (the Halifax House Price Index signalled 6.2% annual house price inflation in March) may well peter out in the summer months. Gordon Brown's 61 minute Budget speech on 22 March was devoted more to justification of his political beliefs than new measures to control Government expenditure or encourage economic growth. An ironic effect of the increase in bond yields is that the deficits of UK pension funds have significantly fallen, because liabilities are discounted using bond intrest rates. The pressure for these funds to sell equities should lessen; indeed the Government may slowly be inching towards an underpinning of pensions funding following the completion of Lord Turner's report.

The UK equity market may consolidate in the short-term. Longer term we are confident that we have not yet seen the peak of the current bull market. Chasing expected bid targets can be a dangerous game; we favour concentrating on value and, in particular, seeking out those companies with important overseas activities

By Jeremy Batstone, Director of Private Client Research at Charles Stanley