Back to Front
Markets have taken fright at the prospect of various governments, most notably in the United States, bringing economic stimulation to an end. This should be a cause for rejoicing and the latest falls in the London stock market present a buying opportunity that I feared might not occur until much later in the year, if at all.
It is a well known phenomenon that the same economic measure can have opposite effects on the stock market at different times. If a government takes measures to help the economy, that can be taken either as a signal that things will start to get better or a warning that the economic situation is worse than we thought.
Similarly when the government tightens up, that can be taken to mean either that things are getting better or that we should all start to batten down the hatches. The problem is that you never know how market sentiment will react to the news.
Hints that the US government will let its economic stimulus programme tail off later this year, plus the reluctance of the Bank of England’s monetary policy committee to indulge in more quantitative easing, has caused a sharp fall in the FTSE 100 index. The inability of the European Central Bank to come up with any new ideas on ending recession and severe unemployment on the Continent has made matters worse.
Let us take them one by one. The reaction of markets to developments in the US is, in my view, particularly irrational. The US economy has come out of the financial crisis reasonably well, indeed exceptionally well considering that it all started with the collapse of the US housing market and the stand-off in Washington between Republicans and Democrats rumbles on.
We should be pleased that the Fed feels it is now in a position to let the US economy stand on its own two feet. The sooner that happens, the less difficult and painful it will be to unwind all the support dished out so far. In any case, the Fed is not proposing a sudden lurch from one extreme to another but a gradual tapering of economic stimulus, sensibly weaning the economy off its life support.
Similarly, the sooner the MPC brings quantitative easing to an end in the UK the better. Its reluctance to indulge in more buying of gilts reflects a belief that the economy is improving, albeit slowly. Latest indications of growth in services, manufacturing and construction support this view.
The eurozone is the most problematic area. As a whole, the continuing recession on the Continent is far worse than in the UK (new readers please note, I do not accept the ludicrous notion that a recession is two consecutive quarters of contraction and that one quarter of growth ends recession). While it is worrying that the ECB feels unable to do anything more at this stage to rescue the situation, I take a little comfort from the absence of any rash, knee-jerk measures. At least the ECB has been able to put off panicking for another month.
I believe that the fall in share prices has more to do with the fact that the bull run this year had gone too far and that good value was becoming very difficult to spot. The latest setback is merely an overdue correction waiting for an excuse to happen. I still have part of my ISA entitlement for this year to invest and was despairing of finding an opportunity. Shares have become worth buying again.
Spare Us the Truth
The truth always hurts more than lies. The IMF has declared that the rescue of Greece was more about saving the euro than about saving the Greek economy. Whoever thought it was otherwise?
This speaking of the unthinkable has naturally provoked outrage in Brussels because it comes uncomfortably close to the truth. There are many criticisms that can be launched against the European Union, and I have mentioned quite a few in this column over the years, but you cannot fault the EU on its determination to defend its dreams.
That is one reason why I remain reasonably optimistic that, in the short to medium term, there is little likelihood of the eurozone falling apart with the disruption that would inevitably cause.
Testing Times
News that AstraZeneca (AZN) is shelving a treatment for rheumatoid arthritis following disappointing trial results is a warning of the dangers of investing in pharmaceutical companies. Look at the share price table and you will see little evidence of decent yields in the sector, while price/earnings ratios are generally alarmingly high.
It is true that an ageing population should increase the demand for drugs but there are many hurdles for drugs to overcome before they are accepted and, at the other end of their lives, the most successful ones come under attack from generic copies.
Astra shares had almost reached an all-time high above £33 before falling back this week. The surprise to me is that the reaction was so mild, presumably because projected sales of the drug were less than 1% of forecast sales so the blow is not seen as too heavy.
Even so, I feel that Astra is overvalued. Sales and profits fell last year and are projected to continue on a downward path this year and possibly next. It is more lowly rated than GlaxoSmithKline (GSK), a key component of my portfolio, and rightly so. Glaxo has moved into consumer healthcare as a backstop in case its drug development programme falters. Astra has no such fallback.
Rodney Hobson is a long-term investor commenting on his own portfolio; his comments are for informational purposes only and should not be construed as investment advice.
Market Performance: June 3-7
FTSE 100 Index: -2.60%
FTSE 250 Index: -2.41%
FTSE All Share Index: -2.57%
FTSE Small Cap Index: -2.44%
FTSE AIM 100 Index: -1.88%
FTSE Fledgling Index: -1.06%
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