Tuesday, September 22, 2009

The head ruling the heart.

My old friends on Wall Street,now occupying frighteningly senior positions, continue to tell me that the rally in equity (and other) markets will continue through to the end of the year. Institutional investors are still relatively underweight equities and the higher the market goes the greater the peer pressure to join in. End of story as far as they're concerned.

The bottom line is that my worries about the health of bank balance sheets or demand for IT products should be set aside for another day. Isn't it galling to have been so right on the way down and so out of kilter on the way back up?

Although clearly wrongfooted by the extent of the rally I'm still not converted to the longevity of this bullish world view. I still cling to the belief that my realistic (some would say negative) stance on the global economic outlook has some basis to it. Banks have led the markets surge higher but strip out one-off gains and frenetic investment banking and you're left with a sector that's enjoying a relief rally thanks to the tax payer. At what stage does a relief rally become froth? Ditto the autos who have enjoyed their time in the sun due to 'cash for clunkers'. When that boost evaporates at the end of the year their revenue streams might again appear exposed. As for IT the consumer credit environment doesn't look any rosier than it did six months ago. Certainly, the airlines are not seeing any sustainable signs of an upturn in either leisure,or more worryingly,business traffic. A harsh autumn awaits them.

Putting it all together it looks as though we're past the worst. Some see bright sunlit uplands ahead whereas I see limited recovery, government budgets stretched to breaking point, and the growing eventuality that stimulus packages are going to have to be reduced (if not reversed). I'm more than happy to stick to those sectors that are lagging behind - ie those enjoying strong demand, high visibility of earnings, and predictable and conservative cahsflows. Undervalued equities have been and always will be attractive. Cyclical stocks (now on PE's of nearly 30x) have been where the action is but from a UK perspective the latest 18% fall in domestic business investment and the biggest decline in commercial credit since records began doesn't seem to be a benign backdrop.I'll put the markets recent enthusiasm down to institutions being dragged back into the game and to a large number of commentators whose heart is ruling their head - a view reinforced by an article saying that day trading is reaching levels not seen since the glory levesl of the dotcom boom.

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