Business

Summer doldrums? Not this year

Cathy Dixon
Cathy Dixon Cathy Dixon

SINCE the beginning of the year we've seen the UK market climb steadily from its low levels of about 6600 to consolidate comfortably at around 7500.

This is despite the continuing political turmoil that continues to rage, with a new Prime Minister due to be announced today and no progress towards a credible Brexit solution.

The market does seem to have been able to shrug all this off, as well as other potentially significant situations such as the rising tensions with Iran.

But this does not mean that optimism rules across the board, with notable examples of shares being marked down strongly.

The retail sector is one area that has seen this as structural changes continue and even erstwhile stock market favourites such as Asos have suffered following disappointments in terms of profit warnings.

Utilities, too, continue to experience choppy waters as doubts surface about their long term prospects if there is a Labour government and there has been speculation as to the sustainability of some of their sizeable dividends.

With all this facing us it is intuitively difficult to understand why the market seems able to continue its upward trajectory. There are different types of rally, though, some driven by better economic growth or increased optimism or greater appetite for risk, whereas others are caused by the reality or the hope of easy money.

Rises caused by increases in economic optimism or appetite for risk usually see bond yields rise as investors move out of “safe” assets. In contrast, rallies driven by liquidity see bond yields fall either because central banks are buying bonds with the money they are printing or because expectations of lower short term interest rates reduce bond yields. Applying this to this year’s rally, liquidity has been the main driver, partly spurred on by the expectation of a rate cut by the Fed.

The fact that we are in a liquidity driven rally does not mean it is not sustainable. History suggests that this type of rally is no more likely to end badly than any other type of rise. The rallies founded on economic optimism can falter when such optimism proves to be misplaced or even when tastes change.

Liquidity driven rallies caused by expectations of looser monetary policy are sometimes based on genuinely better economic conditions. In the current situation, while a cut in US interest rates is anticipated, it is more that we have seen good levels of economic growth on a global basis, without the fear of inflation creeping in. We have seen wage inflation remain low, suggesting that the economy can continue growing without triggering inflation.

Forecasting the direction of the market is a thankless task: the traditional “sell in May and go away” has not been the case this year, but we are only halfway through the summer.

The real justification for this year’s stock market rally is not just lower rates, but more the belief that the UK economy is capable of generating non-inflationary growth going forward.

:: Cathy Dixon is a partner at the Belfast office of Cunningham Coates Stockbrokers. This article does not constitute a recommendation to buy or sell investments and the value of any shares may fall as well as rise.