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Big Ben clocks on

Last week was a little bumpy for markets but, buoyed by a positive reaction to the appointment of Ben Benanke as Alan Greenspan’s replacement, shares got off to a better start this week. Enthusiasm faded fast, however, with bulls and bears fighting for dominance as the week progressed. It paints a confusing picture for investors.

Perhaps now is a good time to reflect on influences that are likely to shape the outlook as the year draws to a close.

The initial favourable reaction to the appointment of Benanke was understandable. A heavyweight academic, he has been a governor of the Federal Reserve Bank for three years and is now chief economist. As this appointment is very much in the president’s gift, the concern was that the person chosen would be an unknown quantity. The feeling is that Benanke is competent and tolerably predictable. His appointment was as close to removing uncertainty for markets as you are likely to get.

In the UK, the economic numbers have not been as bad as feared. Growth in 2005 will be less impressive than the Chancellor had hoped at the beginning of the year but the economy is hardly falling off a cliff. Even retail sales have held up better than expected although life remains tough on the high street. More important, expectations are growing for a cut in interest rates, probably in the New Year.

The headline index – when it does move up – is generally buoyed by resource stocks. Oil and energy, along with mining, have continued to perform reasonably well despite the fact that oil has drifted back below $60 a barrel. Indeed, both BP and Shell delivered positive statements last week although BP dampened down expectations of a profits bonanza stimulated by the high oil price. Perhaps the fear of some form of Government action, such as a windfall tax, kept its comments from being too upbeat. It goes to show that nothing in this business is ever truly clear-cut.

But the fact remains that the prices of financial assets are driven by supply and demand. When there are more buyers than sellers, the price will go up. Reverse the trend and you have falling values. Nowhere has this been more apparent than in property funds, where demand for close-ended vehicles drove recent issues to significant premiums over asset value. With more funds coming on-stream, these premiums are slowly evaporating, indicating that some form of balance is being achieved.

But one unsettling influence is creeping up the worry list – inflation. Higher energy costs appear to be feeding through to other areas of the economy. Core producer prices rose by 0.3 per cent in the US in September. Markets expect the Fed to raise interest rates progressively over the next few months, stimulating concern over future economic growth.

All this has spooked bond markets, which last week went through an uncomfortable period. Although not necessarily bad for equities, the prospect of rising inflation adds to the sense of unease that is holding back the market from making any real progress. Bargain-hunting one day can easily turn into profit-taking the next – hence the swings we are seeing. Perhaps the healthiest aspect of the market at present is the vigorous debate over the direction that shares are likely to take.

It is the wrong time to make sudden moves. Pessimists will say we are seeing straws in the wind that foretell a reversal in the fortunes of markets. The reality is that little of any real significance is happening at present. Clearly, investors’ emphasis on sectors and asset classes will be influenced by inflation, economic growth and interest rates or a combination of these and other factors. The case for a diversified portfolio of assets looks as solid as ever.


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