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Investment view

The banks&#39 reporting season promises to be of even greater importance than usual. The banks are the biggest single component of the FTSE 100 Index, accounting for 22 per cent of the market capitalisation of the UK&#39s premier benchmark. This index has been stuck in a narrow trading range. Technical analysts believe it is building towards a breakout. What they are not certain about is whether it will break up or down.

How investors react to the banks&#39 results could provide a crucial component in whether we travel into territory below 5,000 or build on the somewhat fragile recovery of the autumn. Bank shares have been a friend to investors over the past 12 months. Strip their contribution out of the FTSE index and the behaviour of British shares looks considerably worse than the headline figures, which were lacklustre.

The signs are encouraging. Northern Rock, hardly the cheapest of banks, came out with some excellent figures but, given it is primarily focused on the mortgage market and house prices are buoyant, it would have been amazing if it had not delivered. Barclays gave a reassuring set of numbers while there were no unpleasant surprises from Lloyds TSB. True, revenue performance was slightly below expectations but this was more than compensated by better cost control – to be expected of Lloyds. So far, so good.

The main focus of attention is on the level of bad debts. There are some exceptional items around – Enron has cost Abbey National £90m, Argentina £100m for Lloyds. However, at a time of low interest rates, loans tend to become more affordable, so the incidence of bad debt should be relatively contained, even if a slowing economy brings problems for smaller, less well-capitalised businesses. The banks that have reported so far have generally raised their provisions for bad or doubtful debts but nothing unexpected has emerged yet.

It is an indication of how important some sectors of the market are that so much appears to be riding on this reporting season. Sector rotation is alive and well and keeping stockbrokers in business, even if there remains a lack of confidence overall in the market. Look at what has happened to telecommunications shares as an example. Many of the previous FTSE 100 giants have been consigned to the second-tier 250 share index. Even here, life is hardly cosy. The telecoms sector accounted for more than 12 per cent of this index in early December. By the end of last week, this had fallen to less than 9 per cent – a drop of more than a quarter.

The situation has hardly been helped by an attack of Enronitis afflicting Cable & Wireless&#39 share price. The shares have shed more than 70 per cent of their value from last year&#39s high, itself well down on the new-economy peaks scaled in early 2000. The piece of accounting practice alarming investors centred around so-called “hollow swaps” – exchanging capacity with another telecom provider to boost revenue. In these exchanges, no money typically changes hands but worse for Cable & Wireless was the fact that it appeared to be taking the notional benefit these swaps delivered up front. No doubt it will all be satisfactorily explained in time but the market could do with fewer uncertainties and the occasional run of good news.

That the crowd is usually wrong is often cited as the justification for following a contrarian investment approach. Few will stick their necks out and say the boom days of the 80s and 90s will return. But appearing on a TV show last week, I found myself being told that, despite my wisdom and experience, I was too cautious in my approach to likely market trends. The person taking me to task was Alan Steele, who predicted we would spend our way out of the economic and market gloom. I hope you are right, Alan, I really do.


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