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Shopping outside the high street

I cannot help feeling a bit of sympathy for the high-street retailer. Virtually every other sector is pumping out solid earnings, typically in line with or beating estimates, and confidence is riding high.

Outside retailing and manu- facturing, I have every reason to continue being optimistic about prospects for the UK market. After several years of prudent management, companies are now demonstrating their prowess in generating healthy profits. Cost-cutting and debt-reduction exercises have made companies financially fit and cash-rich. The result is much the same as if a person improves their diet and exercise – they grow in confidence, buy new clothes and generally perform better. If you look at corporate activity, you will see companies that today are indeed confident.

There are high levels of divi- dend growth, share buybacks and investment. As economic growth has slowed, trading conditions have become more difficult and top-line growth has been hard to come by. Most companies have little scope to increase prices and higher energy costs have to be passed on to consumers. In such an environment, mergers and acquisitions provide excellent means of increasing margins and market share.

But investors rarely reward companies that overspend and the fact that shares in some bidding companies are rising implies that they are being seen to be making good deals. We have seen examples in the UK (on rumours of a possible bid from Cable & Wireless for Energis) as well as in the US, as investors realise the beneficial impact of consolidating markets.

In my view, equities are either fair value or even under- valued. Strong fundamentals are underpinning share prices throughout the market-cap spectrum. I believe we will see upgrades to many large caps, due largely to the effects of weaker sterling on the value of overseas assets. Sterling should remain weak as the US Fed continues raising rates now that the soft patch in the US cycle appears to be over.

At the same time, smaller companies should be supported by lower UK interest rates, an abundance of M&A activity and the fact that the market is shrinking, with share buybacks and takeovers outpacing IPOs.

A word of caution may be appropriate at this stage. Equ- ities have risen for most of this year and optimism has been on a high. But investors should not get too complacent, thinking the only way is up. Markets tend to exaggerate news during thin trading months and we are entering what historically have been such months. If we do have a few disappointing results on the corporate or economic front,markets could fall. We should remember that the sell-off in April was not all that long ago and was quite short-lived. I would not be too surprised if we had a dip or two before the year end.

Finally, I do have a bit of good news for the high-street retailer. I believe consumers are still spending money. The Bank of England has done a good job with its monetary policy, stimulating or slowing growth when needed. We may see a couple more cuts by spring but probably not immediately. The bank is likely to judge the impact of its first cut before making any further changes. I am not rushing out to buy retailers at the moment because I do not think they are going to race away any time soon but I am watching a few for the future.

However, I am actively investing in several other areas. Valuations are attractive and companies are using their cash reserves in more shareholder-friendly ways. I continue to favour companies benefiting from Government and corporate spending rather than those heavily exposed toconsumers. I also like companies that are making effective in-roads into consumers’ pockets. Perhaps the high street has not disappeared but is merely moving address.

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