Issue 78 | March 2010

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A bruising start to the year

FTSE All-Share index: last 3 months

ASX - FTSE ALL-SHARE INDEX

DaiIy 9/2/09 - 3/1/10
Last Price 2752.05
High on 1/11/10 2832.47
Average 2679.35
Low on 09/03/09 2462.90

Source: Bloomberg
The UK market: A bruising start to 2010
After a strong start to January 2010, encouraged by positive manufacturing data, and reaching 16-month highs, the
FTSE100 index drifted sideways before trending lower from a combination of China moving to cool its economy by
looking to reign in credit, doubts lingering over the strength of the global recovery, and uncertaincy over central bank
policy on the fiscal stimulus and interest rates. By the middle of January the UK index was back to the start-of the-year
level. With poorer than expected US corporate earnings figures, and a tougher than anticipated proposal by President
Obama for widespread reforms of the US banking system, sentiment was undermined, sending the FTSE100 index
sharply lower. This weaker trend continued as edgy investors increased their aversion to risk. The combination of these
factors and the fiscal problems of the peripheral eurozone nations (Greece, Ireland, Portugal and Spain) conspired to
send the UK index nearly 4% lower on the month. After a brief recovery in markets at the start of February, poor US
economic data and the growing fear of contaigon from a sovereign debt default in the eurozone, sent the FTSE100 index
lower again, leaving it some 9% below its recent high. However, from that point on investor sentiment improved, as
sovereign debt worries faded as the European Union pledged to take action to safeguard stability, generally positive
corporate result news, and, although the Federal Reserve raised its discount rate (taking its spread over the federal
funds rate back towards more normal levels), it confirmed that interest rates will remain low for an extended period. While
upgraded fourth quarter GDP figures from the US and UK helped markets at the end of the month, the three main
themes of the last two months – Chinese monetary policies, an uncertain outlook for global economic growth in 2010
and sovereign debt worries – seem set to continue to unsettle investors for some time to come, leaving nervous equity
markets facing an unclear and volatile future.

Economic Indicators due in March

Announcement Date
UK interest rates 4 March
ECB interest rates 4 March
Eurozone Consumer Price Index (inflation) 16 March
US interest rates (FOMC) 16 March
UK employment figures 17 March
Monetary Policy Committee meeting notes 17 March
US CPI 18 March
UK Consumer Price Index (inflation) 23 March
UK retail sales 25 March

FTSE 100 Company results due in March

Company Date due Type of result Company Date due Type of result
HSBC 1 March Final Prudential 9 March Final
Pearson 1 March Final Standard Life 10 March Final
Admiral Group 2 March Final Tullow Oil 10 March Final
Standard Chartered 3 March Final Morrison Supermarkets 11 March Final
Aggreko 4 March Final Old Mutual 11 March Final
AMEC 4 March Final G4S 16 March Final
Aviva 4 March Final Wolseley 22 March Interim
Cobham 4 March Final Cairn Energy 23 March Final
WPP 5 March Final Legal & General 23 March Final
Intertek Group 8 March Final ENRC 24 March Final
Petrofac 8 March Final Smiths Group 24 March Interim
Antofagasta 9 March Final Kingfisher 25 March Final
Inmarsat 9 March Final Next 25 March Final
International Power 9 March Final Kazakhmys No date Final
Source : Companies
Sector Performance during February
Top 5 % Bottom 5 %
Forestry & Paper + 13.6 General Retailers - 10.9
Industrial Metals & Mining + 13.0 Fixed Line Telecommunications - 10.7
Tobacco + 8.5 Financial Services - 9.8
Travel & Leisure + 7.3 Real Estate Investment Trusts - 7.3
Chemicals + 6.4 Leisure Goods - 5.2
Source: FTSE International Limited

The contraction may be over but the recovery looks uncertain

There has been considerable concern amongst informed commentators following confirmation that the Consumer Price
Index (CPI) of inflation has risen much more sharply over the past two months than economists had been predicting,
and has been consistently higher than the Bank of England’s forecasts over the whole of 2009. The view is that the rate
of CPI inflation has been above forecasts for two main reasons – a greater impact from the substantial fall in Sterling
since the start of the financial crisis and, secondly, the limited degree of slack in the economy. The main concerns are
over whether this rise in inflation will persist, and if so will it feed through into consumer expectations and thus into higher
wage demands. The Bank of England, however, firmly believes that the level of CPI remains manageable and should
subside over the next few months. CPI inflation has increased from 1.1% in September 2009 (its recent low point),
to1.9% (just below the Bank’s target level) in November, and to 2.9% in December last. That one percent rise was the
largest single month increase since records began in 1997. Much of that increase reflected events of a year ago,
including the 2.5% cut in VAT, record falls in petrol prices and heavily discounted prices in shops to reduce unwanted
stock prior to Christmas. The spectacular 2.1% increase in the Retail Prices Index (RPI) of inflation to 2.4% in December
was due to the same factors as well as a fall in mortgage interest payments a year ago.
The upward trend in inflation figures was continued in January 2010, when CPI rose to 3.5%, well above forecast levels,
prompting an exchange of letters between the governor of the Bank of England and the Chancellor of the Exchequer.
The former continues to believe that recent rises are a temporary deviation from the 2% target level, with the principal
reasons behind the increases being the increase in VAT, a 70% rise in oil prices over the past year and the weak pound
driving up import prices. The Office of National Statistics (ONS) has estimated that the reduction in VAT, part of the
government’s stimulus package, reduced CPI by 0.5% over the period. Commentators make the point that the full effect
of the recent reinstatement of the VAT rate (back to 17.5%) may not have yet been felt as many goods were heavily
discounted in January, and some retailers pledged not to increase prices immediately. RPI rose to 3.7% in January, up
from a fall of 1.4% in September last, due to similar factors as for CPI, but also fall housing costs a year ago. The Bank
believes that the level of inflation is now close to its peak as the recession hit economy makes it difficult for retailers to
push up prices and for workers to achieve big pay rises.

Source : Thomson Reuters Datastream : Bank of England : Financial Times

After 18 months of contraction, the UK economy finally emerged from its deepest recession since the Second World War
in the fourth quarter of 2009. The initial estimate (based on only 40% of the total potential data) was for anaemic economic
growth of 0.1%, but this was increased to 0.3% in revised figures (77% of data) in late February. However, second quarter
growth was revised downwards to a contraction of 0.3% (from 0.2%). This data implies that the UK economy contracted
by around 5% in 2009. The improved fourth quarter numbers reflected significantly increased figures from the services
(up 0.5% compared to an initial estimate of plus 0.1%) and manufacturing (up 0.8% versus 0.4%) sectors. Renewed
output from North Sea oil and gas production - after their temporary close down during the summer for routine
maintenance – was also a factor. Household expenditure was 0.4% higher in real terms. Even though this level of growth
is encouraging it should be compared to an average ‘normal’ rate of growth of around 0.6% to 0.7% per quarter.
The latest Bank of England Inflation Report, issued in mid-February, does not make encouraging reading. The Bank
comments that after a period of substantially declining output, the UK economy stabilised in the second half of 2009, and
it believes a period of gradual expansion is in prospect underpinned by the stimulus from the easing in monetary policy,
the depreciation in the pound and continuing global economic growth. Nevertheless, it is likely that credit conditions will
remain restrictive for some time and the need to strengthen public and private sector finances will weigh on spending.
Furthermore, the UK needs to secure growth from investment and net exports, rather than from household and
government spending. There is no doubt that the outlook for the global economy remains mixed, particularly with the UK’s
main trading partners. While the US has revealed strong fourth quarter GDP growth (5.9% on an annualised basis), recent
data from the eurozone area shows that GDP growth stalled (plus 0.1%, with Germany recording no growth at all). The
latest consumer confidence survey data in the US and Europe have fallen back, while the continuing severe winter
weather has further undermined any growth in retail sales. In recent comments the governor of the Bank of England did
not rule out resuming its quantitative easing programme if it was needed. The continuing uncertainty over the strength of
any global recovery was reflected in a reduction in the forecast level of GDP growth over the current, and next, years,
since the Bank’s last Report in November. This shows GDP growth reduced to around 1.3% (from 2.2%) in 2010, similar
to most other forecasts, and to 3.3% (from 4.1%) in 2011 – still well above forecasts (of around 2.25%) from the Treasury
and private sector economists. The European Union has recently reduced its forecast for UK GDP growth in 2010 to just
0.6% (from 0.9% previously).
As regards inflation, the overriding impression is that the Bank does not consider it to be as big a problem as the
uncertainty over GDP growth prospects. While CPI has more than trebled since last September, the Bank believes the
pressures to be largely one-off, and temporary, and that CPI may now have peaked. The main reason for this view is that
as the impact of sterling’s depreciation and the restoration of the VAT rate wane, downward pressure from the persistent
margin of spare capacity in the economy will result in inflation falling back over 2010 to around 1%, before rising again
back slowly towards the 2% target level in 2013. This forecast is significantly different to that made in November’s Report,
both on the short term upside and the greater subsequent decline. In addition, the time scale of inflation’s following rise
has been extended. Many economists however remain sceptical, as the forecast relies heavily on the amount of spare
capacity in the UK economy. They believe that the scope for further reductions in unemployment levels are limited
(companies have ‘hoarded’ key workers on reduced wages), unless there is sustained economic growth, putting further
pressure on wages. In addition, the UK economy has contracted by 6.2% since the second quarter of 2008, and some
5% of output may have been lost forever – based on the fact that some manufacturing capital has been scrapped in the
recession – and business investment levels have been severely reduced. Furthermore, the demise of numerous
companies has reduced competition, allowing survivors to maintain prices. These circumstances could, some economists
believe, lead to a situation of weak GDP growth, but firm prices and wages, resulting in more resilient inflation levels than
are currently predicted. Overall, the outlook, therefore, is highly uncertain, but most likely it is for a slow and bumpy
recovery.

First Equity Limited

Salisbury House, London Wall, London EC2M 5QQ
Tel: 020 7374 2212 Fax: 020 7374 2336
Website: www.firstequity.ltd.uk
Paul Henry
email: paul.henry@firstequity.ltd.uk

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