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Last Updated: Tuesday, 16 November 2004, 00:01 GMT
Will the share rally last?
By Justin Urquhart Stewart
Seven Investment Management

FTSE 100's performance over the past year

The FTSE 100 broke through the 4,800 barrier on Monday, reaching a 28-month high. Are the good times back for investors in the stock market? A leading commentator explains why the market is more upbeat - but cautions investors who are now looking to re-enter the fray.

Forty-six per cent is not a bad rise in an index by anyone's measure.

From its nadir of 13 March 2003 the FTSE 100 has risen from 3287 to something far more respectable and is striving for 5000.

Remember though that this is still nowhere near its peak of 6950 achieved on 30 December 1999. The questions are though - is it sustainable and can it go higher?

The UK market behaves very differently from our cousins in the US. They seem to thrive on eternal and sometimes misplaced optimism, whereas we seem to take on many of the characteristics of Victor Meldrew - if it's bad news "I told you so": if it's good news - "I don't believe it".

Justin Urquhart Stewart
Justin Urquhart Stewart: Short-term confidence

Compared to the US, UK stocks can be seen as being relatively cheap (MSCI UK Share Index trades on 13.9 times earnings as opposed to 18.4 in the US) but that is nothing new and the UK market has traditionally traded at a discount to its US peers.

However, there is a combination of factors here that is making the UK markets react more positively than some had expected.

Most recently it has been the fall in the dollar. This has sent many international investors searching out for safer homes as both euro and sterling values have been rising against the greenback.

The unofficial policy of the Bush administration to weaken the currency has been loudly broadcast and seems likely to continue for the time being. The resulting rush to other assets is inevitable.

Comfort blanket

But why London? Firstly there is that old fashioned issue of Anglo-Saxon markets.

For the Americans investing in London it seems the closest market structure to their own, from language to regulation, whether you approve or not, London often emulates what it sees in New York. This at least comforts US investors.

Secondly UK companies have been throwing off excess cash.

Cashflow yields are at historic highs and companies are actively returning excess capital to shareholders.

This is appealing to US and other investors and has gone someway to negate the equity sales from UK pension funds trying to reallocate their assets away from such high proportions of equities.

To this add the amount of merger activity going on, where private equity firms and active entrepreneurs like Philip Green have been seeing value where others couldn't. This shows a level of confidence in values which in turn will draw others in.

It is exactly at moments like this when everyone is convinced of a rising market that investors fail to see the cracks opening up below them
Justin Urquhart Stewart

Look then at the constituents of the FTSE 100 and you find that this relatively defensive index has been held back by some key areas.

However, the past few months have seen far greater interest in oils and mining, heavily weighted in the index. Add the extra fuel of UK interest rates nearing their peak, and telecom companies becoming of more interest and the other two key areas of weight in the index, banking and telecoms, start to move this juggernaut forward.

The result then is inevitable and can be seen in trading volumes. Once the index gathers momentum then private investors are attracted in, confidence grows and so it can become a self-fulfilling process - for the moment.

But beware; it is exactly at moments like this when everyone is convinced of a rising market that investors fail to see the cracks opening up below them.

With the after glow still warming hearts of US investors following their election, much of this confidence has been exported to the UK and may indeed run up for an end of year rally.

But please beware rallies of short term confidence are often blind to the future - and most of the world's forward indicators are pointing one way - down.

Invest in the rally by all means, but be ready to take your profit.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.

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