Investment

31 May 2007

Reader Writes:

I notice the stock market has performed very well and I am wondering whether or not it is time to consider investing more or whether or not to wait.

No doubt those who invested in the market in 2003 will have enjoyed the recent surge in markets. The current concern over the housing market, and of course rising interest rates, has encouraged investors to take profits from their property investments and we are seeing an increase in those with buy to let properties offloading some of the risk due to the decreased levels of profit on the transaction.

An increase in supply is inevitable as certain truths come home. On the 6th of October 1989, rates peaked at a mere 14.875%. (1)This more or less signalled the beginning of the house market crash with house prices plummeting and not recovering for seven years. Moreover a simple cash investment in 1990 would have outperformed the housing market by over 100% over the next ten years. (2)When sentiment turns, it can really turn. The cost of borrowing has increased to no-where near the levels above but most people have been budgeting at a level below today’s rate when looking at buy to let arrangements and personal mortgages.

Rates hit their floor at 3.5% on the 10th of July 2003 and have risen consistently since then despite one blip on the 5th of August 2004 where they dropped by 0.25% and remained the same for a year. The cost of borrowing since the low of 2003 has now risen to 5.5% with further rises threatening.(1) In real terms this is a rise in debt costs of over 57% and will naturally have its toll on the buy to let investor who will not have had those sorts of margins to play with. We’ll see.

In the equity market, most of the activity has come by way of mergers and acquisitions (M&A) and it remains to be seen whether or not this will continue at its current pace. The general reaction of M&A activity is to drive prices forward as companies, flush with cash, seek to consolidate their position by aggressive and non aggressive takeovers alike. The market reacts by equities surging in price as the bids for mergers continue. Whilst the market will no doubt second guess all the potential bids and takeovers, there is another benefit that will occur in the market:

Management are mindful of the impending threat of takeovers and are being forced into adding value back to shareholders through value adding decisions in order to warn off the circling M&A buzzards. Whether or not this M&A will continue remains to be seen but tightening of monetary policy by banks won’t assist.

Its normal after the reporting season has finished, for markets to remain flat and we all know of the saying, sell in May, go away and buy again on St Leger’s day.
In September 1776, just a few years after the founding of the London Stock Exchange, an Irishman, Anthony St Leger, first ran his flat race at Doncaster. It still runs today and marks the end to the flat racing season, but who would have believed that this event would lend its name to an investment theory?
The theory actually relates to the fact that post the reporting season, activities go very quiet, volumes of trading remain unexciting, and naturally the markets tail off, with September, in the past, having a bad time of it.

The natural threats exist with hedge funds creating lots of noisy data through their trading strategies but the threat for the US economy is not to be ignored.

Their interest rate cycle is ahead of the UK and their falling house prices could easily hit the market sentiment which, if further bowled by any inflationary shocks could be unhealthy. As an upside in the current flatness, consider that companies are also purchasing new shares through buybacks – a sign they have belief in their offering or maybe just too much cash! 


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(1) source bank of England.co.uk – rates attached
(2) Hindsight – graph attached