Volatility… but also value in the UK, says HAMISH MCRAE

Ouch. Every time UK stock prices make a new high, something comes along and hits them on the head. The FTSE 100 index fell to 7,336 after rising to 8,047 in intraday trading last month before closing at 7,405 on Friday.

That trading bottom was a nearly 9 percent drop from the high, so not quite a technical “correction,” the word being used to describe a 10 percent drop. But it’s an uncomfortable reaction to ongoing fears about the stability of the global banking system, and more problems could lie ahead.

But exceptionally, the gloom is imported. Several US banks have been in trouble, including Silicon Valley Bank. Credit Suisse was rescued by its competitor UBS in a somewhat controversial manner.

Deutsche Bank shares were under pressure, temporarily falling 14 percent, but then recovering somewhat. Unsurprisingly, UK bank stocks have also fallen, but I really don’t see any major UK bank in serious trouble. Funds are flowing back into the UK end of SVB after being bailed out by the powerful HSBC earlier this month. In tough times there is something to be said for having banks that are well capitalised, profitable, conservatively run – and large.

However, a sudden slump in stock prices does not come without fundamental concerns about the global economy, and companies in the Footsie derive three-quarters of their profits from outside the UK. So the real question is to what extent these concerns are justified. Let’s try to unzip them.

Volatile: History doesn’t tell us which companies will fail and which will thrive

First and foremost is the concern that central banks will raise interest rates too much, or at least too quickly, which will put unpredictable pressure on the banking system. Having made the mistake of not taking the risk of inflation seriously and delaying action, they are now overcompensating.

There’s something to that. Interest rates in the US and UK are now likely high enough to bring inflation back to acceptable levels by the end of this year.

Last week’s 0.25 percent hikes by both the Federal Reserve and Bank of England may have been a mistake. There are always two considerations that a potential borrower has to face: What is the interest rate and can you still get the loan? When the money is difficult to borrow, and credit conditions are certainly tightening because banks are worried, you don’t need higher interest rates to stifle demand.

But even if those increases were a mistake, struggling for a 0.25 percent increase seems odd. Central banks can reverse their policy at any time. The rise in the consumer price index here to 10.4 percent will turn out to be an outlier in my opinion. If inflation falls even faster in the autumn than the Bank of England expects, we could be back to, say, 3% bank rates by Christmas. The second set of concerns is that behind the loss of confidence in some of the weaker banks is fear that too many of their customers will find themselves in trouble.

There will be corporate bankruptcies, and history tells us that this always happens when interest rates are rising. Unfortunately, history does not tell us which companies will collapse and which will break through bloody but unbowed. There are always nasty surprises in this phase of the cycle.

The third concern is more general. The fact is that there will indeed be some sort of global recession, and it will erode corporate earnings. As far as the UK is concerned, the clouds have cleared up a bit in the past few weeks – actually as I expected. Bank of England Governor Andrew Bailey now believes we will emerge from the recession this year. The latest retail sales numbers are quite strong and PMIs are forecasting some growth led by services.

This all comes on top of a solid earnings season from the largest Footsie companies, some of which have increased their dividends and/or announced share buyback programs. You won’t increase your dividend unless you’re confident about earnings next year.

But there is at least a possibility that the US banking turmoil will push the US economy into recession. As Brett Nelson, asset allocation guru at Goldman Sachs, put it, “We find the case for a recession about as compelling as the case against a recession.”

um My view is that while the “correction” still has some time to go, the right timing can never be achieved. The UK market at least offers decent value for money, even better value than the much larger US market.