London shares on the march

A GROWING number of equities analysts, funds managers and other sharewatchers believe that the London market is set for a long rally into the autumn and winter. That is because, following the Dow's dizzying 700- point rise since last November, many UK shares now look cheap compared with US equities.

Even if this week's 120-point price dip turns out to be the overdue correction predicted by Wall Street's doubters, it may not extend to London. The FT-SE 100 index has still not regained its peak of 3,594 of February 1994, and the London market looks undervalued.

"There comes a point when institutional investors will begin to think the US markets have peaked and begin to move their money into those that are underperforming," said Marcus Grubb, SBC-Warburg's London-based global equities strategist. "I don't think that point is too far away now."

London shares have been dampened for months by Tory Party bickering and infighting. Nevertheless, Britain today provides a pretty stable environment for international investors. Interest rates have ratcheted up to 6.75 per cent from their low of 5.25 per cent last September and may now have peaked, with perhaps one more small rise to come. Growth and jobs remain manageable, with unemployment projected to shrink to 7.5 per cent in 1996 from today's 8.2 per cent, a point still short of where labour market capacity constraints start to create inflationary wage pressures.

The pound has stabilised, thanks in part to recent cuts in Japanese and US interest rates, with France and Germany perhaps to follow soon. For US investors the picture looks encouraging. For the past three years, sterling has moved closely with the dollar within a narrow range of around 1.5 to 1.6. So dollar investors in pound-denominated stocks are exposed to only the smallest of currency risks.

Right now, many stocks trading on the London exchange look like bargains to US investors. P/e ratios of 13 to 15 are not uncommon, where 17 to 20 is more the rule for Wall Street. "The London market is the second cheapest in the world right now, measured by either p/e or dividend yield," claimed Pathmajan Rasan, UK equities strategist for Salomon Brothers (Stockholm is cheapest by p/e and Madrid by dividend yield). "Margins are still improving in Britain, while US profits and margins are almost at peak. I think we are just at the beginning of a bull run here." The UK equities market has lagged that in the US by 10-15 per cent so far this year. It may well catch up in the months ahead.

It is important to remember that Britain lags the US by about nine months in the current economic cycle: Britain went into recession later and emerged later. So the frenzied run on technology stocks that has accounted for much of the US advance this year has not happened here yet. UK telecoms and electronics stocks may well be positioned for such a take-off.

Analysts like British Telecom and Cable and Wireless, with both firms likely to compete well against the sluggish state-owned German and French phone companies in Europe's increasingly deregulated telecoms market. Another stock to watch is the smaller Farnell Electronics, a UK distributor of microchips and other components. With a market capitalisation of pounds 866m and pounds 73m in projected profits this year, its share price could enjoy a healthy bounce.

Many analysts agree that British consumer stocks are likely to stage a decent recovery this year and small-to-mid caps will probably outperform blue chips across a broad range of sectors. "During the past months of uncertainty investors played it safe with the big FT-SE blue chips," said Mr Rasan. "Now they're more relaxed, and the climate looks good."

As the Tories stumble toward the next general election, they are likely to offer some sort of tax cuts and other handouts to win votes and improve their bleak position in the polls. November's Budget is likely to carry a consumer flavour, including some relief for the moribund housing sector. For the million households in negative equity, that would be a great relief.