Market report: London nears another peak, but the view from the top is cloudy

INVESTORS IN UK equities could be forgiven for feeling queasy. The first nine months of 1999 have been a roller-coaster ride as the FTSE 100 and junior indexes swung between rallies and slumps. But recently the market has been on the up again, and the blue-chip index is less than 2 per cent off its all-time high.

You can already hear brokers and dealers screaming that a new peak is on its way, but a wider look suggests that UK equity players have very little to shout about. Compared with rival funfairs, London's ride has been disappointing. By most yardsticks our leading stocks have underperformed their US, Japanese and European counterparts.

A study by Bob Semple and David McBain, UK equity analysts at Deutsche Bank, shows that the total return of the FTSE 100 over a year is a mere 8.6 per cent, compared with 13.4 per cent in the US and an astonishing 55.9 per cent in recovering Japan. If you had put pounds 100 in the UK at the start of the year and reinvested your dividends in the market, you would be 5 per cent poorer than a carbon-copy US investor.

In the past three months the UK has also lost ground to the booming continental European bourses. As the German and French markets raced towards peaks, London was caught in a mid-term crisis that saw the FTSE flirt with its yearly low last month. In the three months the blue-chip index returned just 1.1 per cent, compared with the 3.5 per cent of continental rivals.

The story behind the numbers is clear enough. Despite the City's recovered enthusiasm for equities, London still lags its peers. The key question now is: will the UK market's underperformance continue, or are we seeing the green shoots of a genuine recovery ?

The bears say London will be under the cosh for some time, for three main reasons. First, fears over the Bank of England's aggressive monetary policy, and the view that the Monetary Policy Committee (MPC) is not prepared to "give growth a chance" and will increase rates at the first whiff of inflation. This is bound to create an unfavourable climate for investment in equities, especially compared to the US.

The second point is the poor outlook for UK corporate earnings. Second- quarter profits of UK companies, excluding volatile oils, were still below last year. A few surprises since then, notably from BT last week, should help redress the balance, but many analysts still expect 1999 to be worse than 1998 for UK plcs. Again comparison with the US, which has seen strong profits growth, leaves the UK looking weak.

Third, the London sceptics also point to a liquidity drain. With pension fund cash balances near their historic lows, the big institutions will be reluctant to pile into UK equities.

As you would expect, the bulls ride roughshod over these points, arguing that the London market is ripe for a rally. On monetary policy, they say the MPC's keenness to pre-empt an inflation spike will foster the right not-too-hot, not-too-cold climate for equity investment. As for US comparisons, the pro-London party advises investors to wait for next week, when the allegedly-more lenient Fed could yet spring another rate hike on the market.

In the bulls' eye view, the liquidity and corporate earnings issues are linked. They concede that pensions funds' cash levels may be low and the earnings outlook uninspiring, but where else can UK investors put their money?

In today's financial climate there are very few better investment vehicles than stocks. Bonds are certainly not; over the past few weeks, fixed-income instruments have lost most of their appeal as a strong rally in bond prices sent yields sharply down. UK gilts have risen more than most and the subsequent fall in yields has left UK equities looking rather cheap compared with bonds.

But both bulls and bears will have remarkably little to get their teeth into this week. Most of the excitement comes tomorrow, when Vodafone unveils its first interims since the acquisition of US rival AirTouch. These will be an accounting nightmare because of the deal, but most analysts are looking for earnings before interest and tax (EBIT) of about pounds 940m. The group is expected to have seen strong growth, thanks to a boom in its European, Middle Eastern and African operations. However, the numbers will be a sideshow; what the market really wants to know is whether the growing rumours of a hostile Vodafone bid for German rival Mannesmann are true.

The utility Scottish & Southern Energy is also due to report the first interims since the merger of Southern Electric and Scottish Hydro-Electric. Pre-tax profits, due on Wednesday, should come in at about pounds 185m up from pounds 171.5m last year.

However, the post-figures debate will be dominated by regulatory and corporate issues. SSE is awaiting the completion of five competition reviews, including the all-important probe into distribution agreements. This inquiry is due to finish in December and there is a feeling that it will propose a tough set of measures against the electricity generators.

Industry experts will press SSE to quantify the merger's benefits and will want to see evidence of the first savings coming through. As for corporate action, speculation is mounting that SSE could use its ungeared balance sheet to bid for a water or power company.

Glaxo Wellcome is the other blue-chip due to address the market. On Wednesday, the drug giant will update analysts on trading in the past 10 months. With rumours of a deal with SmithKline Beecham doing the rounds once more, all eyes will be on Glaxo's troubled US and Latin American operations.

Retailer Storehouse, owner of Bhs and Mothercare, will unveil interims on Thursday amid reports that a break-up is nigh. A progress report on the search for a new chief executive will also be sought. The numbers will be poor, but not unexpectedly so; after the profit warning two months ago, Storehouse said it would plunge into a pounds 15m to pounds 20m loss compared with a pounds 38.7m profit last time.

Magazine group EMAP's interims today should show a 10 per cent rise in profit to about pounds 83m. The market will focus on the recently-acquired US magazine group Petersen, where advertising growth has been much slower than expected.

f.guerrera@independent.co.uk