Stock Market Week: Health check shows market looking a bit under the weather

THINK OF the London stock market as a patient. Its daily ups and downs are its heartbeat, while the graph of its closing levels resembles a brain scan and provides a snapshot of its long-term condition.

Until last week, the patient appeared to be in reasonably good health, hovering near its record peaks.

However, the past few sessions have brought a considerable deterioration in the market's conditions. A series of four consecutive falls - only partially offset by Friday's tiny rise - slowed down the patient's heartbeat and caused an ominous blip in the brain scan. The shock has affected every layer of the market. The FTSE 100 is now on the verge of falling below the psychologically important 6,000 barrier while the FTSE 250 and the Small Cap are well off their recent all-time highs.

Is this the sign of a long-term illness or a seasonal cold?

A good way of taking the market pulse is to look at corporate earnings. With companies accounting for more than half of the market's capitalisation having reported their interim numbers, this is a good time to examine the earnings picture.

The vital issue here is to look how the actual figures compare with the market's expectations, as the discrepancy between analysts' predictions and the harsh reality of reported profits is a key driver of share prices.

A recent study by the ABN Amro strategist Gareth Williams shows that, in general, the UK plcs have done better than expected, outstripping analysts' forecasts by nearly 4 per cent.

The star performers have been the financial stocks which have wrong-footed many analysts with their first-half earnings growth. While the Square Mile's finest were fretting about bad debts, rising costs and Asian exposures and were forecasting an anaemic 0.3 per cent rise in profits, Lloyds TSB, Barclays and their peers came out with a stunning 6.3 per cent growth.

The software and and IT sector is another winner of the interim results season. The market was terrified that the end of the lucrative millennium bug contracts would savage the earnings of the computer specialists. However, a swath of companies - including Sage, Sema and Parity - dispelled those fears, calmly telling brokers that they have other business apart from the Y2K problem and posting an average 38 per cent-plus rise in profits.

The battered chemical companies are one of the unlikely heroes of the first half. Most industry experts were predicting an earnings bloodbath as chemical makers' profits were expected to have been savaged by the strong pound, low prices and rising competition. The City verdict was an average fall of more than 20 per cent in interim profits. However, ICI and others showed that they were down but not yet out with a mere 3 per cent dip in earnings.

On the negative side, construction companies were the biggest flop of the interim period, coming out with figures well below market expectations.

However, according to Mr Williams, the overall figure was slightly misleading as it was depressed by bad results from a couple of underperformers: building materials group Aggregate Industries and rail engineer BICC.

Food retailers are one of the better earners in the half so far and tomorrow, Tesco, the country's leading supermarket group, will have the chance to add to the sector's winning streak.

The City expects the "every little helps" chain to post a solid rise in pre-tax profits to around pounds 395 from pounds 371m last year.

Growth in sales should be robust after Tesco reported a 9.6 per cent rise in turnover and a 3.7 per cent jump in like-for-like sales at its June shareholder meeting. Industry experts expect this growth to have continued during the remainder of the half, even though margins are likely to have been curbed by the recent price war among the UK majors.

The performance of Tesco's growing overseas operations will be another item of interest. The company owns supermarkets in Central Europe, South Korea,Thailand and Ireland and could soon buy in Taiwan and Malaysia. With UK growth likely to be curtailed by the arrival of the price-cutting Wal-Mart, the overseas businesses are vital to Tesco's future and analysts will want to see some progress on both the sales and profit fronts.

The group's Internet operations will be in the spotlight too. The company has recently launched Tesconet - its free web service - and the subscriber figures will be keenly awaited. The company's management - led by chief executive Terry Leahy - will also be quizzed on their mooted plan for a chain of Internet cafes.

The other hot topic for discussion is consolidation among UK and European food retailers. Ever since Wal-Mart swooped on Asda, Tesco has been rumoured to be planning a counter-move. Wild rumours of a merger with Marks & Spencer or Kingfisher are fading but the market is still convinced that a deal, in Britain or Europe, is still on the cards.

The cement-maker Rugby Group is the other solid certainty on a barren results schedule. Pre-exceptional interims profits, due out tomorrow, should come in at around pounds 30m, compared with pounds 35.2m last year. However, the major talking point will be corporate activity. The struggling Rugby is constantly mentioned as a target for one of its European rivals such as Lafarge, of France. Last week, broker WestLB Panmure reawakened the rumours with the suggestion that any offer should be pitched at around 150p per share - a 45 per cent premium to Friday's 103p close.

The company could make it easier for bidders if, as rumoured, it announces the sale of its joinery operations with the interims. Analysts believe that the poorly performing businesses are a major deterrent for potential predators.

The drinks and hotels group Bass could generate some interests with its trading update on Thursday. Investors will want to be reassured that recent rumours of tough trading in Bass pubs, especially in the North, were just idle market talk.

The only other item of interest is today's flotation of MG, the metal trading arm of German industrial giant Metallgesellschaft. The shares should start conditional dealings at around 215p, valuing the company at pounds 215m.

PS: If you are reading this in the morning, spare a thought for the thousands of brokers who had to get in an hour early due to the Stock Exchange's new 8am opening time.