View from City Road: Equities strong enough to see off the bears

Less a bloodbath, more a cold shower. The London stock market pirouetted neatly in mid- session yesterday to claw back 60 per cent of its initial mark-down as the expected wave of selling failed to materialise and Wall Street recovered its equilibrium. Long bonds shed barely pounds 1.

Plainly higher short-term interest rates in the US will reduce the appeal of equities relative to cash. But a quarter-point rise in the Federal Funds Rate, the first increase for five years or the longest easing of monetary policy for a generation, is scarcely going to provoke a stampede back into US savings deposits and money funds.

The bearish may reckon that the uptick in the Fed Funds rate, coupled with the rise that has taken place in US long bond yields in recent weeks, signals a turning point in the long bull run of share prices that began in the US and has been transmitted around the world.

History suggests, however, that a turnaround in short-term interest rates does not automatically lead to a peak in share prices, either in the US or the UK, at least for a year or two. There is no point in giving chapter and verse on this, since the only occasions when there has been an immediate and enduring depressive effect on equities from rising short-term interest rates has been in a period of crisis. The 1973 oil shock was one dramatic example. By contrast with the period before the 1987 crash, currency markets are now stable and President Clinton's 1995 Budget plans include the first drop in discretionary public spending for 25 years, which underpins currently low long-term yields.

In the UK, sterling's continued buoyancy against the German mark will lead to a further cut in short-term UK rates as soon as the Bundesbank moves. But the UK stock market is also moving into an earnings-driven phase that will gain support from the imminent 1993 results season. There is life in the old bull yet.