View from City Road: Japan and hope alone support the market

Yesterday's surge in the stock market had a different feel to the bull market of recent weeks. Until now, shares have largely been driven on hopes that interest rates would continue to fall. Cash would be sucked into higher-yielding securities - both government bonds and shares - simply because the alternatives look so unattractive. If a bank deposit is returning only 5.8 per cent, why not go for Thames Water on a prospective dividend yield of 5 1/2 per cent?

But yesterday's trading may mark a change. Gilts retraced a little of the ground they had taken over the past few weeks, failing to participate in the rally. Moreover, the pattern within the equity market was different. Instead of the charge being led across the board, the main gainers were in sectors that have suffered over the past year.

These are signals that the market is heading into choppy waters. Although the leading stocks look well- supported with the FT-SE 100 index at around 3,000, a more enthusiastic run begins to be too demanding of likely profits growth. After all, the companies that have reported recently - Hanson, BICC and BOC - have emphasised the patchy and weak nature of the recovery. Yesterday's figures for retail sales volume should underline the caution. Not for the first time, the economists appear to be more optimistic than the company chairmen.

Perhaps as a result, investors are heading into stocks that have suffered some fairly savage downgradings over the past year even though, in the case of Glaxo and SmithKline Beecham, there was little comfort in the news that President Clinton had not stressed drug prices in his recent pronouncements. This may be natural contrarian thinking. For the more sceptical, it looks like an increasingly frenetic hunt for any value left in the market.

There is, though, one bull scenario that could take the market into new territory. Nick Knight, the arch-bull at Nomura, thinks that Japanese funds may switch heavily out of the Tokyo market and into overseas equities, driven by the adverse impact of the high yen on corporate profits and by the cheapness of other markets when seen from atop a yen worth nearly a cent. With other houses also reporting heavy overseas interest yesterday, share prices may head even higher for a while. At these levels, though, the market is increasingly fuelled by hope.