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Interest rates burst stock market bubble.

Stock markets seem to have reached an impasse in the last month with trading choppy and directionless as the debate rages as to whether interest rates, both here and in the US, have peaked.

Mounting evidence on both sides of the Atlantic from areas like the housing market and shopping mall, suggests that higher interest rates, especially in the States, have brought that rampant economy to heel.

Combined with the severe shake-out in the technology market, higher borrowing costs might just have persuaded consumers that stock markets do not go up in a straight line forever and that at some stage you cannot forever borrow against asset appreciation.

Income requirement has made a comeback as evidenced by the outperformance recently of old economy yield stocks.

But, although interest rates may have peaked, a new worry has surfaced in the shape of the corporate earnings outlook.

With prices under continuing downward pressure from both private and industrial consumers' improved knowledge base because of the internet, the rapid upward movement in costs is resulting in a difficult margin squeeze.

Oil at $30 a barrel against only $10 just months ago, combined with sterling's weakness against the dollar, the currency in which most raw materials are priced, has made life tough for the manufacturing sector. The recent fall in the pound against the euro will help, but only after a delay as the bottom line will be currently hit by sterling's early strength which took the pound to 3.45 against the DM.

As a consequence, the stockmarket is well into a summer lull without any investment theme to hang its hat on - the froth having been blown away from the technology sectors and no other sectors having strong enough fundamentals to take up-market leadership.

At least the MPC left rates on hold and hopefully will again this week, although ominous noises about sterling's weakness and potential imported inflation are already appearing.

But, with the housing market coming off the boil and the pricing pressure mentioned above, it would indeed be a case of self-flagellation if the summer did not pass without a stable interest period.

Possibly the most important economic news to emerge last month was not the Standard Life's mutuality vote, but that company's offer of a 25-year fixed rate mortgage at 6.5 per cent.

At long last, we might be seeing a cultural economic change which finally eliminates the boom-bust housing market cycle in this country which, for as long as most of us can remember, has plagued the quest for economic stability. It has always been the housing market which has necessitied excessive interest rate swings to control it, ensuring investment decision-making for companies is a nightmare.

Houses might now become somewhere to live again and not, as seems to be the case in London and the South-east, another chip in the investment casino.

In time, this change would result in much lower longer-term interest rates, steadier growth and a much healthier economy.

For the stock market, is should also mean a closing of the major discounts to asset values seen in the property and housing building sectors.

A string of recent privatisation and sales in these areas from MEPC downwards are suggesting that the stockmarket. in its concentration on indexation in the major Footsie stocks like Vodafone, is completely mis-pricing a vast number of good companies who patently do not need the stock market anymore.

Likewise, this pricing failure is allowing many UK companies to fall into foreign ownership, however competent their management might be.

Turning to the Shareleagues, the return to safety and yield stocks is evident with Powergen and Severn Trent topping the Major League.

It may be that the recent decision by Kelda, the Yorkshire water company, to become a mutual, will set a trend. It will of course beg the question of why the water and electricity companies ever floated in the first place as most of them have ended up as subsidiaries of foreign giants who are now contemplating selling them off again.

Third in the Major League is IMI, benefiting no doubt from a solid AGM statement and the decline of the pound against the euro currencies, given the group's major European exposure.

In the Medium Company area, McKechnie continues at the head of affairs awaiting the mangement buyout terms.

The decision by Britax to sell its automotive business for pounds 207 million saw the shares rally, although the comments by Richard Marton on pricing difficulties in that industry underlines our earlier statements about corporate profitability.

H P Bulmer featured in third place possibly aided by the consolidation of the drinks industry highlighted by the sale of the brewing operations of both Bass and Whitbread.

At the Smaller Company end of the Shareleague, recovery buyers pushed Frederick Cooper up from 27th to fourth place while Eliza Tinsley moved into second place following its annual figures and prospect of international alliances.

The old economy stocks also featured with strong rises in two basic product companies making bricks and crockery, Baggerage Brick and Portmeiron Pottery.

Shareleague monitors the performance of West Midlands plcs. Percentage figures are rounded up.
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Author:Securities, Tom Morris-Jones Chief Economist Old Mutual
Publication:The Birmingham Post (England)
Date:Jul 5, 2000
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