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The further loosening of monetary and fiscal policy, particularly
in the US, saw a marked improvement in optimism for a global
economic recovery in 2002/3. Cuts of 25bp in October and then
a further 50bp in November by the MPC were reflected by a steepening
of the yield curve, with the UK 2 to 9 year gilt yields generally
moving up about 20bp over the quarter and the UK Government All
Maturities Index posting a negative capital return of 1.0%. In
the US cuts in the Fed Funds rate from 3% to 1.75% over the quarter
had a similar impact, with the US 10yr yield rising from 4.6%
to 5.1% over the quarter and the US Government All Maturities
Index posting a negative total return (capital and income) of
0.6%.
In spite of a rally in the majority of global equity markets
during the closing quarter of 2001, the major indices posted
a negative return for a second consecutive year. For the UK the
bear market lasted 21 months from the first day of 2000 to the
final capitulation on 21st September 2001 by which point the
FTSE 100 had lost up to 36% of its peak value, making it the
most severe decline since the 1973-4 collapse. The broader FTSE
All Share index, in spite of a 7.84% rise (the best quarterly
rise since Q4 1999) declined over the calendar year by 15.41%.
Small cap stocks rebounded strongly after their 26.0% decline
in Q3, rebounding by 20.8% in Q4.
Amongst the sectors that contributed to the bounce in the
indices were the technology sectors, with the FTSE All Share
Electrical & Electronic Equipment index rising 96.56% over
the quarter and the Information Technology & Hardware index
appreciating by 68.7%. This return to favour for technology stocks
largely mirrored price movements in the US, as evidenced by the
30.1% appreciation in the Nasdaq Composite index over the period.
Similarly the more diverse Dow Jones and S&P 500 indices
enjoyed strong recoveries, gaining 13.3% and 10.3% respectively,
but still ending the year down 7.1% and 13.0% (all in US Dollar
terms). In spite of continued signs of difficult economic conditions
in a number of core markets, European equity indices also posted
gains, with the Eurotop 300 advancing 11.5% (in ¤), whilst
in Japan, where the Yen fell by more than 10% against the US
Dollar, the Nikkei 225 benefited from a only small bounce of
7.9%, only partially offsetting last quarter's 24.6% decline.
The fourth quarter rally was fuelled in no insignificant way
by the unexpected scale and resolve of the global coalition and
the seemingly rapid progress made in Afghanistan against the
Taliban regime as part of the "War on Terrorism". Past
conflicts, particularly in the Middle East, have resulted in
short term spikes in the oil price which has exacerbated recessionary
trends. This threat to economic recovery has not manifested itself
this time around and equity markets have drawn further comfort
from signs that warmer relations between the US and Russia may
serve to reduce the Middle East's influence over US fuel costs.
In addition, consumer spending has remained remarkably robust
despite the gloomy environment. This improvement in investor
sentiment saw a number of the more defensive sectors lag the
overall market move, with Pharmaceuticals being the most significant
downward pressure on the index, posting a negative return of
6.8% in the UK, reflecting a rotation into sectors geared towards
an economic recovery.
In currency markets the US Dollar reversed part of its third
quarter declines, appreciating against both Sterling (+1.3%)
and the Euro (+2.4%). Nervousness about potential logistical
problems ahead of the launch of the Euro coins and notes on 1st
January served to undermine the fledgling currency over the period.
Historically bear markets have tended to end in the US during
recession and typically around 6 to 9 months ahead of the economic
recovery. Whilst events in September may have created exaggerated
equity market and consumer sentiment lows, they also served to
kick-start more aggressive monetary and fiscal easing to stimulate
the US economy which, subsequent data has now suggested, was
already in recession by the third quarter, well before the tragic
events of 11th September. These measures may, in turn, prove
to have been key elements in the reversal of the attritional
declines in investor confidence through the first 9 months of
the year and hence the turnaround in equity market values seen
in the closing quarter of 2001. Markets have already bounced
substantially off their year lows in anticipation of a recovery,
fuelled by the surge in liquidity pumped into the financial system,
with the more cyclical sectors providing much of the upward impetus.
In some sectors the moves have been quite substantial, and it
is now a case of companies delivering on the growth implied by
current valuations. In an environment of low inflation, however,
expectations for the rate of future growth will need to be tempered
and investors may find that some projected returns are over optimistic.
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