Brewin Dolphin Holdings plc : Equities are overbought so mind the consolidation

11 January 2012

Two of four technical indicators I look at for the UK equity market are now registering an overbought condition. The last time the market reached a similar condition on the same indicators was October 2011 when the FTSE 100 failed to get much past 5700. The area around this level might now be offering resistance. The trick as always is gauging the reaction. Does a major sell-off lie in store, a minor retreat or just a pause for breath? If there is a reaction, our sense is it will be the latter or nothing more than a shallow retreat and that the momentum that helped the FTSE 100 to climb some 16 percent from this past October's low will resume. At least four features suggest this.

First, and without elaborating, the tone of the US news flow is indicative of an economy that is regaining momentum. An encouraging sign, among others, is the underlying trend towards improvement in the nonfarm private sector payrolls. Behind this lies the Fed's commitment to keeping policy easy for some while.

Second, there is a sense of determination that the Intergovernmental Treaty, to which all eurozone members and most EU members agreed, should be ready for signing by March 1. If this happens, the 'fiscal compact' will come into being along with the enforcement mechanism behind the rules applying to fiscal governance. That will be a big step forward in the resolution, over time, of sovereign debt sustainability.

While the resources available to the European Stability Mechanism remain an open issue, this is supposed to become operational this July (the European Financial Stability Facility is still to run until mid-2013). Importantly, the ECB has now demonstrated, in no uncertain terms with its three-year Long-Term Refinancing Operations, its readiness to stand behind the banking system.

Thus, it may come to be that a credible framework for managing fiscal integration for the eurozone, with or without Greece, is being finally put into place. This, together with the ECB's support, should subdue the destabilizing forces that have unsettled equity markets and pushed yields in quality government bond markets to record lows.

A third feature relates to the developing world which, with its loss of momentum, is starting to refocus the policy effort on growth after having focused on inflation. Brazil has led the way on this among the BRICs and Russia is following. China's central bank has started easing by lowering reserve requirement ratios and is expected to lower them again shortly. Though it is not available for much of the developed world, expansionary fiscal policy is also an option for the developing world. With plenty of scope to stimulate demand through conventional means, the emerging economies can be expected to continue making a substantial contribution to supporting global growth.

Fourth, the FTSE 100 has managed to get through its 200-day moving average, which it did not do this past October, suggesting the momentum players could be inclined to stick with it.

You might say that the fundamental features account for the rebound in equity markets in the first place and maybe the latter technical point. Also, the earnings outlook remains unusually uncertain and earnings estimates for 2012 are still being revised downward, though equity markets have discounted much of this. However, as highlighted in Amid good news and bad news equity markets wait for a lead, mounting tension over US and EU sanctions in relation to oil imports from Iran could boost the oil price thus impairing
the prospects for global growth.

These are risks but, as indicated, all is not bad and for the one economy that still has a lot to do with providing financial market leadership, notably the US, the prospects are looking up. Also, to repeat the point included in the highlighted note about ECB action speaking louder than words, the stress in funding markets for the eurozone banks may now be dissipating, as the chart shows. If sentiment towards the banks is in the process of changing, it is also likely to be changing for equity markets - for the better.

IMPORTANT NOTES
The information contained in this report represents an impartial assessment of the value or prospects of the subject matter. Graphs, performance data etc are as at the close of business on the day preceding the date of the note. The information contained in this report has been taken from sources disclosed in this presentation and is believed to be reliable and accurate but, without further investigation, cannot be warranted as to accuracy or completeness. The opinions expressed in this document are not the views held throughout Brewin Dolphin Ltd. No Director, representative or employee of Brewin Dolphin Ltd. accepts liability for any direct or consequential loss arising from the use of this document or its contents. We or a connected person may have positions in, or options on, the securities mentioned herein or may buy, sell or offer to make a purchase or sale of such securities from time to time. In addition, we reserve the right to act as principal or agent with regard to the sale or purchase of any security mentioned in this document. For further information, please refer to our conflicts policy, which is available on request or can be accessed via our website at www.brewindolphin.co.uk. The value of your investment or any income from it may fall and you may get back less than you invested. Past performance is not a guide to future performance. If you are in any doubt concerning the suitability of these investments for your portfolio you should seek the advice of a qualified investment adviser. Brewin Dolphin Ltd, a member of the London Stock Exchange, authorised and regulated by the Financial Services Authority. Registered office: 12 Smithfield Street London EC1A 9BD. Registered in England and Wales no 2135876.

If sentiment towards the banks is in the process of changing, it is also likely to be changing for equity markets - for the better.