Issue 75 | November 2009

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Fragile confidence continues to be tested

UK Equity Market

ASX - FTSE ALL-SHARE INDEX

DaiIy 10/30/08 - 10/30/09
Last Price 2630.38
High on 10/19/09 2715.26
Average 2233.27
Low on 03/03/09 1781.64

Source: Bloomberg
The UK market: fragile confidence continues to be tested
October started weakly, as a combination of investor concern over the outlook for the global economy, and a sharp rise
in US non-farm jobless numbers (to a 26-year high, equivalent to 9.8% of the working population), resulted in the
FTSE100 index moving below the 5000-level again. However, the mood soon changed with the release of positive
economic data, and, as global demand continued to drive commodity prices higher, boosting share prices in those
heavyweight sectors. During the middle part of the month the FTSE100 index continued its strong, if highly volatile,
upward trend as investors shrugged off disappointment that the UK’s third quarter GDP did not return to growth (leaving
it standing alone compared to most other major industrialised nations) together with the poor state of public finances,
to reach a series of new 12-month highs (flirting with the 5300-level). A significant part of this optimism came from the
better than forecast third-quarter corporate earnings results from many major companies, although there is scepticism
over the sustainability of much of the drivers (cost savings and a rundown of inventories) of those figures. However, the
last third of the month again saw increasing unease from investors, leading to some profit taking selling, as weak retail
sales figures in the UK highlighted concerns that while industrial companies in developed economies have seen a
rebound, consumer-facing companies are still struggling to improve revenues. At the end of the month markets were
generally weaker as risk aversion again increased (poor US data on consumer confidence and new home sales) together
with uncertainty over US, european and UK central banks’ future policy (all are due to meet early in November) regarding,
in particular, the continuation of the various stimulus programmes. These factors provided further ammunition for the
growing view that the seven-month rally in equities has run out of steam, which, despite, at the end of the month, the
return to positive US GDP growth in the third-quarter, provided only a temporary respite before equity markets again
turned sharply lower.

Economic Indicators due in November

Announcement Date
US interest rates (FOMC) 4 November
UK interest rates 5 November
ECB interest rates 5 November
UK employment figures 11 November
Eurozone Consumer Price Index (inflation) 16 November
UK Consumer Price Index (inflation) 17 November
Monetary Policy Committee meeting notes 18 November
US CPI 18 November
UK retail sales 19 November

FTSE 100 Company results due in November

Company Date due Type of result Company Date due Type of result
Marks & Spencer 4 November Interim British Land 17 November Interim
Cable & Wireless 5 November Interim Burberry 17 November Interim
Invensys 5 November Interim Experian 18 November Interim
Man Group 5 November Interim Icap 18 November Interim
Vedanta Resources 5 November Final Land Securities 18 November Interim
BA 6 November Interim National Grid 19 November Interim
Imperial Tobacco 10 November Final SABMiller 19 November Interim
Vodafone 10 November Interim Severn Trent 24 November Interim
Sainsbury 11 November Interim Compass 25 November Final
Scottish & Southern 11 November Interim Johnson Matthey 25 November Interim
BT 12 November Interim London Stock Exchange 25 November Interim
3i 12 November Interim United Utilities 28 November Interim
Lonmin 16 November Final

Source : Companies
Sector Performance during October
Top 5 % Bottom 5 %
Forestry & Paper + 9.2 Support Services - 8.9
Leisure Goods + 8.5 Construction & Materials - 8.4
Chemicals + 5.0 Electricity - 8.4
Beverages + 4.7 Banks - 8.1
Personal Goods + 3.4 Travel & Leisure - 7.6
Source: FTSE International Limited

Poor employment prospects

Significantly better than expected news on unemployment in the UK was released earlier this month. The Office of
National Statistics (ONS) reported that during the three months to August the rate of increase in the level of
unemployment slowed considerably with ‘only’ 88,000 more people out of work compared to the three months to July.
This was the lowest quarterly increase for thirteen months, and left the total number of unemployed persons at 2.47m,
equivalent to 7.9% of the workforce – an unchanged level compared to the previous month. This percentage compares
favourably with levels of 9.8% in the US and 9.1% across the European Union. Furthermore, the picture has been
improving for some time, especially when compared to the figure of 281,000 persons made unemployed in the three
month period March to May this year.

The lower than expected rise in unemployment provides evidence that the UK labour market is performing better than
in previous recessions, with employers keen to retain skilled workers, where possible, rather than make them redundant
for short-term savings, only to have to go into the labour market to re-employ them as the economy picks up (hopefully)
later this year. This different tactic has been exemplified by the way businesses have used pay freezes, pay cuts and
offering workers time-off at reduced or nil pay rather than outright redundancy. In many cases employees have chosen
to see their pay reduced rather than be made redundant. The Chartered Institute of Personnel and Development also
commented that an important aspect of the slower than expected rise was due to the increase in part-time employment
for women. Although the impact of this was to emphasise the extent to which male employees have been harder hit
than women in this recession.

GDP growth Labour pains start to ease

(% change on previous quater) Number (m)

The government was concerned by the divergence between the two main measures of unemployment, that is the
claimant count (at 1.6m) and the Labour Force Survey (LFS) at 2.47m, although in recent months the figures have moved
closer together. Part of the reason behind the divergence seems to have beeen that the LFS includes some quarter of a
million full-time students looking for part-time work, who are not entitled to benefits, which is why they are not in the
claimant count. Also there appears to be a reluctance by unemployed second earners in households to sign up for
unemployment benefit. Another of the major concerns revealed by the recent numbers was the high number (946,000)
of 16 to 25 year olds out of work, although even this total number fell over the previous period – if only by 1,000. However,
if the number of full-time students looking for work is deducted the figure is significantly lower, although still worryingly
high. The government’s view is that the labour market has changed since the last recession in the 1990s, with more active
welfare to work programmes keeping people closer to the labour market and a stronger job seekers regime. This has
seen the number of people claiming the job seekers’ allowance rising by only 20,800 – the lowest increase since May last
year. This rise is a substantial decline on the rate seen between last October and April this year of around 60,000 per
month. Although economists believe that the reduced numbers may just be a delayed effect, rather than a significant
change in relationship with the overall number of unemployed. In further signs of a stabilisation of the labour market
vacancy levels, at 434,000, were unchanged in the three months to September compared to the previous quarter.

In addition, the picture from the employment side also looks better, with a fall of only 45,000 persons in work to 28.95m
in the three months to August. This compares to a decline of 269,000 persons in the previous three months. As the
Sunday Times recently pointed out the 5.9% fall in UK GDP has resulted in a 1.6% decline in employment, whereas in
the US second quarter GDP was down under 4% (third quarter GDP has returned to positive growth) but employment
fell by around 5%. This is a reflection both of the flexibility of the UK labour market and the government’s policy measures
in training and helping the unemployed get back into work.

The preliminary UK GDP estimate for the third quarter revealed a surprise contraction of 0.4%, against expectations for
modest (0.2%) growth, which had been based on numerous recent relatively positive survey data. This was, therefore,
the sixth consecutive quarter of declining growth, a fall of 5.9% since the recession began, the longest period of
contraction since records began in the 1950s. While it is likely that this early estimate will be revised upwards, as the data
is based on around only 40% of total hard data on output and nothing on spending and incomes, this initial figure is likely
to adversely impact on already fragile business and consumer confidence. The figures reflect a poor performance from
the construction, distribution hotels and catering sectors as well as negative growth in services output (although here
there was an improving picture), with only government spending showing a marginal increase. The continuing contraction
in the UK economy contrasts poorly with the French, German and Japanese economies, which revealed modest growth
in the second quarter of this year, while the US has also just returned to positive growth in the third quarter (although
much of that growth is a direct result of temporary stimulus programmes). As important as to when the UK economy
returns to growth is whether that recovery is anaemic – as now seems more likely given the highly indebted nature of UK
consumers and difficult borrowing conditions for businesses, both of which are likely to be long-term constraints on
growth, together with the prospect of a gradual withdrawal of the government stimulus programme – or whether growth
can be sustained at around long-term average levels.

Assuming the increasingly likely outlook of an anaemic level of economic growth in the UK over the coming 12 months,
the prospects of an improving employment picture remain poor. Thus, most economists expect unemployment to
continue to rise, albeit at a reduced rate, through 2010, and probably longer, given the amount of spare capacity in the
UK economy, as meaningful levels of rising employment will only occur when GDP growth returns to, or is above, long-
term GDP trend levels. This view is supported by the International Monetary Fund (IMF), which recently warned that
countries should be prepared for a ‘jobless recovery’, or at best a tepid pick-up in job creation. Given this background,
combined with the relatively low rises in unemployment across Europe compared to previous recessions, at a time when
productivity levels have fallen sharply, it is likely that companies will be able to expand output without the need to take on
additional staff. Overall, therefore, the labour market picture remains fairly bleak, although the hope is that the UK
unemployment figure will not now rise to the widely forecast level of some 3m persons (or 10% of the workforce). Much
of that increase was focused on the expected job losses of around three quarters of a million in the public sector as a
result of the fiscal squeeze, however, this huge number is unlikely to be fully implemented, at least in the shorter-term, if
at all, given the political implications.

First Equity Limited

Salisbury House, London Wall, London EC2M 5QQ
Tel: 020 7374 2212 Fax: 020 7374 2336
Website: www.firstequity.ltd.uk
Paul Henry
email: paul.henry@firstequity.ltd.uk

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