New highs all round

20 March 2008

The wobbles of february seemed a distant memory last month, with stocks around the world rallying strongly to hit record highs. Week 22 saw both the Dow and, perhaps more significantly, the S&P 500 hit record highs in the US.

While the Dow is the most famous and widely reported index of US stocks, it is a narrow measure, being composed of just 30 companies' equities. The S&P 500 is a much broader measure of stock market performance, due to its composition of 500 large capitalisation US companies.

The mid-April to late May period saw good gains elsewhere in the world, with the German Dax Xetra index looking strongest. It gained +9,40% between weeks 16 and 22, compared to +4,99% for the CAC 40 and +2,98% for the FTSE 100. Like the UK, stocks in Japan saw subdued gains, with a +2,98% gain, coincidentally identical to the FTSE 100's.

Construction Gains

The boom in US stocks fed into the CET Index for the construction industry, lifting it +10,52% over the same period to a new record of 236,45 points. The key contributor was the US-dominated equipment sector, where high capitalisation companies like Caterpillar, Deere, and Ingersoll-Rand lifted the CEE Index for the sector an impressive +16,62% to a new high of 261,51 points.

But this is not to say that other companies did not contribute. Of the large European manufacturers, Volvo lead the charge with a +25% gain. This was linked to a complicated share split, which saw

Volvo spilt its stock six ways and then automatically redeem one in six shares for SEK 25 (€ 2,69) each. Another way to look at it would be as a 5 for 1 split accompanied by a one-off extraordinary dividend.

The equipment sector was very buoyant in general, with double-digit share price gains being very much the order of the day. The underlying driver for this is the apparently strengthening US economy. This is having a knock-on effect of encouraging mergers and acquisitions (M&A), thanks to a combination of high company valuations – good for the seller – a bright economic outlook, and the apparent availability of lots of money to fund purchases.

A prime example is Ingersoll Rand, which, following the divestment of its road building equipment business earlier this year to Volvo and its rock drilling division to Atlas Copco a few years previously, is now planning to exit the construction equipment business all together. It announced in mid-May that it wanted to divest its remaining construction products divisions, the cornerstone of which is compact equipment specialist Bobcat. The company says it will use the proceeds – expected to be around € 2 billion or so - to buy-back its own shares.

Mergers and acquisitions also played a part in the materials sector over the last six weeks, with Heidelberg Cement launching a bid to acquire Hanson for some € 10,7 billion. This of course did wonders for Hanson's share price, with a +30,70% gain between weeks 16 and 22, and helped push the CEM Index for the sector up +10,15% to a record high of 189,35 points.

Hanson has long been singled-out as an acquisition target, perhaps the last major one in the European heavy materials industry. However, the risk of its on-going liabilities for former employees' asbestos-related illnesses in the US has been a barrier to any deal in the past. Although these are not massive in the context of this deal – about € 50 million per year – they seem to have been enough of a worry to deter other suitors.

Although Hanson's gains stood out, there were good performances elsewhere in the normally subdued materials sector. Cemex, CRH, Lafarge, Saint-Gobain and Wienerberger all managed double-digit gains, while Kone was alone in seeing its share price fall over the six-week period.

In contrast to the materials and equipment sectors, the normally bullish contracting industry had an unusually subdued six weeks. The CEC Index for the sector gained just +4,08% between weeks 16 and 22, although it should be said this took it to a record high of 288,47 points. Indeed the fact that both Veidekke and Vinci undertook stock splits over the period underlies the on-going demand for contractors' equity among investors.

Having said this, share price movements in the sector were something of a mixed bag, with some good gains – most notably Acciona, Amec, BAM, Impregilo and Strabag, and some marginal to heavy losses, particularly for Taylor Woodrow. Without any clear geographic or market-based pattern to these movements, it is difficult to draw any firm conclusions.

Currencies

Late April and early May saw the Japanese Yen depreciate further against the Euro, touching a series of new lows. By the end of week 22 it had settled at € 1 = JPY 164,10, almost a -2% drop in six weeks. In contrast, the Euro fell -1,21% against the US Dollar, with strengthening economic performance across the Atlantic helping the Greenback to recover some of its previous losses.

Surprisingly, there was not much movement between the Euro and the Pound, despite a +0,25% increase in UK interest rates in May. The Bank of England is sounding more hawkish about interest rates, and there is a general expectation in the markets for one or two more +0,25% rises before the year is out.

Elsewhere in Europe the Euro saw a few small slides against the eastern and northern currencies, but in general appreciated more than it fell. The only exception was against the Romanian Lei, where it saw a relatively heavy slide of -2,18%.

Outlook

The strengthening US outlook is good news for shares around the world. The flip-side to this is that this brings the threat of higher inflation, which could lead to interest rate rises. There needs to be a fine balance if shares are to continue climbing – the US market in particular has shown itself to be quite sensitive to interest rate rises.

Another factor to watch out for is the spectre of further ‘market corrections' like the ones seen in February and last May. The longer the rally continues, the more likely a sudden fall becomes, and this leads to a certain nervousness among investors that can translate to big sell-offs in response to only mild sounding economic bad news.

But these two concerns notwithstanding, the markets look strong and well-placed for further growth.

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