UK Consumer Prices (CPI)

September's UK consumer prices numbers are rather better than the market had expected. Not only did the headline rate of CPI inflation nudge up just a tick from 2.4% to 2.5% (the consensus forecast was 2.6%), but this was due entirely to rises in petrol prices and gas/electricity bills. Excluding energy, inflation fell back for the second month in a row from 1.8% to 1.7%, while the "core" rate, which also excludes food, held steady at 1.7%. In the detail, clothing inflation saw a particularly sharp drop from -4.4% to -5.3%, while furniture/household equipment slipped from +0.1% to -0.2%.

The message is that competitive conditions in the high street are continuing to bear down heavily on core goods prices, despite the rise in pipeline cost pressures over the last year or so. Inflation could yet rise a bit further in response to more gas/electricity prices rises over the next few month. But with few signs of second round effects on wage claims and inflation expectations, it should drop back below its target towards the end of this year or early next. Bottom line: Nothing here to stop the MPC from cutting rates.

Global Equities: Stay Defensive For Now

The shakeout in global financial markets may have further to run. Equity sector strategy should favour defensive sectors.

The threat of higher inflation and slower growth, particularly in the U.S., is unnerving financial markets and precipitating an unwinding of leveraged trades. This year’s high-beta sectors such as resources and basic industries, are vulnerable to further downside in the near term as investors protect profits. Resources, of course, are at greatest risk given their 30% year-to-date gains. Non-cyclical consumer goods, which includes staples and healthcare, will be a beneficiary as investors rotate into less growth sensitive areas. Utilities, a traditional defensive and a strong out-performer this year, will likely struggle given upside risks to bond yields in the near term.

Technically speaking…………………………

FTSE-100 (5275) has endured a turbulent week as investors began to fret over rising inflation and the possibility that it was arriving at the same time as lower growth. Lat week, the second in a row, the leading index posted sharp losses and is now 226 points (or 4.1%) below its recent 52-week high. Although there have been other 2-3 week losing streaks this year none have been this large, either in points or percentage, and you have to all the way back to the start of this bull run, in March 2003, to find a decline of similar magnitude. On that occasion the market was touching bottom and sentiment was terrible (although it was about to turn decisively, of course) but what appears to be happening here is that investors who have been happy to trade risk have suddenly become slightly more risk averse, and it seem unlikely at this stage that this phenomenon has already played itself out.

Indeed, the chart above suggests that there could be room for further downside. Since the aforementioned lows in early 2003 there has been a clearly defined bull market in place and it is possible to break up this advance into a series of waves. The first began with the lows and culminated in the highs in April 2004. After a short corrective phase (the second wave) a new up wave started in August 2004. That third wave came to an end in February of this year and there was then a pull-back (wave 4) to around 4800. Since that trough we have had a fifth wave up to the recent 5500 peak and the question now is this: has this market now completed a full five-wave cycle? One clue might lie in the projected level of the index given by the magnitude of wave one which, when multiplied by 1.618, indicated a possible top at around 5440. Admittedly, that level was recently exceeded by some sixty points (or 1.1% - well within the realms of statistical probability) but the fact that the top was followed by an immediate pull-back seems to strengthen the bear case. In this situation the minimum downside expectation should be around 5000 (although if it’s a true correction it will be somewhat lower than that). One shred of hope for the bulls is that over the last twenty years October has been a pretty good month for the market with just three losers in that time - 1987, 1991 and 1997. Still, for this October to end up a winner it now has to rally more than 200 points over the next 11 sessions, and that seems like a pretty tall order. 

And finally………………

It's Grim Up't North

Prometheus from sources: ADM, Barclays Capital, Cazenove, Charles Stanley, HSBC, ING, SocGen, UBS.