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Share prices: upward, ever upward?

Equity markets may not be uncomfortable with higher inflation, butthey will take fright from a tightening in monetary policy to counteractit.


Are equities due for a big fall? Tony Dye at PDFM (one of the UK’s largest fund managers) believes so. Indeed, over the past 18 months he has accumulated a u7.1bn cash reserve to buy up shares in anticipation of a large correction in prices. His gamble has not paid off – to date at least.


According to Capital Data Bondware, over the first nine months of 1996 international bond issues amounted to $509bn (#320bn), well ahead of the record annual figure of $464bn in 1995. But expectations of higher interest rates in the US over the next six months has dampened down bond prices. This could ease the flow of new issues in the fourth quarter.


On an annual comparison, output price inflation (i.e. increases in the prices of goods leaving factories) may continue to slow for some time.

But there is little doubt that we are at, or have passed, the trough for input price inflation (i.e. increases in the cost of goods and raw materials purchased by industry), implying that the longer-term outlook for inflation has become less benign.


High UK share valuations are justified by very good prospects for stronger earnings (and dividend) growth in 1997. But the same cannot be said for the US, where equities also appear expensive by traditional criteria. However, the American economy is fundamentally in good shape, suggesting that a correction on Wall Street may be sharp, but is only likely to be short.


The effective exchange rate (a measure based on a basket of trade-weighted currencies) has strengthened appreciably recently, lowering the sterling prices of imported products. Normally, this would provide the Chancellor with ammunition to argue for lower interest rates. But such a move now would alarm markets.

Information supplied by Lombard Street Research: 0171-337 2975

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