Beware bears as rates pressure grows

By Daily Mail Reporter
Updated: 04:38 EDT, 29 January 2007

The winter chill was not the only thing sending a shiver through markets this week. Cheap money makes the world go round, so what happens when it stops being cheap?

That is the spectre raised by the Bank of England hiking base rates to 5.25%, and the 4.4% annual rise in UK retail prices that explained its move.

After an initial fall, shares shrugged the warning aside. The feeling is that companies and markets can live with inflation and interest rates at this level, and even get used to the idea of base rates moving to 5.5% or beyond.

It seems the pain threshold that will trigger a correction has not yet been reached. Some think the figure to watch is the ten-year UK bond yield, which has edged up to 4.96%, but is still predicting that interest rates will come back down.

The higher rates rise, the more attractive it is to keep your money in the bank or bonds rather than risk it in shares. Top savings rates are nudging 6%, up from 4.5% two years ago. Index linked savings certificates return 5.5% tax free, though this may drop as inflation falls.

But some shares offer dividend yields of 4% plus, with growth prospects thrown in. So the temptation to dash for cash is not overwhelming. At 7% to 8% savings rates, it would be different and the stock market bears would come out to play.

Bears have had a thin three years in which the Footsie has climbed almost 3,000 points above its March 2003 low. At 14 times earnings it is not overly expensive. But I would not chase the market aggressively. If you have funds to invest, it might be wise to put half in cash. In this column, we will try to be cautious and selective, and to watch out for bear raids.

How far will inflation rise? The big question is whether wage pressure twists it further upward. Wage rises are running at 4.1%, but some unions talk of using the 4.4% retail prices index as a benchmark.

If pay deals break upwards to 6% or 7%, it will be time to sell. The hardest hit sectors are likely to be those with the biggest debts - including the few water and power stocks yet to be taken over, and highly geared property groups.

Some property stocks sell at 30% above asset value, which is really pushing it. Dan Bunting, the strategist at Fortis, thinks hedge funds and private equity groups might also suffer. Some have loaded up with high-risk bonds. Just as houses are hard to sell in a downturn, many stocks will be hard to shift if the market wobbles. Hundreds of Aim stocks have been floated and then forgotten.

Speculative mining and energy explorers will be tough to sell. If you are loaded with these, it might be wise to lighten up now. The outlook is not wholly gloomy. Oil has come down from $78 six months ago to $55. Wholesale gas prices are signalling a cut in household bills. This could bring inflation back down again. Meantime, watch out for bears.

Seed capital

It is good to see Plant Health Care, which protects seeds and roots with a natural fungus that helps them feed faster, signing a global licensing deal with German chemical giant Bayer.

Though it did not publish the details, it will supply its Myconate coating to Bayer and be paid when certain milestones are reached, plus a royalty; broker Evolution thinks this could be about $1.25 (64p) per hectare. The deal is confined to corn, soybean, cotton and sunflowers, which leaves PHC free to seek other deals for wheat and vegetables.

PHC, floated at 52p, was 62p when tipped here 13 months ago after Evolution highlighted its potential. The shares hit 259p after the Bayer deal, and are now 244p. It has other ideas, including a gel used as balm in infants' nappies, and there is more mileage in Myconate. But the next major news could be months away.

At 244p, PHC is already valued at £98m, against just £7m sales last year. Take profits.