Market recovery underlines yield attractions in equities

Does this equities rally have legs? Sceptics warned it was only a snap-back in a bear market; but Janet Yellen at the US Federal Reserve has released more doves, as if cooing that cheap money will continue in the face of global risks.

Investors celebrated, at least initially, at a return to "bad news is good news" and a lower dollar environment, which is considered good for equities. Since oil is priced in US dollars, the two are inversely related, with higher oil seen as a proxy for risk-taking. So is it time to relax?

Company reporting still true test of value

Rises in US stock indices soon eased, as if investors are wary that first-quarter 2016 reporting gets underway from Monday 11 April, amid expectations for S&P 500 firms to declare an overall 8.7% drop in earnings.

All ten industrial sectors have lower growth rates today, compared with end-2015, due to downward revisions led by the energy sector. Moreover, the 12-month forward price/earnings multiple on the S&P 500 is 16.4 - which to British eyes appears full indeed, if typical of the ratings US stocks have enjoyed under loose monetary policy. Irrationality can persist; even an expert in bubbles, Robert J Schiller, has said this market could stay high.

But it will be interesting to see what the results show about company profit margins, in case central bank policies have hit diminishing returns. The bearish argument is that falling margins favour share buybacks instead of capital investment; and the longer interest rates remain close to zero, the more banks' margins shrink and the less inclined they are to lend.

Such factors conspire for sluggish growth, and the Fed's latest message shows it lacks other initiatives. So mind how imminent US company results may check the bulls.

UK firms broadly "in line", if wary

Outside the resources sector (and related services) there is overall insufficient evidence to reckon on a downturn. With the UK economy imbalanced towards consumers, a notable caution has come from Next, which believes "the outlook for consumer spending does not look as benign as it was at this time last year".

Next cites wage growth versus inflation slowing markedly since September; also growth across services, manufacturing and construction all reduced in 2015. It also anticipates a switch in consumer spending from clothing to eating out, travel and recreation; an insight supported by travel group TUI AG citing UK revenues up 8%.

The last recession showed how well-managed pub groups benefited from people unwilling to sacrifice socialising; and "Brexit" concerns don't appear to be having any material effect on behaviour ahead of June's referendum. Nothing to get too perturbed about, then, and perhaps Next is feeling some squeeze from rivals online.

Among other cautions, engineering group Renishaw has said large Far Eastern orders dropped away, otherwise its underlying growth continued. Outsourcing services group MITIE cited revenue shortfalls due to economic pressures and uncertainty, albeit alongside annual profits within the range of expectations.

Such updates convey conditions that are challenging, if unlikely to impact equity values or indeed encourage central bankers to raise interest rates. It may neither imply a "Goldilocks economy" nor investors facing the gruel of widespread dividend cuts - which should be broadly supportive for equity values.

Moreover, the business recoveries specialist Begbies Traynor has cited company insolvencies in England and Wales down by 10.3% in 2015, extending a downward trend since 2011 and now at the lowest level since 1989. While such evidence is obviously backward-looking, it's a supporting factor helping offset the moderate risks in trading updates.

Low growth to prompt more takeovers

In such a scenario, bigger firms will find it harder to grow organically, lacking new angles to transform revenues, while investors may remain cautious of turnaround prospects, which may mean market values do not reflect companies' commercial progress.

This may explain why various stocks I've drawn attention to have become bid situations, and why more are likely. Home Retail Group became a favourite for short-sellers yet bidders have recognised its investment in digital sales as worth integrating; Premier Foods has seen strong progress in international sales, attracting two multinationals' interest; and Penna Consulting, to which I drew attention last June at 170p and again at 305p last January, is recommending a 365p per share cash offer from Adecco, the global recruitment giant.

Penna is a strong business, yet the deal reflects similar drivers for multinationals seeking growth.

So, even if the macro environment does deteriorate, it will be worth staying alert for special situations like these. Bid approaches do not mean you have missed an opportunity; indeed the game may only be starting.

What next for oil prices?

Stockmarkets have trended with oil prices this year, as a proxy for risk appetite. In one sense it appears odd, because lower oil has a stimulus effect in freeing up cash e.g. for consumer spending and firms investing or paying out dividends.

But, in the US especially, there's an estimated £2 trillion equivalent of debt tied to oil companies in loans with sensitive covenants. The fear has been carnage in the US high-yield bond market, spreading to affect all asset classes and markets.

That was exaggerated, given it has only needed an excess of crude oil short positions to close, and new speculative longs to be taken, to drive oil back to around $40 a barrel.

Its fundamentals continue to look weak, given record stockpiles, and a mooted production freeze - Iran says it will not join - is unlikely to change this. OPEC output has also risen in March.

So care is needed as regards hopes for a 17 April OPEC summit, but at least producers are talking. Perhaps the chief factor currently is short sellers lacking conviction to attack oil again; there appears an uneasy equilibrium rather than a clear "line of least resistance" visible for speculators to exploit, like in the second half of 2015.

With the Federal Reserve turned dovish this week, a weaker dollar is also supportive for oil. It has all meant a reprieve for oil explorer/producer shares, especially those highly indebted such as Premier and Tullow, also Royal Dutch Shell as sentiment swings over its yield prospects.

But take care, as sentiment is based on overall poor fundamentals for oil.

Current account deficit risks further sterling weakness

With latest figures showing a rise to £32.7 billion, or 7% of GDP, in the final quarter of 2015, mind that this could become more of an issue, when combined with Brexit fears as the 23 June referendum approaches - principally because it makes it harder to attract investment inflows to finance the deficit.

Lower sterling is, however, welcome news for exporters, coming at a time when the US dollar may ebb with the Fed turned dovish again. But it's something sterling-based investors need to be aware of, i.e. favouring overseas earners.

So, in conclusion, it's going to need more serious bad news from companies reporting - e.g. news that undermines faith in the US economy, plus more bad numbers from China and Japan - to reassert "deflation" and dent this equities recovery.

It reinforces "buy the dips" to capture dividend yields, amid zilch returns from cash.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.