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UK stock market commentary (January 09, 2013): Cuts continue but are they enough to save triple A?

The coalition government managed to impose one of their “cuts” last night by capping the increase on all welfare benefits to just 1% which has got the New Year off to its usual start for politicians who continue to score political points by attempting to take opportune and voting winning stances. Whilst none on welfare will actually see a freeze or a fall in their benefits in cash terms, the effect of inflation will mean a real terms cut and a saving for the government. So a “cut” of sorts although hardly the sort of cut that is required to really tackle the UK deficit and address the bloated welfare state that now makes up a third of government spending. Opponents of the move are trying to pander to voters claiming that the ramifications of restricting rises to welfare to 1% are unknown and likely to affect the lower earners and in so doing they continue to try and pull the wool over the eyes of the public. The UK simply cannot afford such a welfare state in its current form and so something has to give. In the run up to last night’s vote we saw UK gilt yields fall back but this morning those yields have risen a little which goes some way to indicate that whilst the markets might be happy to see that more measures are being taken to curb government spending, this so called “cut” doesn’t go far enough and more has to be done. If we are to keep our triple A credit rating not only do further cuts (or “cuts”) have to be made, but growth measures are now becoming all the more important.

Last night’s little bit of profit taking in the US saw the Dow shed 55 points to 13,330 but the earnings season across the pond got underway after the close and Alcoa’s results were received well which gave Asian markets impetus overnight and this strength has filtered through to European indices this morning with the FTSE up some 20 points at 6074, higher than our original calls. As the bulls get a little wind behind them they’ll be looking to see if the FTSE can test the recent highs around 6100 and beyond. There’s little in the way of any economic data out today so a degree of focus will be on the US earnings season which is now underway.

Clients remain sceptical of the recent strength largely being short of the FTSE and in honesty the start to 2013 has taken most people by surprise who did not expect quite such a rally. There are plenty of bullish calls but now those bulls are thinking that a move to the downside has to occur before we can climb higher, which is probably what clients are expecting and certainly hoping, will happen.

The economic results in Germany were lower than initially anticipated sending the euro 34 pips lower against the dollar to 1.3079. Europe’s largest economy has seen its factory orders dropping due to weaker demand from outside the euro area with trade balance also below expectations. In addition, German Chancellor Angela Merkel acknowledged on Dec 31 that this year could be more difficult than 2012.

Gold closed at $1660.3, up by $13.1 as investors took bullish positions whilst waiting for decisions by policy makers in Japan and the Eurozone. Japan is considering easing monetary policy and interest rates are expected to remain unchanged in a Eurozone meeting on Thursday. The precious metal's price was also buoyed by continued physical demand from Asia, this time coming notably from China before the lunar new year. Last week gold fell to more than a four-month low below the $1660 mark and many believe that the sell off was excessive as there were no clear signals by the US that they would stop their bond purchasing programme any time soon. Investors are keeping their eye on the real interest rate, that is the rate with inflation taken into account as a clearer signal to sell. Higher rates mean an increased demand for the dollar and gold tends to depreciate.

The WTI crude prices had another quiet session yesterday dropping just 16 cents to $93.12 a barrel in a very tight range. There are expectations the weekly crude stockpiles could rise putting downside pressure on its price but that might be counterbalanced by the elevated prices for oil products. The US Department of Energy will release its oil inventories report later today.