Strong headwinds make going tough for UK equity market

London Briefing: Since the global rally in stock markets began around a year ago the UK equity market has performed as it always does during the early phases of an upswing: it has been extremely dull, writes Chris Johns.

Of course, that is a relative description. The FTSE 100 is up more than a 1,000 points from its lows but it has not done nearly as well as other markets around the world.

There are lots of reasons for this, a simple one being the fact that the UK market has more than its share of boring companies (banks, oil stocks and pharmaceuticals are obvious examples).

Given the recent volatility of stock markets we might think investors should be inclined to place a premium on "boring" but it seems the allure of the flaky is as strong as ever - hence another indiscriminate rush towards telephones, technology and Germany.

But there has been another important factor holding the UK market back. A year ago, we knew that life insurers all round Europe were dumping equities at their fastest ever rate. For many market professionals, this was the surest sign that the three-year bear market was finally coming to a close. A combination of regulatory pressure plus old-fashioned fear was driving many insurance companies to sell equities.

Nowhere was this pressure more acute than in the UK. Many people suggested, quietly, that life companies would ultimately come to regret their selling frenzy; indeed, there were some half-serious suggestions that insurance company asset allocation strategies were the perfect contrary indicator and that the next key sell signal would be sent when those firms started buying again.

It seems, however, that the selling was far from over. This week we learned that one of the UK's biggest life firms, Standard Life, has quietly been selling billions of pounds of equities through the early part of this year.

Under pressure from the regulators to shore up its balance sheet, the firm has been forced to abandon its long-held love affair with equities. It has been claimed that because the firm executed its sales via "complex derivative strategies", the impact on the equity market has been minimal.

This only goes to show how some people don't understand derivatives.

If Standard Life has been forced to this, I would bet that others have been following suit, albeit in a less public way. This must have amounted to a huge headwind for the equity market.

I wonder if it is no coincidence that the equity market has, for a few days at least, been doing very nicely since the Standard Life announcement. Some people clearly believe that if the insurers are still selling then we should be buying. And it is hard to disagree with that.

But there are other headwinds. In what has been described as "mission creep", the Bank of England has doubled its list of targets, to two. It now thinks that overall inflation and house prices need to be controlled. And housing and property-related sectors account for nearly a third of UK market capitalisation.

The foreign exchanges have inevitably noticed that the Bank of England is way out in front on the interest rate cycle; sterling is riding high, even making back lost ground against the euro.

It is sobering for investors to realise that the UK firms now derive more than half their revenues from non-domestic sources.

None of this is likely to change unless some way can be found to remind the Bank of England that its remit has nothing to do with house prices.

There has been a low-level spat going on between the government and the bank, and I suspect that Gordon Brown and his acolytes would dearly like to figure out how they could emulate their American friends and engineer a currency depreciation.

But with the bank in feisty mood this seems remote. It clearly relishes the independence that Gordon Brown granted it. A soaring currency will not stand in the way of further rate rises: interest rates are going up until the housing market stops going up.

Mr Brown has had his own pop at the stock market with £6 billion additional taxes on pension funds, so he won't be too bothered by the market consequences of the bank's actions. But he won't be too pleased by the new-found determination to have a go at house prices.

The upshot of all of this is that the UK equity market doesn't have too much going for it at the moment. Old-fashioned types might say it is one of the cheapest stock markets in the world. Of course, that sort of thing doesn't count for much these days.