Long-term share slide on the horizon

TURNOVER on the London stock market is in a slump and there are few signs of revival. It is a worry to City traders who are starting to feel the squeeze on profits and bonuses.

Traders will tell you any fool can make money in a bull market. You can even make money in a bear market, but when volume dries up everyone suffers including Harry Hedge Fund. He needs liquidity to move swiftly in and out of trading positions.

'Sell in May and go away, return again on St Leger Day' (in September) is one City adage and seems to have been taken to heart by fund managers cautious about short-term prospects for equities.

Many have thrown themselves enthusiastically into the summer season, which started at Royal Ascot and the Chelsea Flower Show and has now moved on to Wimbledon.

In May last year, 43.9bn shares changed hands as the FTSE 100 index traded between 3900 and 4000. The invasion of Iraq barely two months before created an unsettled political and economic backdrop. Market sentiment was at a low ebb.

A year down the line, the Footsie traded between 4400 and 4500. Investors had held high expectations of the first quarter, fuelled by talk of global economic revival, political stability and heavy involvement by powerful hedge funds.

But by the end of May, stock market turnover dipped to 43.1bn shares, a drop of some 2% on the corresponding month in 2003.

Strip out activity in hedge funds, derivatives and contracts for difference (CFDs) and the genuine level of investment in equities is a lot lower. Some brokers will also argue that the value of many transactions has fallen.

Vodafone dominates

THERE have been exceptions. Trading in Vodafone continues to dominate turnover on the London Stock Exchange (LSE) with hundreds of millions of shares changing hands daily. It remains the biggest and most heavily traded stock and often accounts for up to 30% of all shares traded daily in the City.

Marks & Spencer has also been noticeable in recent weeks. Hours before entrepreneur Philip Green launched his initial offer for the retailer last month, the price took off and more than 60m shares changed hands - several times more than the usual daily average.

Each month, the LSE publishes turnover data for its Sets computerised trading system and each month they appear to show record numbers, in contrast to whatever else is going on in the marketplace. But brokers claim the records on Sets mask a general lack of volume.

They believe better prices can be obtained for clients by dealing direct with other operators on the phone. There is a deep mistrust of Sets, which often throws up wild price movements.

'Each trade on Sets is recorded. It may take 15 or 20 hits to complete one order in, say, 100,000 shares and each hit is recorded as a separate trade. That's how the LSE is notching up such encouraging numbers,' says one trader.

So why have investors turned their backs on the market and where are they now investing?

Justin Urquhart Stuart, founder and boss of Seven Investment Management, says equities trading in the first quarter was sustained by big hedge funds: 'They made a fortune when the market was falling and continued to make money when it recovered. But they are now being squeezed.'

He says the slowdown in economic growth in China, soaring oil prices and rising interest rates are making life difficult for them. 'They need volatility and when it's not there they suffer. The equity market is not trading, it is treading water. Share prices have become a fog bank. No one can see what is going to happen next year,' he adds.

Cash appeal

THAT makes cash appealing and there is evidence institutional investors are happy for it to account for a bigger percentage of their portfolios when it comes to asset allocation.

Urquhart Stuart says allocation is often in five areas - equities, fixed-interest, property, commodities and cash. Fixed-interest, property and commodities may have run their course for the time being and equities are out of favour, which makes cash increasingly attractive - especially with rising interest rates.

'The only problem with that scenario is that brokers can't earn commission from cash,' Urquhart Stuart points out.

The LSE is so concerned about the demise of the equities culture that it ordered an internal report to find out what has reduced their appeal.

WM Group collates and monitors performance of UK pension funds. It says that, during the past 10 years, the total of home and overseas equities in the portfolios of UK pension funds has fallen from 77.6% to 67.1%.

Within the overall equity total, the British proportion shrank from 70.9% to 58.5%. WM concludes interest in all equities has declined with UK stocks leading the slide.

The Investment Management Association found that 56% of its members invest in domestic and foreign shares but that figure is likely to drop as low as 30% within two years - the equivalent of a £150bn sell-off, which will bring them in line with insurance companies, forced to sell due to regulatory pressures.

Throw in the fact that private investors have come to mistrust the City and the financial services industry in general, and the outlook appears bleak.