Over the past three months, utilities have fallen substantially, with some down by more than 10%. Some of these organisations, water companies for example, have high dividends but very high borrowings. Not only have their share prices fallen but, as interest rates rise, so does their cost of borrowing. This is not a very comfortable place to be.
A number of the bigger active funds have meaningful holdings in the large growth stocks that are in the FTSE top 20 by capitalisation and are on heady P/Es.
Substantial corrections
Valuations look extremely demanding in the higher capitalised stocks. A quick look at some P/Es is quite alarming: British American Tobacco, 19; Diageo, 23; Imperial Tobacco, 29; Reckitt Benckiser, 32.
These are so far above the normal P/E that probabilities suggest a substantial correction. There are a number of catalysts that could precipitate such a move.
Some of the very big funds are likely to suffer the most should such a correction occur, the main reason being that it is difficult for them to sell what could be 1-3% of the total free market float of a company, especially if they have more than one type of this company in the fund. Such an exercise is not to be undertaken lightly because it can move prices to the detriment of the unitholders.
The most gentle correction could occur simply due to the stock rotation mentioned above. Should the exodus from the bond proxies into value and quality gather momentum, this would mean the FTSE would fall because the top 20 holdings in the large funds are also the ones with the highest market capitalisation. The FTSE rankings are based on capitalisation, ergo selling will produce a fall in the index.
A lack of stimulus to the consumer economy, addressed to some extent in the Autumn Statement, could easily bring about a serious correction because the consumer is responsible for more than 70% of GDP, and retailers are already suffering with reducing margins and slow trade. This could also affect Mid-250 and smaller companies, which tend to be domestically orientated.
