AS we head into the summer months recent stock market behaviour has reflected the weather some sporadic sunshine with occasional thunderstorms. International markets have been suffering from a bout of jitters mainly on the back of renewed tension in the Far East. The economic and political outlook in Japan and the Far East continues to deteriorate. Meanwhile, the situation in Russia one of the world's emerging markets remains fragile.
This more unsettled international financial environment transmitted itself to the Irish market which suffered its first serious setback so far this year. In fact the Irish market has under-performed most of its European peers over the past four to six weeks. This stemmed from some worries regarding the potential for overheating in the Irish economy. Essentially the argument is that excess demand in the Irish economy will put upward pressure on wage rates and other costs. This then puts pressure on profit margins, eventually causing a squeeze on corporate profitability.
With the Irish economy continuing to grow rapidly some commentators are forecasting growth as high as 12 per cent for this year the risks of the economy overheating are clear. Furthermore, a report from NCB Stockbrokers forecasts that the economy can sustain an average annual rate of growth of 6 per cent over the medium-term.
With the Irish inflation rate beginning to creep up towards 3 per cent, trade union leaders are beginning to get restive and are flexing their muscles. At the same time wage rates for workers with skills that are in short supply are already rising. The booming construction sector is experiencing increased wage costs while labour shortages in the rapidly growing technology sector are now commonplace.
Given the extraordinary pace of growth of the Irish economy, a sustained period of upward pressure on wage rates and other costs seems inevitable. Taken on its own this must be considered to be a negative factor in assessing the outlook for the rate of growth in Irish corporate profits over the medium-term. However, the context in which this is occurring is one which contains many positive factors.
Rapid economic growth means that firms will be enjoying rapid growth in sales revenues, enabling them to increase profits even if profit margins are being reduced.
A further positive factor is that stated Government policy towards corporate taxation is to progressively reduce corporate tax rates over the medium-term. This will serve to bolster the rate of growth in after-tax profits and it is a very positive factor for the Irish corporate sector and stock market.
As long as any rise in labour costs is spread over a sufficiently long period of time it should not seriously threaten the generally positive outlook for the Irish corporate sector. Therefore, for the private investor the recent bout of weakness in the Irish stock market should not be cause for any alarm. If anything it has acted to bring the prices of some shares back to levels which now offer attractive long-term value.
Financial shares which had been leading the bull market suffered in the recent market setback. From their high of £15.50 Bank of Ireland shares had declined by close to 20 per cent at their recent low. In recent days the shares have recovered, but they still represent good long-term value. The other high-flying financial share this year has been Irish Life. This partly reflected a catch-up on other financial shares but it also reflected the strong growth prospects for long-term savings products in the Irish market. From their earlier high of over £7 Irish Life shares had also fallen by close to 20 per cent but have since recovered and are now trading at just over £6 where they offer good value.
Amongst the industrial shares the major piece of news was the merger between Jefferson Smurfit Corporation and Stone Container in the US. This long-awaited deal was greeted enthusiastically by the market with Smurfit shares hitting a high of 290p in the immediate aftermath of the announcement. Since then profit-taking and weakness in the US paper sector has brought the shares back to around the 240p mark. At this level Smurfit shares offer very substantial upside over the medium-term.
A number of the smaller companies on the Irish stock market have also suffered significant corrections in recent weeks. Barlo, the radiator and plastics manufacturer is 15 per cent below its year high. The company's profits are growing at over 20 per cent per annum and the management is actively seeking to grow the company through acquisition. After a very strong run so far this year Fyffes has also declined by about 15 per cent. After years in the doldrums the shares suddenly sprang to life earlier this year and would seem to offer good medium-term prospects.
Another star performer of the current bull market is Kingspan and its shares have been treading water for a number of months. Profits continue to grow and the company has a proven ability to acquire new businesses.
Overall, the medium-term prospects for the Irish stock market remain healthy and investors with funds looking for a home should continue to invest in it despite the recent bout of nerves.
