View from City Road: Stresses and strains reflect global decoupling

Think global, act local. Dealers in the British stock market are clearly still finding it impossible to ignore the manic-depressive behaviour of Wall Street.

Yesterday the UK market shared in Wall Street's relief that Armageddon had been at least postponed, albeit on the basis of a dubious, weather-affected batch of US leading indicators. But it may be time for local conditions to reassert themselves.

The stresses and strains of recent weeks reflect a process of decoupling at various levels.

First, US and other markets have to move apart to reflect the different economic developments in each territory as the US moves strongly ahead while Europe lags, with the UK somewhere in the middle.

Then equity markets and bond markets have to find their own separate ways forward.

Last year an over-optimistic view of inflation led to tumbling real yields in the bond market, which lifted equity prices in its wake.

This left UK bond yields looking very exposed at the start of the year and equities tightly priced against them, with the implied yield ratio down to 1.9.

Although dividend yields have risen, bond yields have taken up the bulk of the strain since and the yield ratio has risen towards a more comfortable 2.2 currently.

Developments in the US are quite likely to cause their fair share of alarms on this side of the Atlantic in the months ahead.

Political worries have been important in the UK but the big investing institutions, whose coffers have been swollen by being out of the market, may conclude that the subdued trend in European interest rates and inflation encourages local buying of bonds then shares.

The recent round of company results has, after all, surprised analysts with the strength of dividend growth.