The UK Stock Market Presentation before and after 2000 - Essay Example

The UK Stock Market Presentation Before and After 2000 1. Introduction In this paper the performance of stock markets in UK before and after 2000 were examined. The reasons for growth and falls will be analysed. The difference in the returns before and after 2000 in the UK stock market will be found out and examine d. The reasons for the difference will be explored and analysed statistically. The share prices of various companies that influence the stock market will be taken into consideration and the analysis will be done accordingly. The confident intervals are found out. The reasons and consequences of them were analysed. Correlations between returns and the performance of FTSE 100 index will be taken into consideration and its effects and causes will be examined. The data sets taken are presented in the form of statistical analysis and represented in the form of tables and graphs explaining them. The main reasons for the fall and rise of FTSE 100 index will be explored and they are presented in a analytical form. The confident intervals on monthly and weekly returns will be analysed and examined according to the available data. The equality of two populations means will be searched for and if found it will be analysed. The run test for testing the efficiency of the market hypothesis will be done and the predictions are compared. The efficiency of the market hypothesis will be discussed according to the statistical analysis and run tests conducted on the available data regarding UK stock market. The integration of the market after 2000 also will be taken into consideration and its effect on the UK stock market will be explored and analysed. The results if found interesting will be interpreted and the causes will be analysed. 2. General Statistics of UK Stock Market The above picture is adopted from http://www.statistics.gov.uk/cci/nugget.asp?id=479 The above figure indicates the net worth of UK including financial assets at the end of 2005. It was estimated at 6,012 billion pounds. It is 119 billion pounds more than the previous year. The most valuable assets of the country are housing assets, which indicates the demand for building industry and the stocks of those companies. 59 percent of the national wealth is considered as housing wealth. The value of housing stock when both household and non profit organisations considered will at 3,356 billion pounds. This value is estimated after considering the depreciation of the assets in the previous year as 131 billion pounds. The net capital stock of the plant and machinery increased 6 percent after deducting the depreciation for older assets. The increase is rigorous in last 5 years. The increase in the value of the stocks regarding housing and machinery reveal that the investment is greater than depreciation, which is an healthy indicator for the stock market. 1 The replacing of capital assets at the current condition is estimated to be 2,670 billion pounds. If 2003 prices are taken as standard, the net capital stock of UK increased from 551 billion pounds in 1948 to 2,547 billion pounds in 2005. The table below shows the people and institutions who own UK shares The above table is adopted from http://www.statistics.gov.uk/cci/nugget.asp?id=107 From the above table it was clear that the foreign investors one third of the UK shares. The investors based in Europe own 34 percent of shares in UK stock exchange that values 164 million pounds. This is 0.3 percent up from that of 2003. The value of the share market increased by 112 billion pounds between I January to December 31st of 2004. At the end of 2004 the UK individuals hold 208 billion pounds valued shares, which is 14 percent of all shares. 50 percent of the shares are owned by insurance companies, pension funds and other institutional share holders. This indicates that there is healthy trend in stock market as the institutional investors like insurance companies, pension and mutural funds are investing in share market to give profits for the individual investors. These share holdings were worth 722 billion pounds out of it the share of insurance companies is 254 billion pounds and pension funds 233 billion pounds. 2 There is a significant rise in the holdings of other financial institutions in UK stock market in 2000 and 2001 from 5 percent to 10 percent. After that it was stabilised at 11 percent in the last three years. Banks own 40 billion pounds valued UK shares, which is highest in the data contained from 1963. Generally FTSE 100 companies continue to dominate the UK stock market. The 65 percent of the individual funds and 86 percent of overseas investors’ funds are invested in the FTSE 100 companies. The trend can be considered to be long term, when the percentage of the shares held by rest of the world is substantial. The investment of foreign institutions and individuals is increasing while the holdings of individuals are decreasing. 2.1 Share holders and equity in UK The worth of UK stock market was valued at 1,480 billion pounds on 31st December 2004. Since then it increase at 8 percent per year. The increase of UK’s equity market has increased over thirty years. Those trends are shown in the following figure. There are rise and falls in the values. The rise that continued till 1999 resulted in falling from then to 2002. The above figure adopted from http://www.esrcsocietytoday.ac.uk/ESRCInfoCentre/facts/UK/index57.aspx?ComponentId=13071&SourcePageId=18135 At the end of 2000, the UK was listed as world’s third largest stock market. This is in terms of market capitalization. The following table shows various stock markets in this point of view. Table 1: The world's 10 largest stock markets by market capitalisation (in $ million) (at the end of 2000) [3] 1 United States  15,104,037 2 Japan  3,157,222 3 United Kingdom  2,576,992 4 France  1,446,634 5 Germany  1,270,243 6 Canada  841,385 7 Switzerland  792,316 8 Italy  768,364 9 Netherlands  640,456 10 Hong Kong  623,398 the above figure is adopted from http://www.esrcsocietytoday.ac.uk/ESRCInfoCentre/facts/UK/index57.aspx?ComponentId=13071&SourcePageId=18135 The above figure denotes the share of the various agencies and players in the stock market. Though there are bigger companies listed in the stock exchange, most of the companies are smaller. It was observed that more than 50 percent of the companies listed had a market value of less than 50 million pounds. This was shown in the following figure. The following figure shows the distribution of the UK equity market at December 31 2004. The trends in the UK share market tell about the increase of the power of share holder. There was an example for it. In may 2003, the share holders of the glaxo smithkline did not approved the proposed pay package for directors at its annual general meeting. The main cause is that the CEO will receive 22 million pounds if he was dismissed at any circumstances. This was assumed by the share holders as the over protection of the interests of CEO than the share holders. As a result they rejected the proposal regarding the payments for the directors. The changes in the trends and the rules are resulting in the increase of the engagement of the companies with the share holders. The introduction of the operating and financial review in UK is compelling companies to disclose as much information possible to the share holders. The disclosure of the information will provide the shareholders to have longer view of the company’s performance. This gives the share holders the necessary information to decide on their investment in the company. The operating financial reports is termed to be focused on share holders. Some experts feel that they needs of stake holders also should be taken into account. There is no logic about keeping secret information for the sake of stake holders. The information disclosure is more important for the share holders because, they do not participate in the decision making of the management. The stake holder is not like that. If he was aware of the decision making of the management, they have to decide accordingly. The disclosure of the information will be difficult when the value is created due to intellectual capital. The value of the company created from the intangible assets also will stop from disclosing the information. At the end of 2004, the amount of money put into UK ethical savings and investments exceeded the 10 billion pounds limit. This is the first time in the UK’s history. After that in the course of activities in 2004, the investment increased to 10.6 billion pounds. It was recorded that in 2004, 4.7trillion pounds value of equities were traded on the London stock exchange. This is 30 percent more than the amount traded in 2003. This is another instance that tells about the rapid growth of stock exchange business after 2000. On some important days in 2004, it was found that the London stock exchange made 261,011 trades and 18.6 billion pounds worth equities are traded. This trend was not observed before 2000 or 2003. The number of companies listed in the London stock exchange are 2,837 by the end of 2004. The companies that are playing in the main market are 1,816. There are 351 international companies operating in London stock exchange. The stock exchange’s market for the smaller growing companies AIM contains 1021 companies. Out of these 116 are recognized as international companies. 293 initial public offerings are offered in 2004. Due to these initial public offerings the newly listed companies are able to raise 7 billion pounds. There is an index known as FTSE 100 index. This contains the largest 100 companies according to market capitalization. There are selected from the companies listed in the London stock exchange. These 100 companies generally dominate the business in the UK stock market. The FTSE 100 companies were first calculated on January 1984. The opening value of the index at that time is 1000 points. Those companies are there still unchanged in the UK stock exchange. Now the total market capitalization of those 100 companies is 100.145 million pounds. The highest value of FTSE 100 index was recorded on 30th December 1999 as 6930.2 points. The lowest values is 5413. 56 and it was recorded on 23rd September 2005. 3 3. UK stock Market Before 2000 It was observed in the previous chapter that the UK stock market and capital assets increased rapidly after 2000. In this chapter the trends of UK stock market before 2000 will be discussed. It was observed in the trends before 2000 that the sector effects are more important than international economic differentials in managing the equity funds. In this context the research on sub sector is ignored or very little research was observed. There is volatility observed in sector and sub sector in the stock market between 1967 and 2000. The analysis reveals that most of the time series variation in total variance is due to changes in market and sub sector variance. The volatility of individual sector was found out to be more than the volatility of the institutional sector. The consistency of the institutional investors has been gradually increased and that of the individual investors decreased in the period 1967-2000. After 2000, the institutional investors dominated the holdings in the UK stock market.4 The analysis of monthly index series of UK financial assets that covers equities, bonds, bills and inflation reveals that the volatility is sector related. The sub sectors also play an important role. The sector effect on the UK market has been changed from 1955 to 2000. The comparisons of the UK market with that of United states, Germany and Japan also indicated the same trend. In all the cases the institutional sectorial effect has been increased. The stock market seasonality, inflation linked bonds and real dividend growth rates and small firm effects are also studied, but the sector influence on the market is considered to be more. The findings reveal that the UK and US stock markets resemble each other in functioning. This is due to the fact that the UK works in tandem with US in international business and the support of US is to UK when it preference in Europe is considered. 5 The reason for this trend is the international economic differentials decline on country specific factors and is favouring the sector specific tracker funds. The investors are more sector specific than country specific. This is due to the opportunity available to the investors to invest in products that are specialised in specific areas of stock market. This is resulting in investors favouring sectors and sub sectors instead of being country specific. The continuity of business cycles coverage and the process of globalisation the correlation between country specific fundamentals are observed to be increased. The portfolios are diversified across countries and their efficacy is reduced if there is lack of diversification. The need of diversification compels the institutional investors to invest according to the sub sector preferences also. The portfolios that are based on sector decisions provided market sectors are independent are less positively correlated. This will add more value to increase the opportunity to control risk. The portfolio will be motivating if there is desire to produce the most efficient one with the required diversifications. The sector and sub sector specific risks have become more important in the atmosphere of less importance to market factors. 4. Empirical Results The above figure is adopted from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=276048 The above figure provides a time series plot of market volatility for the period 1968 to 2000. The research revealed that the market returns are constructed as the weighted average using all the sub sectors in the sample in a given period. The weights for the period are market value of sub sector in period t-l. To make easy the interpretations, of the graphs the equation Market Volatility at time t 2 2 ) ( ˆ - = = t j m mj mt R m s is multiplied by 12 and the square root of it is calculated to report market volatility as the standard annualized derivation. The same trends are found in US also. In May 1970, the aggregate of the UK stock market volatilityis 28.6 percent while that of US is 33. In October 1987 it is 66.5 for UK and 81.9 for US. This resulted in the questions that makes methodology consistent when the weighted average is derived. The correlation regarding the derived market return constructed when the market is in down trend is 0.998. The similarity between UK and US markets is not there in 1973-75. The volatility is more in UK than in US by almost 50 percent. This is due to the lagged move of average of order 12 of the market volatility is exhibited in the following figure. The above figure is adopted from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=276048#PaperDownload The oil price shock also may be a reason for the rapid tightening of monetary policy. This was a major source of uncertainty for UK in that period. After that the oil price effect on the stock markets was reduced gradually and was brought to the minimum extent by 2000. 6 One important observation from this graph is that the market volatility is low during 1993-97. A structural shift was observed in 1992 regarding the underlying volatility. According to that a high market volatility was predicted and that did not materialized.7 This gives indication about the volatility due to time variation at the sector and sub sector level. In the following figure the average sector specific volatility is depicted. The series is the annualized standard deviation of sector volatility and is calculated as the square root of equation Sector Specific Volatility at time t 2 ˆ s w multiplied by 12. The lagged move average of order 12 of the annual standard deviation also was observed in the following figure. The figure is adopted from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=276048#PaperDownload The sector specific volatility in 1973-75 is 21.21 percent. This is lower than the market volatility at that time. This is due to systematic aggregate forces in the UK economy. The sector volatility in 1987 is 17.6 percent and again lower than the market volatility. This suggests that the total volatility at the above mentioned time was composed due to the systematic risk. The peak observed in 1984 may be due to the privatization of the british telecommunications plc. This had a returnof 28 percent on the day of privatization. According to the following figure the sub sector specific volatility can be observed. The above figure is adopted from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=276048 Excluding the 1973-75 period, the sector volatility is similar to the market volatility. In 1973-75 and 1983 it is due to oil price shock and privatisation of British telecommunications respectively, the standard deviation of sub sector volatility is higher than sector volatility. In the rest of the time considered in the above figure the sector volatility is in similar to the market volatility. Though there is a peak of 27.5 percent of sub sector volatility in march 2000, there is no regular trend of growth. After 2000 the growth and volatility of the market is sector specific. In the following figure the average movements of sub sector volatility are portrayed. The next figure shows the sector and sub sector volatility combined. the above figures are adopted from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=276048 The result that can be noticed from the above figures is that the sector specific volatility recorded the increase considerably during 1997-2000 when compared to the previous values. The most volatile component of total volatility with annualized standard deviation 30.6 percent was observed. The volatility regarding sub sector and market are 27.5 and 18.6 percent respectively. This may give the idea of more weightage offered to sector volatility by the market. It depends on the needs of the investors and the returns they get from those sectors. When the subsector volatility is less, the sector specific volatility is more deepening to sub sector specific. This in turn may result in comparatively more stability to stock markets unlikely to the situation of the it when these sector specific volatilities are absent. The more and more the volatility is turning sector and sub sector specific, the effect of fluctuations of the economy can have a chance of minimized effect on the stock market. There is a long run convergence between US, UK and seven other European stock markets. The short run diversification gains occurred in UK stock market and it was observed that they are short lived according to the above analysis. The UK stock market has another quality of being less bound to common trend. This will imply that thee is increased stock market merger activity and it resulted after 2000. The large stock market adjustments in UK are observed when the common currency transition took place in certain areas of the business between European countries. 5. Stock Market reactions to announcements of dividends The important reaction that is to be considered by the stock market is that the one due to the announcement of dividends by the companies. The UK stock market is not averse to that reaction. It is observed that the stock market records growth directly proportional to the announcements of the dividends. In general a 620 UK companies announcements of dividends are capable of making the UK stock market react. When the dividend is left unchanged the reaction is neutral and the reaction is positive and negative when the dividend announcements increase and decrease respectively. This will acknowledge the role of dividend as a signal to investors. Yet times the increase in dividend may result in positive abnormal growth that may result in a quick fall in the future and vice versa. Though this trend is observed in UK it was observed that this one is less than the thing prevailing in other stock markets. The reason is that the dividends in UK are invariably announced simultaneously with information about corporate earnings. The important reaction that can be considered in UK stock market is that the reaction will be negative if there is conflict in announcements. For example, if the announcements of dividends are associated with the decrease of earnings, the UK stock market is expected to be negatively react. This means the investors and institutional investors are more attentive in this issue. This trend has been established after 2000 as the institutional investors increased their presence and investment involved the strategic planning. 8 The reactions depend on current earnings, current dividends and management forecasts of next year’s earnings. It was found that the stock market reacts to the surprise in forecasts regarding the managements. The reactions depend on current dividend offered also. The breakdowns observed indicate that the signaling models and hypothesis of cash flow will explain the separate reaction components of the stock market reaction. In this chapter the dividend irrelevancy is not considered. Miller and Modigliani in 1961 put forward the irrelevance of dividends. The reason behind this is that the perfect capital capital markets will not affect the investment policies of the company. There fore they have no impact on valuation of the firm. The value of the firm will be estimated by the share holders by the earnings and growth opportunities. Since the effect increase the dividends they will result in the rising of new capital to fund. This will make optimal investment policy in the market. Though the dividend irrelevance is proposed, the dividends continue to exist and are frequently used in the market. The empirical studies denote that the market reaction to dividend announcements was frequently observed. The puzzle caused due to the difference between theory and the practical consequences has generated a number of theories. These attempted to explain the existence of the dividends. The argument and the theory of Miller and Modigliani in 1961 recognised the potential for dividend announcements to contain information. The reactions for the dividend changes will give a signal of management’s expectations about the future profits of the company. This affects the market reactions towards the dividend announcements. The market react according to the estimations of the future profits of the firm depending on the present dividends. This results in dividend change are making a price change inevitable. Though the dividends cannot be termed as a cause for the change of price, it will provide the chance required for the fluctuations in price. The idea relating dividend and the prices was elaborated on the literature that attempted to explain the existence of dividends. This explanation used the signalling models that are based on information asymmetries between management and share holders. The explanation of dividend related price change is based on conflicts between managements of the companies and the share holders. Thus the relationship between the management and the shareholders are capable of bringing the reactions in the share market. Dividends can mitigate the problems by decreasing the free cash flow. The cash flow available with the management also thus was capable of creating reactions in the stock market. These sections discussed makes managements submit themselves to the discipline of financial market’s reactions. The explanations for the existence of dividends will propose a reaction in the market when the dividends are announced. There is difference in using signalling models and dividend announcements. The signalling models rely on pure informational role of dividends. Whereas the free cash flow theory observes the dividends as the funds that have a real effect. This is due to the fact that they are capable of reducing the investment. Though the empirical literature regarding the market reaction to dividend announcements is large, small amount of it was mentioned in this paper. The empirical studies are conflicting also. The study that is to be taken into consideration should be chosen according to the need of the reactions being studied. The explanation for the control of the confounding effect of the earnings on the announcements also made available by chang and chen in 1991 and leftwich and zmijewski in 1993. In 1983 penman recognised the possible effect of the management’s forecasts of earnings as a contributing event and attempts to assess whether management’s earnings forecasts have more information content. The results are conclusive that the management forecasts will have an effect of creating the reaction in the market. The studies found that the market reaction to dividend announcements depend on the information content provided by the companies on the dividends. Generally the studies on dividend’s and the management forecasts effect on the reactions suffer from possible bias that management has intentionally selected contemporaneous announcing dates. This is in attempt to effect the impact on the returns. Penman in 1984 supported this possibility of influence of the dividend impact on returns. They found the evidence the management attempts to effect the stock market’s reaction. The reaction is due to the announcement of earnings. It was observed that the announcements of the company resulted in rise or fall of the company or companies’ share prices. The usage of data regarding the announcements of dividends and earnings in UK resulted in consistency with the information content. Though the evidence was found, it was not able to explain the reaction due to dividends functioning as signals of variables relevant to the valuation of the firm. If this is true, the dividends effect real considerations in contradiction to the irrelevancy of dividends. To remove the confusion regarding this the informational and the real affects of dividends need management and share holders have symmetric information. The information should be regarding current and future earnings of the company. The earnings must be considered at the time of dividend announcement. Convoy et al in 2000 found that the present dividend announcements do not explain about the market’s reaction to the announcements. The findings were interpreted as evidence. This evidence supports the irrelevancy of dividends. This cannot be case in all the real circumstances as it is not applicable universally. It was observed that the possible information effect on the dividend announcements will be adequately controlled. Then there will be no market reaction to dividends. This supports the proposition that they have no impact on real considerations. This is in regard to the future earnings and opportunities regarding the growth. The results are interpreted in a manner that indicate the present dividend having no signal of future prosperity. This is above and beyond the contained present earnings. The management forecasts for next year’s earnings and dividends will also observed to be a cause for the reactions in the market. Theoretically this should not be considered as the cause for the reactions in the market reactions as they cannot be considered as the assurance for the future earnings. The reactions in the UK market for the management forecasts indicate that the share holders rely on the company’s performance. It was also observed that the reaction will be positive if the current earnings are encouraging and support the future forecasts. The future forecasts about more earnings may not result in the positive reaction in the market if the present earnings are not encouraging. Several studies particularly Hodder and tschoegl in 1990 indicate that the firms have a close and long term relation ship with their share holders, investors and stake holders. The investors, stake holders are capable of effecting the market results thus affect the reactions of the share holders also. References: 1. National statistics team, 2007, UK worth £6 trillion, National statistics, ,electronic, 8-3-07, http://www.statistics.gov.uk/cci/nugget.asp?id=479 2. National statistics team, 2007, UK worth £6 trillion, National statistics, ,electronic, 8-3-07, http://www.statistics.gov.uk/cci/nugget.asp?id=107 3. Black A et al, 2002, Changing UK stock market sector and sub-sector volatilities, 1968-2000, ingenta connect, ,electronic, 8-3-07, http://www.ingentaconnect.com/content/mcb/009/2002/00000028/00000008/art00002 4. ELROY DIMSON , PAUL MARSH , U.K. Financial Market Returns 1955-2000, Social science research network, Journal of Business, Vol. 74, No. 1, 8-3-07, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=247770 5. Anjela black, 2001, Efficient Portfolio Diversification: Changing UK Stock Market Sector and Sub-Sector Volatilities, 1967-2000, social science research network, , electronic, 8-3-07, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=276048 6. Patricia Fraser, Oluwatobi Oyefeso (2005) US, UK and European Stock Market Integration Journal of Business Finance & Accounting 32 (1-2), 161–181. doi:10.1111/j.0306-686X.2005.00591.x 7. AA Loney et al, 1996, The stock market reaction to dividend announcements: A UK study of complex market signals, emerald, ,electronic, 9-3-07, http://www.emeraldinsight.com/Insight/viewContentItem.do?contentType=Article&hdAction=lnkhtml&contentId=1501853 . ESRC, 2007, UK fact sheets, ESRC society today, ,electronic, 14-3-07, http://www.esrcsocietytoday.ac.uk/ESRCInfoCentre/facts/UK/index57.aspx?ComponentId=13071&SourcePageId=18135 9. Carina Sponholtz, 2005, Separating the Stock Market’s Reaction to Simultaneous Dividend and Earnings, cls.dk, ,electronic, 14-3-07, http://www.cls.dk/caf/carina.pdf Read More