The UK stock market gained five per cent since the start of 2005 at its late-February peak. Shares are approaching the year-end targets set by many investment bank strategists.
It helps to explain why institutional investors are growing increasingly concerned about stock market prospects in the months ahead.
Conditions like these often triggered shifts into defensive sectors in the past. These are segments of the economy that generate steady profits and steady dividends, regardless of underlying economic conditions.
But this time may be different as far as Food Processors and Producers are concerned. These are companies that produce, process, manufacture or distribute foods and sweets to the nation's retailers.
Historical Perspective
Food producers have long been viewed as a defensive mainstay of every investment portfolio.
The price trend from mid-1998 to mid-2002 was entirely consistent with the sector's defensive image. As our graph illustrates, sector prices began to fall in the third quarter of1998 in lock-step with the rest of the stock market. Prices continued to deteriorate during the recovery of 1999, one of the casualties of the dot.com boom that caused investors to avoid so-called Old Economy sectors.
The defensive nature of the sector revealed itself from 2000 to mid-2002. Virtually every sector fell during this painful period. Food producers were an exception, soaring by 41 per cent, as investors returned to old fashion virtues like steady profits and rising dividends.
Times Are Changing
But prospects for this sector began to change in mid-2002. Three years have passed and the trend continues to disappoint.
These changes were initially hard to spot. Share prices fell from mid-2002 to March 2003 with the rest of the market in the final stage of the painful bear market.
A new bull market began in March 2003, raising the FTSE-All Shares index by 58 per cent. Food Producers only gained about half of this level. Fair enough, some might think, because defensive sectors often lag near the start of powerful bull market rallies.
But a solid clue finally emerged in 2004. Recall the stock market plateaued during much of 2004, gaining three per cent by late-September. Defensive sectors often benefit in these types of circumstances. But shares in Food Producers were even weaker, falling by four per cent.
In retrospect, two factors unique to this sector contributed to the relative weakness of recent years. Both are unlikely to be reversed in the immediate future
Pricing Power
Food processors have lost control of their pricing power and their ability to grow profits. Sales of most foods and sweets on both sides of the Atlantic now largely go through a few giant supermarket chains. Processors have little recourse if a major retailer refuses to stock a product because the wholesale price is thought to be too high.
The result is that profit margins and dividend growth plans for many manufacturers and producers are vulnerable. Prospects for a reversal of this state of affairs in the near future are poor.
Health
The second big issue is health. Sudan Four has become a household term by virtue of the hundreds of products recently withdrawn from UK retail shelves. But Sudan Four is just one health issue, and a minor one at that. A bigger worry for sector investors is the public's growing concern over obesity. This is potentially an expensive time bomb that could affect any manufacturer that adds salt or sugar to any food product - virtually every company in the sector.
A second serious health problem is the growing concern about marketing foods and sweets to children, a lucrative segment to many food producers.
Consumer groups on both sides of the Atlantic are becoming increasingly vocal about food ingredients and food marketing, especially if they involve youngsters.
Experience teaches that politicians eventually respond to public opinion, as cigarette manufacturers have learned to their cost. Increased government oversight and control over manufacturing and marketing practices could be a serious long-term risk for sector investors.
And we must not forget the threat of legal "class action" attacks in the United States from individuals and groups who claim food producers have damaged their health. It has the potential to affect industry practices for years to come.
These threats help to explain why sector prices have broadly drifted sideways in recent years. As our graph illustrates, the gains and losses have formed a perfect symmetrical triangle. Technicians or chartists believe that breakouts from chart patterns like this are often followed by large continuation moves if they occur early (close to the left side of the triangle). On the other hand, the message communicated by these kinds of chart formations is that horizontal drifts to the apex of the triangle (the right side) are often followed by further drifting.
Whether you choose to trust the headlines or the patterns formed by recent price trends, the message is the same. Food Producers & Processors are not likely to provide positive investment potential for long-term investors in the near future and are best avoided.