Beware dark days after the euphoria of bank bail-out

STOCK market relief at the government's bail-out of three of Britain's big banks could prove short-lived, City experts believe.

They said yesterday it would be wrong to assume the stock market had bottomed following the strong shares surge on Monday after the effective nationalisation of Royal Bank of Scotland, HBOS and Lloyds TSB and further gains yesterday

After last week's 20 per cent plunge in leading blue-chip stocks, the biggest fall since the October 1987 crash, the FTSE 100 index surged 8 per cent on Monday following the government's dramatic action.

Yesterday the Footsie closed up a further 137 points after initially putting on more than 200 points in the morning.

But City sources said there remained the strong likelihood of recession in the final two quarters of this year to depress stock market sentiment.

In addition, fund managers and analysts said the market remained disturbed at the Treasury's decision to ban RBS, HBOS and Lloyds TSB from paying dividends to its shareholders for up to an estimated five years.

Nick Parsons, market strategist at nabCapital, said: "I don't think this (nationalisation of the banks] is an unequivocal buying signal for stocks.

"Japan recapitalised its banks in the wake of the property bubble bursting there in 1990.

"But the Nikkei index, even with its record one-day rise yesterday, up 14 per cent at 9,447, still compares with its peak in December 1989 of 38,957. In other words it has still lost three-quarters of its value despite the banking recapitalisation."

Mr Parsons said investor fears remained that the coming British recession would "not be U-shaped but L-shaped, like the Japanese experience".

City sentiment will also remain shaky because banking stocks, a key swing sector in the FTSE 100, had "virtually become "a dividend-free zone for the foreseeable future", according to one observer.

He said: "Institutional investors are going to quickly work out that the only bet they will have in the banking sector will be on capital gains. Dividend yield has gone out of the window for RBS, Lloyds TSB and HBOS for the foreseeable future until the government's preference shares have been paid back."

Barclays, even though it has not taken up the government's bail-out offer, also indicated earlier this week that it was not paying a final dividend for 2008 to conserve capital, and that payments were unlikely to resume until at least the second half of 2009.

Keith Bowman at Hargreaves Lansdown said: "Drawing a line under the financial crisis is not necessarily the same thing as having more sustainable long-term benefit for the stock market.

"The fact that there is regulatory uncertainty with such a big government presence in the banking sector will also weigh on those stocks and perhaps the wider market for some time yet."

Many in the City believe that while a two-quarterly recession is now factored in to many stock market valuations, sentiment could worsen if the recession lasts longer.

During the 1990-92 recession there were five consecutive quarters of negative growth.

Many experts believe there will be a flight to good cash-flow stocks, where earnings buttress dividend payments in a lengthy downturn.

Analysts say big defensive stocks in this situation could include the utility groups, oil and pharmaceuticals giants and non-airline transport companies.

One market strategist said: "What's out at the moment is retailers, pub groups, restaurants and the like, anything dependent on discretionary consumer spending. They are in the eye of the storm."

Rahul Sharma, a director at Edinburgh-based fund manager Martin Currie, said: "The good news for consumers is if the government's action with the banks eases up banks lending to each other they will eventually start lending to consumers."

But Mr Sharma said this was "much farther down the line" and would have little short-term effect on the performance of the wider stock market.

Another analyst said: "Rallies don't go in a straight line. It's impossible to tell if last Friday was the bottom of this market."