THE recession-hit UK economy is in deeper trouble than we thought, according to gloomy data from the Office for National Statistics, released on Friday, showing that GDP shrank by 0.8% between April and June – much faster than the 0.3% previously projected.

The bad news could have put the kibosh on the equity-market rally, but instead the FTSE 100 extended its winning run to a tenth consecutive day.

The prospect of rising interest rates and the likelihood of a long and rocky road to recovery ought to cast a shadow over second-half earnings and equity-market performance, but bullish analysts in the City are upgrading rather than downgrading their forecasts.

HSBC said that during the past two months earnings upgrades have matched downgrades for the first time this year and the ratio is expected to turn positive in the autumn – in effect ending the earnings downgrade cycle.

This upbeat message is not completely mad. So far this year, 74% of companies have beaten consensus forecasts, with financial stocks providing the biggest upside surprise.

Second-quarter results from America have also come in well ahead of expectations and the huge volume of cash from investment funds placed in low-risk harbours such as treasuries is starting to move from the sidelines into riskier areas such as shares.

The big driver of company earnings performance has been savage cost-cutting rather than top-line profit or sales growth for most businesses. Analysts, though, believe that in many cases costs have been cut so aggressively, profits will bounce back vigorously when the economy starts to improve.

Of course, company chief executives will maintain a gloomy stance for some time yet, no doubt issuing depressing outlook statements between now and Christmas fuelled by thin order books and an unknown future.

However, past recessions suggest bosses tend to be optimistic way past the market peak and, on the way back up, are gloomier for longer, only cheering up once orders come flooding in and they begin to believe in the recovery.

UK equities are currently rated at an undemanding 12 times earnings and they generate an average dividend yield of 4.5% – well ahead of gilts at 3.8% – making them the cheapest against bonds since the 1950s. The pricing indicates a high level of perceived risk and volatility remains well above average.

For the brave who are willing to take a punt, though, there will be plenty of buying opportunities ahead.

Reed Elsevier

ALL EYES will be on Reed Elsevier this week, when the new management team led by former Taylor Woodrow chief Ian Smith enjoys its first outing in the City.

In a note called Evolution or Revolution, analysts at UBS are tipping the Anglo-Dutch business to say it will redeploy up to $150m (£91m) of new cost savings back in the business – particularly the US legal division.

Inevitably Smith will be grilled on his longer-term vision for the company, especially his view of a possible merger with smaller rival Wolters Kluwer. The City believes that a deal could generate huge cost synergies and trigger a significant rerating of Reed shares.

Questions will no doubt be raised over the future of RBI – Reed Business Information – but, after the sale was pulled amid choppy market conditions, Smith is expected to say that he will hang on to it for now.

Following a challenging year, the City will also be pressing for a detailed forecast on Reed’s ability to deliver underlying organic growth. Nervousness remains about its huge debt pile but Smith is thought unlikely to plump for a share placing in the short term, insisting the structure and repayments for its borrowings are manageable.

The shares are trading at 10 times prospective earnings, well below their five-year historic average of 16.2 times. They closed on Friday at 481.25p – 40% below their level 18 months ago. At this price they are worth a punt.

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