Finding the upside in UK equities

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Despite UK GDP figures for Q4 2014 falling short of expectations, Fidelity Worldwide Investment’s Nick Peters believes 2015 could be a year that UK equities could surprise on the upside.

UK equities struggled to make headway in 2014, with the FTSE All Share returning just 1.2% in Sterling terms over the course of the year.

However, Peters, who manages a number of multi asset portfolios for Fidelity Solutions, believes there are reasons to be more optimistic this year, highlighting Sterling weakness, wage growth and supportive valuations as potential drivers for UK stocks:

  1. Sterling weakness

He comments: “I believe key support for the UK equity market this year will likely be sustained Sterling weakness. Around 70% of UK company sales come from overseas (77% for the FTSE 100) and some commentators are forecasting that the Sterling/US dollar exchange rate could fall to US$1.45 due to:

  • A clear change of tone from the Bank of England in light of disappointing inflation numbers
  • The UK economic recovery losing momentum relative to the US, with the housing market cooling and recent PMIs subdued
  • A sharp divergence in current account trends; in the UK, the current account deficit is now 5.2% of GDP, compared to 2.2% in the US
  • The prospect of tighter fiscal policy after the general election (the budget deficit is now at 5.3% of GDP and borrowing is up 6% year-to-date).”
  1. Wage growth

“Employment has increased and latest data releases point towards a continued tightening of labour market conditions. It is remarkable that this has happened during a period in which public sector employment has fallen to its lowest level since records began in 1999, highlighting how successfully the private sector has taken up the baton as the UK economy rebalances.

“Despite this, nominal wage growth has only recently recovered from record lows. But it is likely to only be a matter of time before this picks up. With inflation falling to around 1% – and set to fall further on commodity price weakness – the prospects for meaningful and sustained real wage growth improves rapidly.”

  1. Supportive – but not cheap – valuations

“At 13.5x price/earnings, the market is trading marginally above the Shiller price/earnings (which uses inflation-adjusted earnings and currently stands around 12.5x), while the dividend yield of 3.3% is marginally below the Shiller dividend yield of 3.5%. These numbers suggest that the market isn’t cheap in absolute terms, but it should be noted that around three-quarters of sectors currently trade on a discount to global peers.

“The earnings environment is improving – with revision ratios bottoming out – while another positive for investors is the fact that UK companies are showing an increasing propensity to return some of the large amounts of cash sitting on balance sheets to shareholders by way of dividends.”

Risks

Of course, there are risks to this positive picture, with May’s general election front and centre in this regard. Peters comments: “A hung parliament and the associated uncertainty would likely be bad news for markets, while investors may also be nervous about a Conservative/UKIP coalition, given the associated risk of an earlier-than-expected EU referendum and potential EU exit. At the moment, however, a Labour majority appears to be the most likely outcome.”

 

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