Invesco Perpetual’s Martin Walker looks to UK equity opportunities amid rising bond yields
Martin Walker, UK equities manager at Invesco Perpetual, has identified equity opportunities in advertising, insurance and tiles for houses as he looks to take equity positions amid rising bond yields.
As rising bond yields unsettle equity markets in the near term, where is the best value to be found in UK equities?
An improving outlook for economic growth, notably in the US, has led to concerns over an imminent end to the monetary easing and to bond yields rising in anticipation of a hike in interest rates. The resultant increase in the risk free rate of return, and thereby the cost of equity, has been putting pressure on equity valuations. However, looking further out, I believe that equities own a “call option” on future economic growth. Once expectations of rising bond yields have levelled out, I expect equities to continue their upward path.
It is worth remembering that economic growth is one of the drivers of equity performance, which is not the case for bonds. Economic growth underpins growth in company earnings and hence the improving economic outlook should prove positive for equity markets over the medium and longer term. It is also worth noting that the end game of quantitative easing is not deflation but inflation – and that equities, with share prices driven by nominal earnings growth, are a much better bet than bonds in an inflationary environment.
There are three pillars to stock market returns – starting valuation, company earnings growth and investment of retained earnings. After such a strong run over the past few years combined with the recent rise in the risk free rate of return, equity markets are no longer as compellingly good value. But the latter two pillars are still very much in place, particularly in an improving macro-economic environment.
In terms of constructing a portfolio to perform in this environment, the key, I believe, is that you need exposure to growth – which will mitigate against a rising risk free rate of return. This growth exposure can come in several guises, including a correlation of earnings to economic growth and by under-appreciated self-help stories.
WPP is one example of a company I hold in the Invesco Perpetual UK Growth fund and where I see very clear exposure to economic growth. As one of the world’s largest creative and marketing services groups, with operations in over 100 countries, WPP is strongly placed to benefit from an improving global economic outlook.
The fund’s holding in insurance group Resolution is predicated on growth which is very much more company specific. The provision of defined contribution pension schemes and annuities is not typically viewed as a business to get the pulse racing, but the demise of the company-provided defined benefit scheme and an ageing and wealthier population have combined to make investors see this sector in an altogether different light. Looking forward, defined contribution pensions are likely to provide the major part of people’s retirement plans.
A different type of growth exposure can be found in Topps Tiles. The UK’s largest tile specialist is set to benefit from the up-tick in the housing market, with a further boost expected from the UK government’s recent housing related measures, as well as from its own investments as part of its strategy to grow market share.