With UK key economic indicators suggesting interest rates in this cycle are approaching a ceiling an...
With UK key economic indicators suggesting interest rates in this cycle are approaching a ceiling and inflation has peaked, the UK equity market should benefit from a soft landing. Despite interest rates having risen over the past year, the FTSE All-Share has recently moved to a new high.
This suggests that if interest rates and inflation continue to remain under control the market could move ahead quite strongly over the coming months compared to other major markets. With the likelihood that interest rates will return to a downward trend in the middle of next year the future looks attractive for the UK equity market.
In local terms this year UK markets have lagged performance against the Dow Jones and major European indices. In the technology indices the FTSE techMARK has under performed the German Neuer Mark since the start of the year, and has only marginally outperformed the Nasdaq over the same period.
On a valuation argument the UK economy is in good shape with the consensus for corporate earnings expecting a 15% rise this year. On the back of this, earnings revisions for the longer term are being revised upwards.
This compares with the US S&P 500 where estimates for 2000 are stabilising with 2001 being revised down. Euroland, however, is very different as each country is experiencing varied levels of growth. The volatility of the Euro is emphasising this with new lows against the pound and dollar being reached on what seems like a weekly basis.
If the different economies are valued on a price earnings ratio basis using 12-month earnings expectations the UK is trading on a significant discount. The US has hovered around the 24 range since the start of the year. In the Eurozone a similar picture is seen, but in the UK the trend has been in the late teens and is just breaking above 20 now.
Looking at it simply, for the UK to catch up with the US or Europe one of the two following scenarios would have to happen.
Firstly, the US would need a harder landing than is currently forecast, which would force all world markets to underperform but the UK could outperform as it offers better value. Alternatively, we have the widely expected soft landing in the US and equity markets move ahead. As the UK has underperformed other markets this year there could be greater upside potential available.
On the Federal Reserve valuation model the S & P 500 is 15% over its fair value, which compares to the FTSE 100 at around 6% above its fair value.
Looking ahead on a demographic view, the UK has several sectors that will benefit due to an ageing population that is retiring with greater wealth.
The healthcare and pharmaceutical sectors are the most obvious beneficiaries, as the percentage of the population over 50 is set to rise by over 20% in the next 10 years.
Recent studies in the US have revealed three times more drugs and medical products are consumed with age than the industry can currently supply. This implies the sector is looking at a huge increase in sales volume, and with companies on relatively low historic valuations a further rise in these share prices can be expected.
Other areas within the market likely to benefit over the longer term are banking, electronics and electrical equipment, information technology, software and companies looking at environmental issues, for example, fuel cells and fuel efficiency/improvements to the auto industry.
Outperformance in the UK can be achieved through good quality market/world leading companies coming to market at the cutting edge of technology. One example of this is the upcoming floatation of ARC Cores that designs configurable processors for the telecommunications, voice and data networking and consumer electronics industries.
With the UK having the lowest inflation rate within the European Union the prospects for economic growth look very positive. Eurozone growth is unlikely to moderate very much, and indeed may rise slightly forcing the European Central Bank to make further rises in interest rates.
A move upward in the UK market would also benefit from a significant stock squeeze, as the majority of overseas fund management houses are underweight in UK Markets following the disappointing performance since the technology rally finished in March. Taking all the scenarios into account you have what appears to be a 'Win, Win' situation in the UK.
Simon Silva-Peake is a fund manager for the Capel Cure Sharp UK Opportunities Fund
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