By Robert Waugh, a fund manager at Edinburgh Fund Managers The past few weeks have been quiet in...
By Robert Waugh, a fund manager at Edinburgh Fund Managers
The past few weeks have been quiet in the market - the level of stock rotation continued, with cyclicals outperforming and defensives underperforming the rising market.
One key event was the level of equity issuance. Vivendi sold £1.5bn of BSkyB and Kingfisher announced a potential £2bn rights if it can get the go-ahead to buy out the balance of Castorama.
The Bank of England inflation report in mid-May was a little more hawkish for inflation, with the expectation of the UK returning to above trend growth over the next few years, while keeping an eye on sterling.
On a macro level, the consumer and housing markets remain buoyant but economic output has been stagnant for the past six months. This can be blamed largely on the decline in finance and business services due to a decline in stock market transactions. We believe the outlook for the UK equity market is reasonably positive from here.
We expect to see continued recovery from the current low levels of economic growth.
Global interest rates should remain low until the recovery has strong foundations. This recovery will lead to a rebound in corporate profits, which should in turn lead to a rise in the UK equity market.
The consumption element of GDP is our main concern. The UK consumer has taken on a high level of debt while interest rates have been falling. This debt burden will become difficult to finance when interest rates rise, probably in the fourth quarter of this year. This concern has led us to be wary of consumer cyclicals such as stores and leisure. The drag on UK equities at present is the quantity of equity issuance hitting the market. More than £4bn in the first quarter and in excess of £2bn in the second quarter so far.
This can be weighed against continuing buybacks by large companies and takeovers in the utility sector, however, new issues are struggling to get away after a weak showing from HMV and the pulling of the Punch float.
Companies attempting to repair their balance sheets following the economic downturn is inevitable, and has in the past given way to improving confidence and rising share prices. The over-investment in the areas of technology and telecoms are working their way out of the system, although it is difficult to see much pricing power in these industries for some time to come.
The technology sector has been slow to price in the level of profits collapse that is being witnessed, as prices have chased falling earnings expectations. The leading stocks in the sector are now priced on an enterprise value/sales ratio (this takes out the short-term moves in margins), which is below where they were trading in the first half of the 1990s.
While it is difficult to call the turn, value is starting to emerge in this area of the market. Our largest overweight positions are in construction, beverages and media.
These views are based primarily on individual stock opportunities, focusing on investments that will benefit from an improving economic backdrop.
Interest rates are currently low.
Economic recovery continuing.
Equities look good value against bonds.
Poor results coming from corporate sector.
Over leveraged private sector.
No inflation to reduce debt levels.
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