The UK economy remains dependent on consumer spending to generate growth, while manufacturing is in ...
The UK economy remains dependent on consumer spending to generate growth, while manufacturing is in the doldrums and global trade is depressed.
Dependence on consumer spending is becoming increasingly risky. Concerns over a slowing housing market appear to have become self-fulfilling with house prices generally treading water, and in London starting to fall. Declining house prices will have a detrimental impact on consumer confidence, particularly if negative equity re-emerges.
However, we are increasingly confident that investment spending is due for an upturn and will help mitigate the imbalances which have built up in the economy. Many companies have spent recent years cutting costs, repairing balance sheets and improving cash flows. The latter is a prerequisite for an upturn in investment spending, which must occur in the interests of the long-term competitive position of any business. The UK has experienced the worst investment drought since records began in 1965. We are certainly not expecting a return to the heady days of the late 1990s, but the longer the investment is delayed, the more significant the recovery will be.
Favoured sectors are those sensitive to an upturn in economic activity, such as media and engineering & machinery. In media more evidence is required before a recovery in advertising spend is clearly underway, but conditions appear to be stabilising at these lower levels. Many engineering companies have had to cope with often a sharp decline in revenues as customers have reduced capital spending in the last two years. Consequently earnings expectations have been dramatically reduced. These now bear a much closer resemblance to reality and valuations in Engineering now discount a grim long-term future. In addition, well above-average yields are often available acting as a safety net for valuations.
As far as the largest sectors in the market are concerned, we have mixed views. We feel reasonably positive towards the telcoms sector. Recent results at Vodafone showed subscribers up 18% and a 14% increase in revenue. Although growth is likely to moderate, the stock remains attractive as the required capital expenditure in the company's 3G network is less onerous, generating a substantial improvement in cash flow. This has strengthened the balance sheet and allowed a sharp increase in the dividend payment.
Elsewhere in the largest sectors value is often indiscernible. In banking valuations are fairly full, considering that earnings growth has slowed and is expected to be much slower than the market average. Lending remains buoyant, particularly in mortgages and consumer credit, but is offset by a continuing structural decline in net interest margins.
Overall, we believe prospects for the equity market are encouraging. Certainly, there are risks ahead but my gut feeling is that they will be averted. After such a prolonged bear market is it easy to become convinced the market will never go up again. I think it could surprise us all.
Equity valuations are still attractive.
Scope for a recovery in investing spending.
Interest rates could be cut to stimulate growth.
An ambitious objective
'Something completely new'
'Illusion of control'
Reasons to be cheerful
Total investment reaches £9m