The difference in valuation between the most highly valued areas of the UK stock market, such as tel...
The difference in valuation between the most highly valued areas of the UK stock market, such as telecoms and technology, and 'old economy' sectors, such as industrials, consumer goods and utilities, is vast, and almost certainly assumes too much growth from telecoms and tech.
As the largest single sector in the UK stock market at 14.6%, it is worth looking at the of the telecoms sector's prospects.
While it is true that demand for telecommunications capacity is increasing strongly, the supply of new capacity has grown even more quickly, with, for example, 20 pan-European fibre interlinked networks either built or under construction.
With supply exceeding demand, competition is intense and the result has been, and will continue to be, rapid price deflation. While this appears not to worry most equity analysts, bond investors and the rating agencies have become much more concerned. In many cases, the debt ratings of telecoms companies have been downgraded, even to the extent that they stand at or just above junk bond status.
Returns from mobile telecommunications are also under threat. The extremely high price of the 3G mobile licences auctioned in the UK and the rest of Europe, the considerable cost of the infrastructure and the uncertainty over what customers can be persuaded to pay, suggest that the mobile telephone companies will be lucky to make returns on investment much into double digits.
Furthermore, the technical situation is poor as HSBC Investment Bank estimates e70bn of new equity will be issued in the telecoms sector in Europe over the next six to nine months. For all of these reasons, our fund is underweight in telecoms shares.
Elsewhere, there are many examples of attractively valued companies and, with the high yields that often result from depressed share prices, there are many opportunities for an income fund looking to generate a reasonable and growing dividend. In fact, one in seven companies of the FTSE 350 Index has a yield greater than that of the 10-year gilt. Choosing the right share will give investors the chance to increase income in the short term, benefit from rising dividends over time and hopefully enjoy an increase in capital value.
There are caveats, of course, and in a low-inflation environment with increasing price transparency, many companies will find it hard to maintain any form of pricing power. Unless costs can be reduced as quickly, there will be an ongoing margin squeeze. This is particularly true of companies close to the end consumer and commodity manufacturers.
We believe corporate activity should provide a floor for the valuations of many companies and that investors with longer-term horizons can take advantage of the excellent value on offer.
Julian Cane is director of UK equities at Foreign & Colonial Management
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