Almost regardless of what happens during the remainder of the festive season, this year seems destin...
Almost regardless of what happens during the remainder of the festive season, this year seems destined to be remembered as a disappointing one for UK equity investors. The strong likelihood is that 2000 will turn out to be only the second calendar year, in the past 10, to see a negative return from the UK equity market.
At times like these it pays to step back and consider somewhat more soberly the economic prospects and equity market outlook. Overall, UK equities have gone virtually nowhere for two years now and have been disappointing in an international context.
Given the attractive macro background in the UK, this looks unjustifiably harsh.
For some time, we have felt the top down backdrop is supportive for equities. Inflation, aided by technological and productivity-related advancements, looks to be well under control going forward. Public sector finances are healthy and given that monetary policy has been relatively tight for some time, interest rates appear now to have peaked.
There appears to be scope for a more accommodative stance next year, with base rates set to go lower as early as the first half of 2001.
Given that inflation is set to remain at or below the Bank of England's target of 2.5%, this represents a reasonable performance and, with corporate balance sheets (with certain notable exceptions eg telecoms) generally pretty healthy, dividend growth should also remain reasonably robust.
We believe that the UK equity market offers attractive returns from the current somewhat depressed levels, with the FTSE 100 index capable of around 7,250 on a fair value basis looking 12 months or so forward. Given that inflation seems likely to remain at 2.5% or so and base rates are set to fall from 6%, equity investment should be a far more rewarding endeavour next year than it has been in 2000.
In sectoral terms, we remain of the view that in a low growth, low inflation environment investors will be prepared to pay a premium once again for genuine growth businesses.
Conversely, the defensive rally now looks somewhat overdone with valuation in numerous areas, such as food manufacturing, food retail and beverages, offering little upside potential.
Favoured growth themes continue to include the long-term savings industry, financial services generally, pharmaceuticals, IT hardware, software services, outsourcing, selective mobile telecoms and certain media and content providers.
Overall clearly there are risks, with a hard landing in the US of greater concern to investors than it was a few short months ago. Nevertheless, the risk/reward balance strongly favours UK equities once again and, although volatility and continued sector rotation are likely to remain regular features, the market is certainly attractive at current somewhat depressed levels.
Jon Thornton, Head of UK Equities, Aberdeen Asset Management
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