The outlook for UK equities is less positive now that interest rates are on the rise and valuations ...
The outlook for UK equities is less positive now that interest rates are on the rise and valuations have made up ground from their low point.
Many fund managers have turned cautious and are rebalancing portfolios in expectation of slower growth or even a downturn.
Graham Kitchen, fund manager at Invesco Perpetual, is unsure how far last year"s rally can continue.
He says: "Growth from here will be more difficult. Valuations are fair, they are not cheap, while interest rates are rising and consumer debt is huge. Unemployment is low, so the debt can probably be serviced, but the capacity for consumers to spend from here is limited. It all points to being more cautious."
Kitchen is aware that the market is still interested in high beta stocks but he is putting his portfolio in unfashionable defensives.
His top three active bets are Imperial Tobacco on a weighting of 4.7% versus the FTSE All Share benchmark index"s 0.6%, followed by Gallaher on 2% (the index has 0.3%) and, finally, BAT which comprises 2.6% of his portfolio compared with the index"s 1%.
He is overweighting utilities and tobaccos, but underweighting oils and mining. The latter he feels is "grossly overvalued" on the back of the China economic growth story - which could potentially slow this year.
However, Schroder Investment Management"s head of UK equities, Richard Buxton, has a positive outlook. He says the consensus view at the end of 2003 - that the first half of 2004 would see continued rises and the second a retrenchment - was so universally held it could not hold true. He points to recent FTSE 100 levels as proof that the fallback has already happened.
Buxton says: "There is ongoing selling by insurers with huge lines of stock coming into the market. Then there is the weakening dollar and, finally, the UK has big slugs of defensive stocks, which have not done well recently. None of this is helpful."
However, Buxton believes that when the forced selling stops, the market could make headway, particularly if the dollar stabilises. He says: "Everyone is so scarred by the bear market that they are constantly looking for the time to rush to the exit. But it is too early to think about that. Companies are only just at the turning point of revenue outlook. Everyone is too worried."
Buxton is continuing with his theme of investing in the beneficiaries of increased corporate spending, such as British Airways and Reuters, and is looking for individual stock opportunities. He is underweighting defensives and overweighting economically-sensitive companies. For example, non-cyclical consumer goods have a weighting of just 6% versus his benchmark"s 18%, while cyclical services get a healthy 29% weighting compared to the benchmark"s 15%. Buxton believes banks are too cheap and they comprise his top three holdings by size: HSBC on 5%, RBS on 4.8% and HBOS on 4.6%.
Buxton says: "Unless unemployment skyrockets, which I cannot see on the cards this year, it is not going to be that bad."
At Rathbone Unit Trust Management, fund manager Carl Stick has a foot in both bull and bear camps. He says: 'Our view remains reasonably optimistic, despite the prospects of increases in interest rates through 2004. However, we are nervous about FTSE 100 valuations: growth rates in many cases do not justify ratings."
Stick is focusing large cap exposure on higher than average yielders, such as tobaccos and utilities, but also picking specific growth opportunities such as Tomkins and Barclays.
The top three holdings in Stick"s UK equity income portfolio are First Calgary Petroleums at 1.8%, record company Sanctuary Group on 1.7% and Burren Energy on 1.6%.
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