Following more than three years of strong equity returns, the UK All Share index has fallen back to ...
Following more than three years of strong equity returns, the UK All Share index has fallen back to levels seen at the end of 2005.
However, while this has certainly put a dent in recent returns, this is not a signal of a major reversal in the market, merely a timely pause following a long period of virtually uninterrupted growth.
There has been awareness for some time that there could be a setback in markets. The recent falls can be considered as a financial market event rather than the result of any major macro-economic change. Indeed, while inflation concerns and dollar weakness have been cited by many as contributory factors in the recent global sell-off, both of these have been exaggerated.
A sell-off has been triggered by the recent increase in uncertainty about further monetary tightening, as investors have sought to take profits following very strong gains.
Considering the UK market, while it has certainly taken a hit in recent weeks, this simply represents a due correction following significant growth. Even prior to recent declines there was still not an overwhelming belief in equities as a whole.
Although the market was seeing the return of retail investors, institutional investors remain and are still ongoing sellers of equities, indicating market sentiment has not yet become overdone. With the scars still evident from the bursting of the technology bubble and the last bear market, this lack of bullish sentiment remains reassuring for markets.
However, one of the most significant indicators that this is not the start of a major reversal, is the fact it would be an unusual starting point in terms of valuations. While pockets of the market, particularly metals and commodities, have become overheated and consequently fallen, UK market valuations on the whole are still not expensive, although not extraordinarily cheap. A lot of valuation compression across the market has already occurred, leaving a number of stocks, particularly large caps, representing good value.
To add to this, the corporate sector remains in very good shape overall, with companies continuing to benefit from profits growth, strong cash flows and underleveraged balance sheets following a period of significant restructuring. With corporate confidence remaining high, these significant cash assets are not only supporting further deal flow, but are also being used by a number of companies for the purpose of share buy-backs - an indicator that companies themselves still see good value in their own shares.
Looking ahead, the macro-economic uncertainty regarding US growth, inflation and interest rates is likely to lead to obsessive 'data-watching' throughout the summer months as investors assess the prospects for US and global growth. Hence there is every prospect the UK market is now facing a long, dull summer of sideways trading and increased volatility.
However, this is not to say there will not be strong opportunities to invest, as such volatility provides opportunities for active managers to take advantage of the bad days to enhance returns over the longer-term. More importantly, however, the fact remains many of the fundamentals that have driven and supported the market over the past few years are still in place to support further growth going forward, albeit in a more modest and potentially more volatile manner. But with the outlook positive for UK equities, investors should remain upbeat.
Outlook for UK market is positive
UK market valuations not expensive
UK corporate sector still in good shape
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