The UK market represents good value compared to other markets worldwide, according to analysts, al-though this must be seen in the context of global volatility.
Kate Murphy, fund manager, income funds for Henderson Investors in London is ‘sanguine’ about UK market prospects.
“While we can see huge global question marks on valuations at the moment, when UK equities are compared to fixed interest they look very attractive,” she says.
Stuart Fowler, head of UK equities at Dresdner RCM Global Investors in London agrees with this assessment.
“I expect the market to move ahead quite markedly from here. The UK stock market is amongst the cheapest of all in the world,” he says.
Murphy says that there is huge liquidity behind the market with bids for cash and little in the way of rights issues. “People are generally cautious so the market is well supported.” she adds.
“The fear is that other equity markets will not perform well because of economic forecasts coming down with slower growth predicted by the bond markets - the yield curve would seem to suggest this even in America.”
Fowler adds: “It is only fair to recognise that most of the markets are not that cheap, but none the less we don’t see any of the usual warning signs either from falling profits or rising inflation,” says Fowler. He does see some marginal difficulties from Asia, and possibly the US.
Overall he remains bullish for a number of reasons. First gilts will provide good returns by falling towards German levels as sterling moves towards entering EMU.
“The second unique UK factor is that there has been a virility contest amongst institutional investors to see who can have most cash. This is exacerbated by share buy-backs, special dividends and cash takeovers,” he adds.
Finally the PEP season in April 1988 will still bring in some investors, despite their subsequent abolition.
The earnings outlook which is currently optimistic may be downgraded according to Murphy because of difficulties in the Far East, while the “very high exchange rate” is hitting exporters.
“On top of that the US market is very highly valued, and we don’t see the UK market bucking any set back there. Looking at history we see that that tail wags this dog.” Otherwise she is optimistic. “Time will tell if the negatives outweigh the positives.”
In terms of sectors, Hendersons is taking a defensive stance. “We are continuing to run what are nearly fully valued, large cap defensive UK-based investments.” This, for example, includes continuing to hold utilities.
Hendersons is keeping an eye on those sectors which have the greatest risk of earnings downgrade, namely those industrials that have already suffered a downrating.
However they are also looking for opportunities. “One of the interesting themes developed in the final quarter of the last year is the arrival of the American bidder in the UK market, who is prepared to pay cash.”
Fowler, in terms of sectors, says that he favours banks and financials due to the buoyant bonds, but also because of expected consolidation.
He does not favour general manufacturers. “They have little pricing power and are exposed to cheaper exports from Asia. We don’t think the effects of strong sterling have come through to profit forecasts yet.”
Paul Mortimer-Lee, chief capital markets economist at Paribas in London, expects a slow down next year to 2% and echoes much of the thinking of the analysts.
“Sterling is too high and it is clear from the slow rate of manufacturing output that this is hurting.
“Many companies have taken the hit on the chin in terms of suppressing profit margins but they won’t be able to sustain this forever and we will see exports suffer.”
In addition, there will be no windfall payments - from demutualisation - to help boost consumption, but the main story will be on the net trade side.
Mortimer-Lee expects consumer spending to hold up into January bringing another interest rate hike early next year, although this should not need to increase further because the exchange rate is “supplying a very firm brake”.
“By the end of next year, people will be talking about the first cut,” he adds.
He believes that wages are the key to the interest cycle. The RPI may drift up, but wage pressures will be subdued due to rising manufacturing unemployment and government determination to hold down public sector wages.
On gilts, he says: “Clearly the curve is very inverted and a further rate hike will invert it more, particularly when the market sees this as the last increase.”
He says that the key to the inversion is the high level of short rates in the UK compared to Germany although he notes that expected increases in Germany will constrain the amount by which the long end of the curve can rally.
“Gilts look good value with the UK slowing and Europe improving. Spreads will narrow in the next six months.” John Lappin