If you are considering whether to invest in UK equities at the moment, Nick Peters a portfolio manager from Fidelity Solutions has provided his thoughts on the subject which tackle a few common areas of thought:
Is now a good time to invest in UK equities?
“Interestingly, some studies suggest that there is no direct link between GDP growth and the performance of the market. 2012 illustrates that point, when the UK equity market delivered double-digit returns alongside a GDP growth close to flat. But having said that, emerging signs of economic growth should boost corporate profitability and cash flow generation, and the impact of these will work their way through to stock valuations thereafter.
“Investing in the UK market means exposure to a wide variety of countries. Around half of the business done by companies in the FTSE 100 is done overseas, so optimistic prospects for the US, Asia and emerging markets should translate to good opportunities for UK businesses and their stocks.”
How can investors gain exposure to the UK’s housing boom as it continues to drive the recovery?
“The most direct way to play the housing theme is through construction companies and UK property stocks. These stocks have had a terrific run in recent years, following their lows in 2009.
“But if you look at the UK more broadly, an improving housing market leads to a pick-up in consumer confidence, and the best way to play UK consumer confidence is through investing in smaller and mid-sized companies, since these tend to have more of a domestic bias. Again, these types of stock have performed well, but there are still pockets of value to be found, so look for a fund managed by a strong active stock-picker, who can spot opportunities among companies.”
Since equities have performed so well, is there still value in the UK market?
“My view is that the market is priced at around fair value: not expensive, but not cheap either. Over the last couple of years, we’ve seen market valuations rising steadily without seeing a pick-up in earnings growth. If the market continues to rise from here, we’ll need to see this earnings growth to support it.”
Many investors have taken shelter in so called ‘safe haven’ stocks in recent years. Have these become too expensive?
“Six months ago, these perceived safe haven stocks – mostly defensive companies with quality growth, strong cash flows and high dividend yields – were performing very well relative to more cyclical, economically-exposed stocks in the index. But as the economic data has improved over recent months, more cyclical stocks have performed better than their defensive counterparts.
“A number of defensive stocks have hit bumps in the road: Unilever is a good example. Its share price has tailed off in the last couple of months, primarily due to a message from management that emerging markets are beginning to slow down in the short term. Looking at defensive stocks overall, I think we’ve seen a correction in their valuations. For investors with a three or five year time horizon, they are now offering better value.”
Have profit margins in UK companies reached a peak?
“The share of economic outlook represented by corporate profitability is high by historical standards. Some investors see this as a cyclical phenomenon – and expect the pendulum of company profit margins to swing in the other direction in future – but I think there are a number of factors that could mean margins continue to increase. First, increases in the supply of labour have stalled wage rises, which benefits margins. Second, globalisation means companies are increasingly able to enter new markets, which also supports profitability. Third, technology has allowed companies to become far more efficient, keeping costs low and contributing to margins overall.
“In addition, many companies currently have very strong balance sheets, which they can use to acquire smaller competitors and boost their margins that way. So overall, there’s a reasonable chance that we’ll see margins continuing to progress from here.”