Improving growth and retail spending to lift UK equities despite general election fears, says Trevor Green.

April 2015

Key points

  • Medium term prospects for UK equities, which set record highs in March, are encouraging given a strengthening economy however, the market may turn choppy ahead of the general election and as a rate rise nears.
  • We expect shares in US-focused companies to continue performing well as the US economy and dollar strengthen.
  • With a 3.57 per cent yield1, equities still appeal to income investors, though better value exists outside traditional ‘bond-like’ sectors such as tobacco and utilities.

We expect UK shares, which surged to an all-time high in March, to climb further over the medium term aided by an improving domestic economy. However,we are more cautious in the short term.

Equities are for now largely brushing aside concerns over the result of May’s general election, supported by encouraging economic data and low interest rates. However, markets could turn choppier as the vote nears and as attention shifts to the timing of hikes in US and UK interest rates, with the Bank of England expected to move in early 2016.

Portfolio positioning

We are positioning our equity portfolios according to three investment themes. First, we expect high-quality companies capable of growing revenues and cash flow regardless of economic conditions, to be highly prized.

Mergers and acquisitions (M&A) is the second theme. We are anticipating M&A activity to increase from last year’s disappointing level, as the recent rise in sterling’s value against the euro provides a boost to cross-border deals. Our final theme involves companies with ‘self-help’ potential, in other words those companies which can be run better.

Growth tailwind and political headwind

Earnings growth has been very encouraging in recent months, especially in consumer-facing businesses, as higher disposable income feeds through to improved spending. Our portfolios are overweight shares in ‘general’ retailers and support services companies, both of which stand to prosper as consumer expenditure picks up. For instance, we expect motor distributor Vertu to profit from more buoyant UK car sales, which have risen strongly since last year.

Doubts over the make-up of the next UK government are likely to linger beyond May’s election given the prospect of a hung parliament and post-election horse trading. So our portfolios are underweight sectors particularly prone to regulatory intervention like utilities, banks and some transport industries.

‘Bond-like’ sectors appear expensive

Income investors continue flocking to UK equities which yield 3.57 per cent and have the potential to grow dividends further. However, we fear many consumer goods stocks’ valuations have begun to look very stretched as a result of this hunt for yield. So, we are underweight tobacco. We believe more attractive opportunities exist outside traditional, largecapitalisation ‘bond-like’ sectors such as tobacco and utilities.

US-recovery stocks

In addition to tapping into the domestic recovery, our portfolios have stakes in a number of companies with sizeable operations in the US. These companies should profit from the more vibrant US economy and a stronger dollar. These shares have performed strongly in recent weeks with the dollar surging around seven per cent against sterling since October1.

For instance, Ashtead recently raised its profit forecast for the year to April 2015 as a buoyant US housing market boosted revenues at the construction-equipment rental group. Catering company Compass is another to have reported stronger trading thanks to its US operations.

Improving euro-zone outlook

Packagers DS Smith and Essentra are examples of holdings with a significant European presence that have taken much market share in recent years despite tough economic conditions. DS Smith, a self-help holding, has doubled annual profits since 2012 as its management reshapes the business. Essentra grew earnings per share by 10 per cent in 2014 though by 19 per cent after stripping out currency effects. We are upbeat on these businesses’ prospects, especially since the European Central Bank’s long-awaited decision to start ‘quantitative easing’ should lift economic prospects for the UK’s largest trading partner.

Oil ‘dividend’

The plunge in energy prices seen since June 2014 may help boost consumer spending, but it creates even more challenging conditions for oil companies. So, our portfolios are significantly underweight the sector and are instead investing in companies which are likely to profit from cheaper energy prices such as airlines. Steep falls in industrial metal prices since last summer has encouraged us to stay underweight miners. Within this sector we are investing in those businesses with particularly strong capital discipline.

Source: Bloomberg, as at 23 March 2015


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