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Market views - UK Equities

UK EQUITIES

December 2009

Economy

Economic output was surprisingly weak in the third quarter of 2009 - GDP contracted by 0.3%. This was the sixth successive quarterly decline; the cumulative peak-to-trough contraction is 5.9%. The Bank of England announced a further increase of £25bn in their quantitative easing program to increase liquidity in the economy. Consensus forecasts predict a return to growth in the fourth quarter and the economy to grow by 1.2% in 2010.

The government’s interventions together with low interest rates have increased the inflationary pressures in the economy. VAT will return to 17.5% in January 2010. This will increase the inflation rate as well as drag on consumer spending in 2010. CPI rose by 1.5% year-on-year in October. Consensus forecasts inflation to be 2% in 2010. Global costs and the exchange rate affect UK consumer goods prices more than wage growth and demand.

Consumer sentiment has been improving with the housing market. Mortgage approvals are increasing and the average house price is up from the late 2008 low. Unemployment is still rising - albeit by the smallest increase in 18 months. The claimant count rose by 12,900 in October. This could indicate the bottoming-out of the cycle. Consensus forecasts an unemployment rate of 5.9% in 2010.

The amount of new government borrowing is a cause for concern – the difference between government spending and income surged to £11.4bn in October. Addressing this will likely prove painful for the economy and inevitably be the topic of much political debate. A UK general election is due by May 2010 - policy changes loom. The national debt to GDP ratio is 60% and forecast to rise to 90% by 2013. Unsustainable levels of national indebtedness pose longer-term issues for the UK economy.

Equity Market

All returns to 27/11/2009

After a strong start to the quarter the FTSE All Share sagged and is up 0.5% quarter to date. The market is up almost 20% this year. Earnings momentum has improved. Management across the market are guiding towards better volumes/orders next year. The market is trading on 12.7 times next year’s earnings and yields 3.3%.

There has been a broadening out of performance across the sectors. Some defensives no longer lag the market. The mining sector has performed well, beating the index by 13% quarter to date. The recovery in commodity prices and Chinese demand helped. Beverages have outperformed by 10% this quarter. Banks have underperformed the index by 8% in the same period. Disappointing results from Barclays’ Capital Markets division as well as further capital adequacy concerns had a negative impact on the sector. This quarter the electricity sector has underperformed the index by 6%.

There have been many rights issues of late. Lloyds has raised £13.5 billion - this is a UK record. The funds will help shore up their weak capital ratio and enable them to exit the government’s costly asset protection insurance scheme. National Express is raising £360 million to alleviate balance sheet concerns. Ladbrokes raised £286 million for similar reasons. There has been some corporate activity this quarter: Cadbury’s was the subject of a (since rejected) bid from Kraft. Other interested parties are rumoured to include Nestle and Hershey.

Strategy & Outlook

We are cautious on the outlook for the UK economy. With unemployment still rising and political uncertainty likely, we look to avoid companies overly exposed to the UK consumer. We remain defensively positioned with a bias towards larger, geographically diversified, quality names.

Page last updated December, 2009 ID1717