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Market views - UK Equities

UK EQUITIES

March 2010

Economy

Analysts have started to revise their growth assumptions down very slightly since the year began.  We would be unsurprised to see this trend continue (the current 2010 forecast for GDP is 1.4%, rising to 2.3% next year).  US GDP forecasts continue to improve however,  which is more relevant for our market.

We calculate the UK national debt to GDP ratio will surpass 90% within three years, (currently 62%).  Bringing fiscal deficits under control will be difficult for any government – and not least for a hung parliament.

Inflation expectations remain becalmed.  Although sterling has been weak recently, it is at similar levels to twelve months ago.

Although house prices drifted up over the quarter, they were weak in March, and accompanied by low volumes.  Mortgage application volumes have started declining again.

Equity Market

UK equities have risen around 6% this year.

The current 12-month forward PE ratio is 10.9x (down from 11.3x at the last meeting – source Cazenove) versus the long-term average of 13.  Upwards earnings revisions this year have exceeded the market rise.  Cyclical sectors continue to outperform defensives.

The bank sector made large losses in 2008, small losses in 2009, and are now guiding to £10bn of profits in 2010.  Lloyds recently guided up its 2010 profits by more than £2.6bn – after only ten weeks of trading.  Factset suggests that 2010 Q1 revisions to banks net income were 30% (after 44% and 47% in the previous two quarters!).  Valuations had largely predicted these moves, however – share price movements have been far more mediocre.

M&A activity has increased dramatically in recent quarters.  Prudential has made a mammoth bid ($35.5bn) for the Asian assets of AIA which looks to be going ahead successfully.  IPO activity has picked up too – including a minority float of Barrick Gold’s African assets.

Strategy & Outlook

Fiscal deficits are typically resolved either via inflation, fiscal restraint or strong growth.  However financial crises historically precede periods of weak growth.  We do not subscribe to the ‘muddle-through’ option.  The eurozone remains under strain as the PIGS economies continue to struggle with their fiscal deficits.  We believe there will be periods of volatility ahead as this situation resolves itself. 

Nevertheless markets climb a wall of worry.  Many leading indicators remain fair, and investors are all well aware of the problems outlined.  Monetary policy looks set to remain relaxed for some time yet, and equities could easily go higher in the short term.

Page last updated April, 2010 ID1717