Gill Lakin, chief investment officer at Brompton Asset Management (pictured above) explains why they are turning more positive on UK equities.
'UK equities underperformed during the first quarter of 2018, falling 7.29%. I am, however, becoming more positive on UK stocks since the last time I contributed to the MPS investment committee in February.
Investors were deterred from investing in the UK stock market due to fears about the impact of Brexit on the economy, or the leftward shift in domestic politics shown at the last election.
The economy grew steadily, however, expanding 1.7% in 2017. This surpassed the worst predictions made during the Brexit referendum and was only marginally below the 1.9% growth in 2016.
Economic data released in the first quarter of 2018 suggested a further slowdown, but this may prove temporary. Poor weather in March left retail sales lower, yet consumer confidence rose.
Consumers were more optimistic because unemployment had fallen to 4.2%, its lowest level in more than 40 years, and wage growth was picking up.
UK businesses shrugged off the Brexit gloom and increased investment spending at the end of the quarter.
The chart below shows the return on equity against the price-to-book value of a sample of overseas markets, revealing US and Indian companies to be the most expensive.
It also shows UK equity valuations appear attractive relative to overseas markets, according to the return on equity against the price-to-book value of a sample of overseas markets.
US and Indian companies are the most expensive because of the returns on equity delivered by these companies. UK companies’ returns on equity are similar, but UK equities measured by price-to-book are valued at less than half US and Indian equities. This discount appears excessive in light of the global nature of many UK companies.
Corporate buyers appear to share this view. In recent months, takeover bids have been made for major UK companies such as Hammerson, GKN, NEX and Sky.
The recent weakness in UK economic data and the headline inflation fell from 3% in January to 2.5% in March, led some commentators to conclude that the Bank of England would keep interest rates on hold at its policy-setting meeting in May.
This view may prove too sanguine, despite recent dovish comments by governor Mark Carney. Inflationary pressure is building as a result of the 20.38% oil price rise in sterling terms over the six months to 31 March 2018, and real wage growth resulting from low unemployment.
I believe UK interest rates may rise more rapidly than anticipated, lifting the pound and generating falls for longer-dated gilts and sterling corporate bonds.
A more inflationary environment may also lead to a change in equity market leadership, with hitherto out of favour ‘value’ companies outperforming ‘growth’ stocks.
Adding a value bias to the portfolios are Schroder UK Recovery and Aberforth UK Smaller Companies. For an income focus, we like Schroder UK Income and MAN GLG UK Income. All four funds have a value bias.'