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March of the markets

It is a year since the UK stock – market sank to a dismal low with stunning falls in some share prices but 2009 saw a remarkable turn-round with huge gains. Gregor Watt finds out if we can expect further growth

Leigh Harrison
Leigh Harrison

This month marks a year since the FTSE 100 hit a six-year low to stand at 3,512. This low point was the end of a six-month slide that saw the index of the UK’s biggest companies lose 37 per cent of its value as the financial crisis took hold.

UK equities have rebounded strongly since then and by March 16 the FTSE 100 had risen by 60 per cent to stand at 5,620. The turn-round has seen prices increase across UK stocks but there have been some remarkable individual company gains.

City Index market strategist Joshua Raymond says: “There have been some really fantastic plays over the last year if you had got on the right side on the trend. Barclays is an excellent example where share prices have risen by almost 620 per cent from a low of 47.3p in January last year. Kazakhmys shares have had a terrific run too, rallying by almost 560 per cent, while rival BHP Billiton shares have also rallied by a healthy 113 per cent since the 2009 bottom was reached.

“It certainly feels like the tremendous bouts of volatility and uncertainty in the markets from the days of the Lehman failure have passed and the subsequent bull market of the last year has done much to repair the damage done to investor confidence.”

But with the strong growth of 2009 now hitting a plateau, many investment managers are suggesting that continued growth will come down to more selective investment in companies and sectors that can continue to perform in an economy slowly emerging from recession.

HSBC head of equities and deputy chief investment officer Alec Letchfield says: “We do not expect the same magnitude of performance as seen in 2009, with returns expected to be much more moderate in 2010. At the sector level, as is normal in the early stages of a recovery, poor-quality companies led markets higher as their earnings rebounded from distressed levels.

“However, poor-quality companies inevitably remain poor quality and generally return to underperforming higher-quality companies whose profits ultimately prove to be more durable. Hence, we would expect a transition in the leadership of the market in 2010 back to higher-quality entities.”

Threadneedle head of equities Leigh Harrison also says selection of individual companies will be more important this year.

He says: “In last year’s strongly rising market conditions, beta was the dominant component of total returns – simply being invested was the most important decision. We expect this to change in the next phase of the market. With the recovery in risk appetite substantially complete, stock selection is likely to gain in importance. The focus is likely to be on well managed and financially resilient companies with strong market positions and the ability to sustain or grow their dividends in a tough environment. Certainly, our current portfolio positioning is driven more by bottom-up stock selection than by any big sector trends.”

Harrison suggests there are several factors acting as drags on the UK economy, including the size of the budget deficit, high levels of personal debt and increasing speculation over a hung Parliament in the coming general election.

But he says, over the medium term, UK equities remain attractive. “While we acknowledge the economic and political challenges facing the market, we believe that equities can make progress over the next two years.

“Following the rally of the past year, valuations are no longer compelling at the aggregate level but they are still on the right side of fair value. Moreover, parts of the market look very good value. One example is defensive growth companies. These were left behind in the liquiditydriven rally of 2009 but, with economic growth likely to plateau in the coming quart ers, companies offering solid, sustainable, single-digit growth are likely to be re-rated. Our portfolios are well represented in such stocks.”

Letchfield says opportunities will be split between special situations, recovery stocks and high-quality stocks that will benefit from growth in their underlying markets. He highlights cash and carry group Booker as a good example of a special situations stock. In the high-quality category he puts Whitbread, Premier Inn and Costa Coffee. He also highlights paper and packaging group Mondi, aerospace, defence and
electronics systems supplier Meggitt and IT supplier Aveva Group.

Leigh Harrison: ’Times of financial stress often create opportunities for positive change, with new manage ment teams improving returns by increasing efficiency, cutting costs or implementing new growth strategies. The most recent crisis has been a case in point, with the industrials sector proving a particularly fertile hunting ground for this theme’

Last March, Standard Life Investments launched a UK equity recovery fund which was timed perfectly to take advantage of the recovery in value of the UK stockmarket. One year on, manager David Cumming says there are still plenty of opportunities for individual stocks and he is upbeat on the valuations of the index generally.

Cumming says: “We believe that despite the sharp recovery in 2009, UK equities remain attractively priced both on a historical basis and
compared with other asset classes. There still remains very significant value at individual stock level which we expect to capitalise on, particularly as sentiment on economic recovery prospects remains excessively bearish.”

Cumming says the fund has remained deliberately underexposed to defensive stocks such as tobacco, pharmaceuticals, utilities and consumer staples.

He says: “Since launch, our stock selection has led us to focus on companies in the real estate, travel and leisure, general retailers and industrial goods and services sectors.”

With economic recovery in the UK lagging behind many other countries, both Letchfield and Harrison suggest that UK companies that derive significant earnings from overseas could do well.

Harrison says: “We are also seeking to invest in companies whose earnings are not tied to the prospects for the domestic economy. More than 5 per cent of UK stockmarket earnings are derived from international operations and we are finding good opportunities in a range of sectors to access demand from faster-growing economies in Asia and emerging markets. Times of financial stress often create opportunities for positive change, with new manage ment teams improving returns by increasing efficiency, cutting costs or implementing new growth strategies. The most recent crisis has been a case in point, with the industrials sector proving a particularly fertile hunting ground for this theme.”

Letchfield says: “Looking at the hard economic data, we find that world economies continue to pull themselves out of recession, albeit with some economies doing better than others, and, importantly, companies continue to post better than expected profits.

“In addition, the UK stockmarket is blessed with a high proportion of company profits generated from overseas and emerging markets.”

But Raymond says despite the opportunities available, there are still significant doubts on performance.

He says: “Many traders still have the scars to show for their troubles over the last two years and with Greece’s debt situation far from resolved,
a potential hung Parliament in the UK to come and future UK GDP figures still uncertain, we are not out of the woods just yet.”


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