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Mark Barnett: UK equity market struggles to find direction

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To date, 2014 has seen the UK equity market struggling to find a convincing direction. Concerns over the situation in Ukraine and, more recently, Iraq and the outlook for economic growth in China have outweighed positive news on UK employment and inflation. 

Partly reflecting the impact of sterling appreciation against the US dollar, aggregate consensus earnings estimates also fell a further 2 to 3 per cent in the second quarter and have fallen around 8 per cent since the beginning of the year. Stockmarket volatility has remained very low by historical standards. 

Looking forward to the rest of 2014 and beyond, is there value to be found within UK equities?

Should we have sold in May?

The stockmarket has performed well over the past few years and we should not be surprised if the upward movement in the market does not continue for the time being, partly because the market has re-rated so strongly. 

The price movements have been reflected in higher ratings of stocks and have not been matched by the underlying earnings of businesses.

I see the outlook for the stockmarket as more representative of a market which is on the expensive side of fair value, not in bubble territory by any means but just up with events. So I would not be surprised to see the market move sideways for a period.

Some risks are worth thinking about, not least, of course, the fact that the lack of earnings growth from the market is troubling and means there will be price vulnerability. Where expectations for earnings growth are too high and those expectations are not fulfilled, we expect to see falls in share prices, so we need to be vigilant. 

But we also need to bear in mind some bigger issues such as the continued tapering of quantitative easing in the US, which will continue to unwind over the rest of this year. And, importantly, we need to consider the effect QE has had of lifting asset prices, including equities, around the world and how the slowing down or ending of QE may have the reverse effect.

The removal of QE is a potential risk, as is the chance that the Chinese authorities prove unable to manage a soft landing in China. The question here is whether the Chinese economy will continue to grow at the rate the Chinese politicians would have us believe is not one, I think, that the stockmarket is fully factoring in. 

Also of note is that some geopolitical risks are increasing by the week, not least events in Iraq, which have knock-on effects for oil prices and will therefore have destabilising effects for global growth. Life is going to be a bit tougher for the equity market than it has been over the past few years.

Is there still value within the mid-cap sector?

I am still positioned in mid-caps, which is a very large, 250-stock universe, and I believe there are both expensive and cheap shares within it. The index looks generally more expensive than it has done and we need to be as vigilant in the mid-cap as in any other part of the market.

I have maintained holdings in certain mid-caps, with some big positions in financials, for example. I see more overall value in the FTSE 100, and that is where I am mostly adding to stocks or new holdings, but I still see some selective value in the mid-caps.

Will we see an interest rate rise in 2014?   

Uncertainty over when we will see a hike in interest rates is having an impact on equity prices – notably some of the consumer cyclicals. Bank of England governor Mark Carney’s comments that interest rates may be raised sooner than expected were just a shot across the bows of the market to remind it that rates are at historic lows and will not stay there forever. 

I do not think Carney will raise rates this year but some well-chosen words were a first step. The Bank of England is conscious there is little inflationary pressure in the economy, particularly with regard to wages. A pick-up in the level of wage inflation would be of concern but I do not foresee one. 

Barnett

Mark Barnett is head of UK equities and portfolio manager at Invesco Perpetual

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