Last month we saw interest rates remain unchanged in the US for the first time in around 18 months. Coupled with recent data which suggests a slowdown in economic activity, this has led to a marked shift in interest rate expectations. Most commentators now expect rates to peak at the current level. The recent increase in inflation has been driven by rising commodity and energy prices but the fall in the oil price in the last six weeks and reductions in other related areas, such as gas prices, will help to reverse this as an investment risk.Corporate bond yields have for some time remained below the free cashflow and earnings yield of the UK equity market. This factor should mean that the rise in merger and acquisition activity experienced over the past 12 months or so will continue. These macro themes should help the mix of assets we hold in the UK equity income fund. In an environment of low interest rates and low inflation, it is important to keep a perspective on returns from equity markets. The UK market is up by more than 8 per cent in the year to date. The market has been strong over the last three years but most of this has been driven by rising earnings and the market has not rerated. In the absence of a major economic downturn, the market looks well underpinned. Equities also look attractive relative to other asset classes such as bonds. After two to three years of a value-friendly environment following the TMT bubble, the market has been relatively style-neutral in the last couple of years. We expect this to remain the case over the next few years. Our two biggest overweight sector positions are banks and retailers, both of which are unloved by the market. We are more positive than the consensus on the outlook for the UK consumer. Wage growth, the continued recovery in the housing market and robust employment situation underpin the prospect of a recovery in household disposable incomes. This is a view the Bank of England appears to share, given the recent movement in base rates. Although we are more positive than others, it is important not to simply take a naked macro view as stocks must also have other dynamics. DSG International (Dixons) is a good example. I believe the consumer electronics cycle has a long way to run. Dixons benefited from the World Cup but should continue to do well beyond this. On the TV side, there should be a much longer duration to this demand cycle as high-definition TV is only just being introduced and the Government plans to turn off the analogue signal in a few years. Stocks such as DSG International will also benefit from an increase in demand for white goods as the housing market recovery feeds through. In the banking sector, the market seems to be obsessed with adverse consumer debt trends. Much of the impact of this is now in forecasts and reflected in valuations. By contrast, the traditional income sectors such as utilities and tobacco hold little appeal for us. As well as offering a lower yield premium than they did, say, two to three years ago, tobacco stocks are now trading at around 14 times earnings and hence look very expensive to us on an absolute basis. Water stocks are trading at a 15 to 20 per cent premium to their regulated asset values. For these reasons, we are cautious on these areas. Markets have rallied as a result of more clarity over global interest rate trends but I believe valuations on UK equities remain extremely supportive. Coupled with what we see as a relatively benign economic outlook, this should see the UK market continue to make headway over the rest of this year. Clive Beagles is senior fund manager on the JOHCM UK equity income fund
The contrasting approaches taken by Skandia and Rensburg in compiling best ideas portfolios will add interest when comparing performance. Will the long-term relationship between Rensburg’s managers give it the edge?
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