What lurks beneath

by

7 Apr 2015

Miscellaneous

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Andrew Parry, head of equities at Hermes Investment Management, adds: “I think investors will be reluctant to make big commitments to the UK equity market due to the uncertainty over the election, potential rate rises and the rollback of quantitative easing which will happen eventually.

“You have to remember that low interest rates   are a temporary economic solution and   once the growth normalises they will rise again.”

At the moment the election is too close to call, but this is not stopping the bookies or political pundits from taking bets. There are various possible outcomes including a second election within months of the May vote, in which no party is predicted to win a majority; a Conservative-led government followed by two years of EU referendum panic, since the party has pledged to hold a   ballot on membership by 2018 or a Labour-led government perceived as anti-business.

The potential for the Scottish National Party (SNP) and Labour coalition is also a cause of concern for some since the SNP supports the break-up of the UK. In terms of the impact, some analysts believe   that a win for the current opposition Labour Party, or a Labour-led coalition, would likely lead to an increase in spending,   a higher budget deficit, increased regulation   and taxation especially for the utility   and banking sectors while a victory for the Conservative Party, or the current Conservative-   led coalition, would be unsettling due   to the EU vote.

“When I look at the election as a bottom up   investor, I think the outcome of most election   scenarios are negative for the equity market,” says Matthew Beesley, head of global equities at Henderson Global Investors.

“A Conservative minority government is more economically sound, but a possible exit from the EU could cause a sell-off. If   Labour won, markets would worry about fiscal recklessness and a tax on big business. If there is a SNP/Labour coalition then they would have greater bargaining power and accelerate a referendum on Scottish independence. I think a repeat of the coalition government we have now would be the most stable and non-disruptive to the economy.”

Investors are also nervous about the impact of the ongoing Ukraine and Russian crisis, the fresh round of European Central Bank quantitative easing which will keep interest rates depressed on the continent as well as plummeting oil prices.

They dropped below $60 a barrel earlier this year and continue to fluctuate at historically low levels.   The FTSE 100 is particularly affected   because the oil and gas sector accounts for a weighty 22.3% chunk. Investors may be better off playing the markets directly to gain exposure when the cycle turns around.

The other major constituent – financials, which comprise around 14% – have been hit hard by a swathe of regulations since the credit crunch. Bank balance sheets have been constrained and margins squeezed by Basel III and they are being forced to mine new revenue streams.

 A GLOBALLY-DIVERSE INDEX  

The other differentiating factor is that the FTSE 100 is home to many overseas companies which are more exposed to global  trends. In fact, only 23% of revenues emanate from the UK and vacillations in the currency market can take their toll.

For example,  the pound may have dropped  almost 10% against the dollar since the oil sell-off started last summer, but the dynamics of interest rates in the US and UK suggest the pound could grow much weaker over the longer term. During the same period, sterling gained almost 9% against   the euro which makes UK stocks unattractive.

“One of the difficult things about the large cap UK equity market is that it is dominated by oil and mining stocks which are not doing well because of the commodity correction,” says Beesley.

“These sectors   account for a big chunk of the dividend pay-outs and while yields remain high, I   think they are unsustainable especially if oil prices remain low and they have to continue to cut their capital expenditure programmes which will impact profitability. We look for companies such as Lloyds Bank, GlaxoSmithKline, ITV and Rentokil that are benefitting from specific industry changes although we are mindful of top-down trends.”

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