Investment Week - UK Equities
Investors who started 2012 with the conviction of better things ahead have thus far been well rewarded. The first-quarter earnings season has turned out to be solid, particularly for some of the more cyclical sectors, while US GDP forecasts have seen steady upgrades, having bottomed out last October. Wholesale funding markets have responded, resulting in a significant contraction in yields on both corporate and peripheral European bonds and a surge in corporate bond issuance.
Having positioned themselves for Armageddon late in 2011, it is becoming clear that many investors simply became too pessimistic and have started to exhale again. The speed at which positions have been reversed has led to some wild U-turns in sector performance, with financials and cyclicals leading the market higher thus far in 2012. We have continued to favour mid and small-cap cyclical stocks over large-cap defensives. Our view is supported by a) listening to what company management teams have been telling us; and b) the results of our quantitative research. The volatility we have seen has been unwelcome, but many of our holdings are beating earnings forecasts and valuations have started to re-rate from very low levels. This suggests it would have been wrong to have been caught up in the short-term swings in macroeconomic sentiment.
From an economic standpoint, the key point is that the scenario of a double-dip recession – one still being pushed by many commentators – is looking increasingly improbable. Data releases from the US are supportive of a recovery in that country, while numbers from the UK, though more modest, have provided a few hopeful portents. In Europe, the LTRO has unlocked funding markets, removing the tail-risk of a disorderly break-up of the euro as bank liquidity is underpinned. This improvement in funding conditions is important to the wider economy; at a time of fiscal austerity, it is vital that monetary conditions are easy.
There are several investment themes we are pursuing. One is a boom in capital expenditure within the oil & gas and mining sectors. The main beneficiaries are likely to be the picks-and-shovels businesses: firms such as Weir, Kentz and Petrofac. The longer-term economic impact of increasing shale-gas development could be dramatic: a reduced dependency on imported oil, and lower prices. This could become a powerful tailwind to the economic recovery.
Our funds are also positioned for rising bond yields. Quantitative easing has clearly had a significant effect on yields in the US and UK, but as economic growth picks up and the threat of deflation eases, investors are understandably asking themselves whether a rate of 2% represents sufficient protection on a 10-year bond yield. Intuitively the answer seems to be no. Certain sectors will be major beneficiaries of a pick-up in this area, in particular banking, insurance and financial services.
Another area we are paying close attention to is the internet, which after a decade of over-hype is finally reaching a critical mass. What has been striking about our recent management meetings with the likes of SDL, IG and MoneySupermarket.com is how under-penetrated their respective markets are. The dice are loaded in favour of these businesses: the market looks set to grow strongly for years to come.
We are excited by the opportunities that we are seeing to build positions in winners across different sectors. Market conditions have become much more benign for stock-pickers and this has allowed our funds to achieve a strong rebound in performance so far in 2012. Our conviction in improved conditions for UK equities hasn’t faded: the market should continue to climb the wall of worry and make further progress this year.
Thomas Moore, Investment Director, Standard Life Investments