Standard Life Investments

Published Article

Investment Week - UK Equity Income Outlook


Markets appear to be regaining their poise after a brief period when macro-economic drivers such as bond yields had a marked impact on different asset classes, including UK equities. Lower bond yields saw some relief for large cap defensive sectors, in a reversal of the "taper tantrum" seen in June 2013 when QE tapering chat led to higher rate expectations.

It is hard to see this reversal as anything other than transitory for a number of reasons:

  • The move lower in bond yields appears to have been caused by technical factors, rather than providing any valid economic signal.
  • The large-cap/defensive sectors that have outperformed are typically seeing big earnings downgrades and have poor worsening balance sheets.
  • The mega-cap M&A flurry, led by AstraZeneca and Vodafone, appears to have been and gone, leaving valuations looking uncomfortably frothy in both cases given deteriorating earnings trends.
  • Mid-caps remain the area of the market seeing the best earnings trends.

Recent wild share price action has given us the opportunity to add to winning high-conviction positions that had sold off for sentiment reasons, where valuations had become compelling. We remain very selective in large-caps, favouring BT, whose strong earnings outlook marks it out from its large cap peers.

The triggers for markets to shift into the next gear will be (1) decisive economic data and/or (2) further monetary policy action. Recent commentary from global monetary policy-makers demonstrates their determination to ensure that economic recovery becomes self-sustaining, before they begin to raise interest rates. When interest rates do eventually rise, this will reflect normalisation in the economic situation after years of monetary stimulus. While higher rates may be more challenging for consumer stocks, it will materially drive the earnings of financials companies, via higher interest income.

As sentiment steadies, the market is set to revert to examining companies' earnings and dividend fundamentals, which will tend to favour younger mid and small caps at the expense of large caps. This approach is rewarding investors in the Standard Life UK Equity Income Unconstrained Fund with rapid dividend growth and enhanced total return. Despite recent market wobbles, these conditions are set to remain very benign for stock-pickers willing to search outside traditional income hunting ground.

Thomas Moore, Fund Manager, UK Equity Income Unconstrained, Standard Life Investments