Of course, it is impossible to predict whether these events will take place, but one thing that is for certain is that the FTSE 100 broke through its record high two weeks ago to reach a level not seen since the height of the dotcom bubble of the late 1990s.
Performance of index since 30 Dec 1999
Source: FE Analytics
The blue-chip index has since retreated back to below 6,900, but nevertheless our most recent poll showed that the large majority of our readers still expect UK equity market to move higher and therefore didn’t agree with some of our recent bearish articles.
According to the poll, 71 per cent of the 1,809 readers who responded said they weren’t taking profits from their UK funds despite the FTSE’s record high.
Though the FTSE is at the same level it was during the TMT bubble, most of our bullish contacts say that there are a number of distinct differences between the current market and the one they were presented in the late 1990s.
They point to the fact P/E ratios are much lower now than they were then, the current market level doesn’t take into account 15 years of inflation and UK equities have already been through a tough 12 months or so – especially relative to bonds and other developed markets.
Performance of indices since Jan 2013
Source: FE Analytics
All those points are true, but given that such an overwhelming majority of investors aren’t reducing their exposure, is complacency starting to creep in?
As a result of extremely low valuations after the financial crisis, ultra-low interest rates and huge amounts of quantitative easing, the FTSE All Share has delivered a positive return in five of the last six years – the exception being 2011 – and has posted double-digit gains in four of them.
That’s not to say 2015 will be any different – it is already up 6.2 per cent year to date – but there is an increasing concern that politics will be a big problem for UK investors as one of the most hotly contested general elections for several generations will take place in May.
A number of fund managers, such as Neptune’s Robin Geffen and Henderson’s Bill McQuaker, have already sold down their UK exposure due to the political uncertainty and Andy Merricks – head of investments at Skerritts – thinks the election is a major reason why investors should lock in at least some of their gains.
“We’d be amazed if the election is clear cut, which means uncertainty. And what do markets hate most? Of course, uncertainty,” Merricks said.
“So can anyone confidently expect the UK stock market to ignore what’s coming? Or the gilt market? Or sterling?”
“It seems to us a good time to prepare for a short period of underperformance from anything UK focused, and hope that the result of May’s general election does not drag on into something that will lead short -term underperformance to develop into something more longer lasting.”
Of course, most investors won’t be too disheartened by a period of short-term underperformance in search of long-term gains and a number of commenters believe that “the stock market will be indifferent to whichever government gets in”.
Our data also shows that previous election years have been good for investors in the UK stock market. According to FE Analytics, while there was heightened volatility around the election date, the FTSE All Share made double-digit gains in four of the last five election years.
Source: FE Analytics
The exception was in 2001 when UK equities fell 13 per cent, but that was largely due to the deflating dotcom bubble and the September Twin Tower terrorist attacks rather than anything to do with Tony Blair.
However, Merricks says the general election in May is likely to be a lot different than on other occasions when the UK has gone to the polls.
“We have taken the decision to reduce our exposure to the UK market in the run up to May. If you recall the last election, it took a few days for the Conservatives and the Lib Dems to come to some kind of an agreement about how the coalition should be formed.”
“That was only concerning two parties. If, as seems entirely possible, the next government is formed of more than two parties then how long will it take to see a new government formed?”
“Imagine the trading that will need to be done between various combinations of the following: Conservatives, Labour, Lib Dems, SNP, UKIP, Greens, Plaid Cymru, Ulster Unionists, Sinn Fein, Respect”
He added: “Even Al Murray’s pub landlord could be elbowing his way onto a back bench somewhere.”
Aside from politics, there are more global headwinds facing UK investors which – given the international aspects of the FTSE 100 – the UK equity market would be sensitive to if they were to worsen.
As a recent FE Trustnet article highlighted, market commentators are concerned about the negative impact an inflation/interest rate shock in either the US or UK, the Greek debt negotiations and the tensions between Russia and the Ukraine could have on the UK equity market.
Richard Scott, senior fund manager at Hawksmoor, also warns that things aren’t too rosy at a corporate level either, pointing to HSBC’s recent fall in profits as a reason for UK investors to be more cautious.
“I think the HSBC results show that the earnings growth needed to drive the equity market higher (given valuations are quite full in general) may not be as robust as many people are hoping,” Scott said.
Performance of stock versus index in 2015
Source: FE Analytics
Given the risks facing the UK market, both domestic and abroad, Merricks (pictured) says complacency is creeping into investors’ mentality.
“It would be interesting to see how many of that 70 per cent of investors were late coming to the party, as it is the classic mistake that investors are too late in and then too late out,” Merricks said.
“If you are investing for income, then I wouldn’t suggest investors need to reduce their equity income exposure. If you are investing for growth, you should always be re-assessing where the best opportunities are.”
“Surely, the best opportunities are not in the UK market at the moment with a messy election coming up? For those who think I’m scare mongering, I’m no, I’m just pointing out that now is a good time for a little self-inspection.”
However, that’s not to say Merricks thinks investors should completely sell out of their UK funds.
“If you are going to sell out you need to find something different that is really attractive. Most investors will have a portfolio of five or six funds so, if you can, you should just tinker with them,” he explained.
“For instance, we are running a higher than normal cash balance at the moment because we have been on a phenomenal run. One of our funds is up 20 per cent since October and we know that sort of performance isn’t going to continue.”
“Now is a good time to lock-in profits and wait and see, not sell-out completely. It doesn’t have to be all or nothing, but that’s the assumption that most investors make. It’s just about being sensible.”