The outlook for UK equities continues to improve, with confidence in the UK economy rising.
The FTSE 100 finally surpassed its previous peak, achieved on 31 December 1999, by reaching 7,000 during March: 17 years after first hitting the 6,000 mark, as quantitative easing of €60bn per month in the eurozone, low oil prices and improving data points led investors to reconsider equities following a volatile end to 2014.
Price performance of index since 31 Dec 1999
Source: FE Analytics
However, a number of issues may still cause volatility in the coming months and chief among them for the United Kingdom is the May general election, which could dissuade some foreign investors from investing in UK companies, due to the uncertainty of the outcome, and further volatility in potentially politicised sectors.
For UK investors, the second quarter of 2015 will be split in two, the periods before and after the general election. There is of course also a strong possibility that we will face a hung parliament, which would cause further uncertainty in the weeks following the election too.
However, we do not feel the election, regardless of the result, will considerably change the economic landscape of the United Kingdom.
Both the Labour and Conservative parties have signed up to the Office of Budgetary Responsibility’s (OBR) debt reduction targets, leaving very little wriggle room for genuinely transformative policies.
The pre-election Budget delivered by the chancellor George Osborne contained very little that could truly affect the markets, but there were two announcements which may have longer-term consequences; the changes to pension provisions could be a bonus for markets over the long term, while the decision to make the bank levy permanent could adversely affect competitiveness.
The latter is not wholly unexpected, as we expect banking to be one of the most politicised sectors during the campaign.
As we mentioned last quarter, the date of this election has been set for some time, because of the current coalition government’s decision to introduce fixed-term parliaments, so many investors may already have been “placing bets” via allocation decisions on the possible outcome.
We are likely to hear a lot of noise in the coming weeks, but we expect there to be minimal long-term effects on the UK equity market.
An issue that many believe will be raised again once the election is over is when interest rates are likely to rise. However, with inflation now at 0 per cent, this is unlikely to occur in the short term.
The market has been looking to a September rise for some time, but there is now talk of even cutting rates further and those on the Bank of England’s Monetary Policy Committee (MPC) who had been calling for a rise are now voting in line with other members to keep rates as they are.
From a consumer perspective, wage increases of any amount will now be higher than inflation and we will look closely at whether this translates into an increase in discretionary spending.
In conclusion, a rise in interest rates later in the year still appears to be the most likely scenario, as we would expect inflation to start to rise again later in the year.
We are also keeping a close eye on interest rates in the United States, as any rise will undoubtedly strengthen an already strong dollar, which could have knock-on effects for emerging market economies, especially as many hold US denominated debt.
While oil prices bottomed in January, we have yet to see the impact of capital expenditure cuts on supply from OPEC, (Organisation of the Petroleum Exporting Countries) as well as shale gas suppliers. Recent data suggests that demand is starting to pick-up and therefore we would expect the current oil price to potentially form a new base level for the commodity.
Performance of index since Jan 2015
Source: FE Analytics
The underlying strength of UK companies could further support the equity market in the coming months.
A 10 per cent rise in dividends during a period of low-to-zero inflation is impressive, and an average yield of 3.7 per cent, still ahead of markets globally, offers an attractive return for income investors.
Strong balance sheets and a growing number of share buybacks also bode well for companies’ prospects throughout the rest of 2015.
IPOs and secondary offerings are still being warmly received by investors, while M&A activity has continued in the early months of 2015, after being a major component of the market in 2014. For example, Spanish bank Sabadell’s purchase of TSB for £1.7bn in March was warmly received by market participants.
Once the noise of the election campaign has receded, we expect investment to pick up, as overseas investors once again look to the United Kingdom, and growth to continue gaining momentum.
The European Central Bank’s (ECB) decision to proceed with quantitative easing and a pick-up in growth in the euro zone should also feed into the United Kingdom’s economic performance, though the possibility of a Greek exit from the euro zone could continue to cause uncertainty.
We believe the appetite for risk remains, with UK growth exhibiting momentum, and the possibility of a weakening pound against the US dollar aiding earnings.
Alan Custis currently manages the Lazard UK Omega, Lazard Managed Balanced and Lazard Multicap UK Income funds and has a track record spanning back to the start of the century.
Performance of managers versus peer group composite over 15yrs
Source: FE Analytics
According to FE Analytics, he has returned 121.89 per cent to his investors over 15 years meaning he has beaten his peer group composite by close to 30 percentage points in the process. His five crown-rated Lazard UK Omega fund has outperformed both the IA UK All Companies sector and FTSE All Share over one, three, five and 10 years.