Equity markets have been on an upward trend since bottoming out in 2009 after the financial crisis but with markets flatter in 2014 and the prospect of rising interest rates in both the UK and US next year many commentators have been turning more cautious of late.
Performance of indices since 15 September 2008
Source: FE AnalyticsJeffrey (pictured) says while bonds look the most likely asset class to sell off next year due to the end of the Federal Reserve’s quantitative easing, US and UK equities should hold up even as interest rates rise and avoid a major pullback.
“The UK is losing momentum at the moment and the Bank of England is being forced to acknowledge that in its latest inflation report. However, I think it is still overly optimistic about what the economy is likely to do. It is still forecasting growth of over 3 per cent next year,” he said. “The UK looks reasonably attractively valued but the issue is that it is a very international market and has a heavy weighting in mining, commodities and oil.”
“What we need now is an improved trend in productivity to drive GDP growth into earnings growth in the same way that we have seen in the US.”
He says economic data suggests a slowing of business activity but adds that recent gains were propped up by one-off events.
“Looking at measures such as the purchasing managers’ index, we can see that those have come off at the top. That is a good concurrent indicator of what is happening on the outlook side of the economy.”
“Indicators of household demand in the economy, which are still very important if not increasingly important given what is going on in overseas economies, show demand is slowing down a little bit and not growing as fast.” Jeffrey says this was because there was a boost to consumer activity from the government’s Help-to-Buy scheme, which is beginning to wane, and payment protection insurance (PPI) paybacks to consumers from the banks’ mis-selling scandal.
“The lift from PPI was pretty substantial and boosted spending, but we are now seeing that growth subside,” he said.
The Help-to-Buy scheme was launched in March 2013 by chancellor George Osbourne, prompting a boost for the UK stock market, particularly among house builders.
According to FE Analytics, the FTSE All Share Household Goods & Home Construction has gained more than double the FTSE All Share since then.
Performance of indices since 20 March 2013
Source: FE AnalyticsJeffrey’s sentiment echoes the words of the prime minister David Cameron, who said recently that “warning signs” of a threat to the global recovery are increasing with a weak eurozone and slowing growth in China.
The CIO says this will be an ongoing theme for the UK economy, reflecting “a new normal”, although growing risks will stop short of causing a return to the falling markets seen in the last major market contraction during the financial crisis.
“It is interesting Cameron is saying there are red lights flashing for growth in the world economy and there are I absolutely agree with him but there I think there will be permanent red lights,” he said.
However, Jeffrey says he is not worried about this environment because the UK economy was previously growing too fast and a lower growth environment won’t affect equity markets.
"Three per cent [GDP growth] is too fast a rate and it was clearly feeding through to the labour market quite strongly. Wage inflation is now showing signs of picking up and we have probably left the period where wages were being squeezed in real terms because alongside this, headline inflation is dipping.”
Jeffrey says investors in US equity markets, which have re-rated more rapidly than in the UK, still look set for further upward movements and recommends an overweight position here.
“The US has experienced the best recovery to date. It has the best momentum and it has been better at translating GDP growth into earnings growth. The prospect for the US market are reasonably positive and it is the one to remain overweight in.”
The US market has divided opinion recently due to its rapid gains. Premier’s Simon Evan-Cook recently told FE Trustnet that while the US has been the place to be over the past few years, investors should not chase past returns and that current valuations put US stocks close to bubble territory.
