The FTSE 100 is likely to trade sideways this year and its upside remains limited, according to Gary Waite and Andrew Morgan, portfolio managers of Walker Crip’s model portfolio service Alpha: r².
While the managers maintain underweight positions in UK equities in their portfolios, they remain broadly positive about the market, despite admitting that it is more likely to fall than rise over the coming year.
As such the portfolios have overweight positions in alternative assets and are underweight developed markets such as the UK which they believe have become overvalued.
Morgan said: “Our key overweight is in the alternatives sector and that is mainly driven by a lack of enthusiasm for other sectors really.
“We see the equity market both here in the UK and in the US having risen so far so quickly we struggle to see value in both those areas.”
Performance of indices over 5yrs
Source: FE Analytics
Indeed, as the above graph shows, both indices are at new highs, with the FTSE 100 up 49.42 per cent over the last five years and the S&P 500 up 134.71 per cent.
Below we look at the arguments made by the managers for and against investing in the UK’s main market.
Pros – We’ve passed the point of maximum uncertainty
According to the managers, the positives for the UK market come from perhaps its biggest negative in the eyes of many investors – the triggering of Article 50.
While the Brexit vote shocked markets in June, overall the effects have been somewhat short-lived, with the FTSE 100 up 16.58 per cent since the EU referendum.
Performance of index since EU referendum
Source: FE Analytics
Some will note that Article 50 has yet to be triggered and the UK remains a member of the European Union, limiting the impact of Brexit.
However, the managers see this prolonged process a positive for the UK, with much of the uncertainty currently felt in markets slowly subsiding with each new announcement that comes from the government.
Morgan said: “This whole concern over Article 50 – I think we have passed the point of maximum uncertainty which is what markets dislike at the moment.
“We had the speech a couple of weeks ago from Theresa May and now have much more of an idea of the direction that Britain is heading in so it’s not going to be a shock when Article 50 is triggered.
“And every snippet that comes out from these negotiations as far as we can see is lessening the uncertainty as time goes on so it is actually improving the situation.”
He says the economic fundamentals in the UK appear to be “fine, so we are actually reasonably positive on the UK”.
Waite adds that while the UK has got its own issues with Brexit, the triggering of Article 50 and the rigmarole going on with the vote, it remains in a better shape than Europe.
“At least it’s got its own currency, it has its own fiscal and monetary policy which makes it a safer bet than Europe,” he said.
“We are very slightly underweight the US and UK and that’s based on valuations than a view that the UK and US are in a bad position.
“Our view is that they are both in a reasonable position comparing to Europe, we think the UK is actually not a bad place at the moment.”
Cons - The chances of it hitting 8,000 are very low
On the other side of the coin, the managers say the market is unlikely to reach new highs, probably destined to end the year around 7,000 – its current level.
Waite said: “No one expected the FTSE to be beyond 7,000 in the event of Brexit and yet here we are beyond that and still going up. For us it’s been very difficult to call with any conviction.”
While the UK market is in a better position than some, global issues including policies made by US president Donald Trump and European elections, could derail markets.
“If you had put £5 on Leicester City winning the league and added an accumulator of Trump winning the election and Brexit you would have made £12.5m and that shows you how left of field last year was,” Waite said.
Morgan added: “It’s totally dependent really on whether one of these left field events happens and given the number that are in the mix there is a reasonable chance that one of them will happen.”
As such the managers are looking to add structured products because while they don’t believe a crash is imminent they are conscious of the levels of current valuations.
Waite said: “Putting the structured products in these elevated times to give us a return of 6 per cent seems very sensible risk mitigating trade for us.
“Structured products are essentially where you can buy into the FTSE 100 at a certain level and then it will give you a steady return providing the index doesn’t trade outside certain boundaries.”
Morgan added: “That boundary is usually about half – so if the FTSE is at 7,000 today provided it doesn’t drop below 3,500 you get back the full capital value at the end of the term which is usually five or six years and every year you get a fixed rate return somewhere in the region of 6-9 per cent.
“If the market goes up 20 per cent next year you are only going to get 6 per cent but we take the view that we don’t think the market is going to go up 20 per cent.”
Waite concluded: “If you though the market was going to shoot up you wouldn’t do it because you are capping your upside when you buy structured products.”
“But the chances of it hitting 8,000 are very low but the potential for it hitting 6,000 are much more likely given what might potentially happen this year – on the balance of probabilities.”