While market uncertainty seems likely to continue during 2017, some UK sectors could offer attractive opportunities for canny investors.
Hargreaves Lansdown has highlighted three sectors it is backing for growth over the coming year against a backdrop of Brexit negotiations and key elections among the EU’s largest members. The FTSE 100-listed financial services firm believes mining, defence and manufacturing sectors are likely to offer the best prospects in the near term as new market trends begin to emerge.
Indeed, a number of industry experts believe certain sectors will shine during the coming year.
Below, FE Trustnet looks at the sectors financial services heavyweight Hargreaves Lansdown is backing in 2017 and asks other market commentators for their views.
Mining
Miners enjoyed a spectacular 2016, with Anglo American shares, for example, rising more than 280 per cent and Hargreaves Lansdown says the sector could have further to go “though gains of that magnitude are very unlikely to be repeated”.
Chris Beauchamp, senior market analyst at IG Group, added: “It might not be another bumper year, but there are grounds for optimism on a fundamental basis.”
“The persistent oversupply of recent years has disappeared, while demand is holding up well and looks to be increasing.”
Indeed, as the below graph shows, the FTSE 350 Mining index rose 106.47 per cent last year as commodity prices rose and miners reaped the benefits from the substantial cost-cutting measures taken in 2015.
Performance of FTSE 350 Mining index in 2016
Source: FE Analytics
Within natural resources, Hargreaves Lansdown says oil has attracted most of the headlines with prices up 50 per cent ending 2016 at $56 per barrel with further positive news from Organisation of Petroleum Exporting Countries (OPEC), which announced it would manage production levels more proactively this year.
“However, US shale lurks in the wings,” the firm noted. “The number of active rigs in the US has fallen sharply since it peaked in late 2014, but is climbing again.”
It added that it does not expect oil to move back near the highs seen before 2014 as shale firm will likely offset the OPEC cuts.
The same factors are not at play in other commodity markets, however, as it takes time and vast sums of money to open new mines.
“Many of the market’s largest players are still trying to wind down huge debts built up in the boom years. As a result, capital expenditure is likely to remain low, preventing a sudden increase in output and keeping prices high,” analysts at Hargreaves Lansdown said.
“Expectations for global economic growth have been increasing in recent months, and increased growth suggests greater demand for commodities.”
“The UK’s largest miners, Rio Tinto and BHP Billiton, control some of the highest quality assets in the world, and produce at incredibly low costs, particularly in iron ore.”
“With businesses much leaner than they were two years ago, it should be much easier to convert every dollar on the commodity price to cash. That’s good news for shareholders, who have suffered as dividends were slashed in the face of falling revenues.”
IG’s Beauchamp adds that investors looking to get into the mining sector this year should wait for their opportunities, as the returns will be lower this year than last.
“Last year they were a ‘death or glory’ trade, but this year will probably be more of a buying the dips idea, with the sector likely to keep pushing higher.”
“Short-term markets generally are probably due a correction, so there may be an opportunity to buy at lower prices later in Q1, so those looking to pick their moment may wish to wait."
“Those happy to ride out some near-term losses will probably be happy with the fundamentals and undemanding PE ratios.”
UK manufacturing
The UK has a host of high-end engineering companies focused on the natural resources sector, thanks in large part to the North Sea oil industry and unsurprisingly, these companies fared poorly in 2014 and 2015 as lower commodity prices put the brakes on investment decisions.
“However, a recovery in commodity prices should start to feed through to the services sector this year,” Hargreaves Lansdown said.
“We feel companies such as Rotork and Weir that supply components rather than just services to the sector could be particularly well-placed to succeed.”
“These components are high-end and niche, making it difficult for would-be rivals to enter the market, while significant international earnings mean both are benefiting from a weaker pound.”
Indeed, Ben Yearsley, investment director at Wealth Club, says the weakness of sterling is the biggest reason to invest in UK manufacturing this year.
“The collapse in sterling has suddenly made UK exports 20 per cent cheaper. So many sectors and companies should benefit, especially those where the UK is world leader, i.e. high end precision manufacturing for example.”
“You only need to look at the swift takeover of ARM post the Brexit vote by Softbank to see the value on offer in the UK for overseas investors and buyers.”
The collapse of sterling following the EU referendum vote in June - which is 16.16 per cent lower against the US dollar over the past year - has provided a boost for UK exports and could lead to a number of investment opportunities.
Hargreaves Lansdown added: “Sterling’s previous strength and the high cost of operating in the UK may have consigned many UK manufacturing businesses to the history books, but it also means that those still standing have kept a rigid eye on costs.”
“Lower sterling makes products from the likes of flooring manufacturer James Halstead more affordable to an international client base.”
“With international sales accounting for two thirds of the business, and having proven capable of low digit underlying growth at a higher exchange rate, it will be interesting to see what the group can achieve given the increased competitiveness of its products.”
Defence
Defence is a contentious industry with the government putting defence budgets in the firing line in the age of austerity but this could be about to change.
The sector has struggled in recent years, with the FTSE All Share Aerospace & Defence index making a 6.24 per cent loss for investors over a three-year period.
Performance of FTSE All Share Aerospace & Defence index over 3yrs
Source: FE Analytics
Sheridan Admans investment research manager at The Share Centre, said: “One of the key features of the defence sector in recent years has been the contrasting fortunes of companies based on their level of exposure to the civil or government sides of the sector.”
“Those exposed to government contracts and defence spending have been experiencing tough times.”
But Hargreaves Lansdown says the era of spending cuts looks to be coming to an end in certain key defence markets.
“In particular the US, whose defence spending dwarfs those of any other players, seems likely to increase expenditure on military hardware under Donald Trump.”
“This increased expenditure reflects the changing nature of global threats, with the technologically demanding and capital intensive navy and air force set to be particular beneficiaries.”
“That’s good news for those companies that manufacture planes, ships and tanks. Demand for these has been in decline since the end of the Cold War, as multi-million pound jets and cutting-edge warships proved of little use against guerrilla insurgencies.”
Additionally, the surge in cybersecurity threats over the last few years have ramped up, with prominent defence companies including BAE and QinetiQ looking to increase their market share in the space.
“In a sector which is still coming to terms with a new range of threats, existing relationships could prove invaluable in winning future contracts,” it noted.