Stronger economic data, a shift in monetary policy and swings in commodity prices are all starting to be felt in the UK stock market, according to Artemis manager Ed Legget.
Legget, lead manager of the £605.3m Artemis UK Select fund, noted that the FTSE All Share had reached a new all-time high in October, with large-cap oil & gas and mining stocks boosted by a rally in crude oil and base metals.
Additionally, monetary policy – such as the Bank of England interest rate hike and early signs of tapering by the European Central Bank – was also starting to feed through to market, said Legget.
“We retain our view that accelerating economic growth, combined with the inflationary effect of rising commodity prices, will see bond yields moving higher from here,” he explained. “Given this, we believe that many assets look mispriced.”
He said that, from a bottom-up perspective, momentum in earnings continues to drive share prices, rather than valuations.
“Movements in many share prices, however, would seem to be multiples of what we would regard as a logical reaction to results,” he added.
Legget cited Next as a prime example. The clothing company’s shares rallied by close to 30 per cent in September after its summer sales came in slightly better than expected.
“The management indicated that this was weather-related. A month later, a warm October resulted in a slow start to winter sales,” the manager said.
“And although profit guidance for the year remained largely unchanged, the shares have fallen by over 20 per cent from recent highs.”
Performance of Next over 3mths
Source: FE Analytics
He added: “On the whole, good news continues to be rewarded handsomely while even modest slip-ups are being punished. In the short term, valuation appears to have little influence on share prices.
“The lists of stocks hitting 12-month relative highs and those hitting 12-month lows are becoming increasingly static. Meanwhile, the discrepancy in valuation between the two lists is growing.”
Legget (pictured) said stocks hitting 12-month relative highs are trading “well above their own historic valuation levels” while those on 12-month relative lows are, on the whole, trading “substantially below”. 
“We maintain our view that, ultimately, valuation does matter,” he said. “So, where an investment thesis hasn’t changed but valuations have, we are taking profits in stocks that have been better-than-expected and recycling the proceeds into stocks that we like but whose shares have underperformed.
“In the short term this has often been a losing strategy. But we do feel it will be rewarded eventually.
“The question we find ourselves asking most often is: what will be the catalyst for current trends to change? We could be wrong, but the answer we keep returning to is monetary policy and, in turn, bond yields.”
He added: “Stronger economic data and hawkish comments from central banks are increasing our conviction that the global economic outlook remains robust and that bond yields will edge higher from here.”
According to the manager, encouraging corporate results suggest that stronger global economic data is feeding through to strong results in early-cycle sectors such as airlines, recruitment companies and industrials.
The fund holds 28.3 per cent of the portfolio in financial stocks. However, its largest sector position is to industrials stocks, which represent a 31.1 per cent allocation. Further, the fund has an 18.8 per cent allocation to consumer goods and 12.5 per cent held in consumer services companies.
“In the UK, many consumer-focused sectors remain under pressure, both from the squeeze in real incomes and from structural changes in the way consumers interact with businesses,” said Legget.
“Set against that, and in contrast to the wider market, the valuations of domestic-focused stocks generally remain well below their historic averages, providing the potential for a sharp re-rating should sentiment towards the UK become slightly less pessimistic.
“For this reason, we still have exposure to them, with a focus on those with a strong franchise, limited threat of disruption and that pay us a growing yield while we wait for sentiment to become less negative.”
He added: “Overall, we remain confident in the Artemis UK Select fund’s positioning and believe that our holdings in financials and our tilt towards value will aid its relative performance as central banks withdraw liquidity from the financial system.”
Legget, who is supported by deputy manager Ambrose Faulks, noted that the fund had traded at a forward price-to-earnings multiple of 11.5x compared with the UK market which trades on a multiple of 15.5x.
The fund’s largest individual holdings are insurer Prudential and UK-based international packaging company DS Smith, both representing 5.3 per cent of the portfolio.
Over three years, the fund has returned 36.63 per cent compared with a 29.79 per cent gain for the average IA UK All Companies fund and a 27.47 per cent rise for the FTSE All Share index.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Analytics
The fund has an ongoing charges figure (OCF) of 0.83 per cent.