Outlook for UK Equities
While the recent UK General Election had little impact on UK equities, Brexit concerns have begun to damage cyclical economic indicators. Over the next quarter, we anticipate ever increasing signs that inflation is approaching a near-term peak, coupled with only a few signs of second-order inflationary impacts. Nevertheless, we believe that the UK economy cannot continue to defy gravity – this is an economy vulnerable to periodic misfiring.
Thankfully, the backdrop for global equity valuations remains supportive. In our view, investors seeking yields will not fall back in the near-term. Yes, there are concerns, including the distributive impacts of globalisation, but we continue to espouse an upbeat outlook for UK equities.
Don’t mistake us for dewy-eyed optimists, though. There are systemic risks, including the distortionary impact of leverage. But we are analytical rather than astrological; we do not forecast market inflections without the data to back them up. Without signs of tightening liquidity, acute price swings or public policy mistakes, we are not calling an end to this bull market.
The UK and the Global Economy
We expect the UK economy to grow by 1.6% in 2017. This represents a slowdown on the 2% growth rate achieved in 2016. While we face the dual challenge of Brexit and higher inflation, it remains our belief that this represents a steady headwind to activity rather than a more acute challenge to UK output growth. In addition, recent falls in the oil price and the recovery in the value of Sterling should reduce the risk of sustained >3% year-on-year UK inflation and keep the Bank of England on hold for a protracted length of time.
For the first time since 2009, the loosening of fiscal and monetary policy is occurring alongside a stimulative exchange rate. Since Q4 2016, we have favoured the outperformance of UK cyclicals but, having seen global equity markets rally on the recent recovery in global growth and with renewed doubts over US policy reform, we downgraded our outlook to equal weight at the beginning of Q2.
As it stands at the moment, there are significant challenges to sustained UK growth, not least housing market inefficiencies, poor productivity, and the ongoing failure to eliminate the UK’s twin deficits. The odds of the US Federal Reserve raising interest rates three times this year have increased but there are still considerable uncertainties over US fiscal policy and the trajectory for US inflation, although we anticipate that the Federal Open Market Committee will remain cautious.
Conviction List Rules
We monitor our Conviction List closely, reviewing it every quarter to ensure that every stock continues to justify its place. We have no compunction in removing stocks if the Buy or Sell case has altered significantly. And compelling Buy or Sell cases will be selectively added if we deem it prudent to do so.
While there is no set number of selections, between 10 and 15 stocks is typical. In addition, each stock selection must have a minimum market capitalization of £125m.