Outlook for UK Equities
The bumpy ride in UK equities over the last three years will have left many equity investors feeling queasy. But it may surprise some that the market has actually returned over 70% since the March 2009 lows - especially given the lengthy list of things to worry about; the near-collapse of the UK banking system, concerns over a double-dip recession, government austerity measures, deflation, inflation, stagflation, interest rate rises, the EU peripheral sovereign debt crisis, emerging market overheating and, most recently, unrest in the Middle East and the repercussions of Japan’s earthquake and tsunami.
Many of these concerns continue to exert their influence. Some may well cause further market volatility in coming months. In such an uncertain climate, it is easy to get whipsawed in different directions by rapid changes in sentiment and end up selling low and buying high, while missing the bigger picture.
Ultimately it is the cash earnings from a company that drive its valuation and when earnings growth leads to sustained dividend growth equities outperform.
Over the last two years there has been the recovery in earnings of UK plc. For the FTSE All-Share as a whole, pre-tax profits have rebounded from a low of just over £100bn in 2009 to £140bn in 2010. Based on consensus City forecasts, they are expected to grow again to more than £165bn this year. This 65% rise in profits over the last two years is broadly in line with the rise in the stockmarket over the same period. As a result, the FTSE All-Share today trades on just 10x forward earnings - a significant discount to its long-run average of around 13x, and, perhaps more interestingly, 20% cheaper than at this time last year.
Over the same period, UK plc has reduced its debt and now looks under-leveraged versus long-term history. With little debt left to pay off, and borrowing rates at near record lows, it is no surprise that the strong profits and cash flows that companies are generating are manifesting themselves in higher dividends, share buybacks and a sharp pick up in M&A activity.
All three uses of cash should be supportive of the stockmarket in the near term.
This, combined with very low absolute valuations, is why we remain confident that investors who are willing to ride out short-term market volatility will be rewarded.
The value of investments is not guaranteed and can go down as well as up.