Where to find value in UK equities
There’s no denying that the bumpy ride is set to continue for the UK economy.
With unemployment sitting at a perilous 17-year high, and pessimistic revisions of economic growth coming through, there are some very disappointing angles from which investors could view the market.
However, with continued overseas growth, particularly in emerging markets, and some impressive dividends, there is still value to be found in UK equities if you know where to look.
At the beginning of October the Office of National Statistics (ONS) revised down second quarter GDP growth, a discouraging assessment of the state of the domestic economy. The ONS halved its figure for the quarter and now estimates that year-on-year growth is likely to be less than 1 per cent.
Combine this with an unemployment rate of more than 8 per cent – the highest this century – and also inflationary pressures, in addition to the government’s austerity measures which are really yet to bite, and the figures do not paint an attractive picture of the UK’s domestic economy.
There is no easy solution to the UK’s deep-rooted structural imbalances, and these may take years to sort out. Investors would be forgiven for looking overseas to build their portfolios, particularly when they are presented with the attractive economic statistics that have enticed people to put money in Asia and the emerging markets.
While these economies do offer opportunities, one should not be so quick to rule out investing closer to home. Why? Because UK companies are not necessarily representative of the UK economy. Unlike the average person on the street, or the government, companies are innovative and have strong balance sheets.
Indeed, many companies listed in the UK only have a tenuous connection with domestic economic activity. In the UK, some 70 per cent of FTSE 100 company revenues come from overseas and roughly one-third of those from emerging markets.
People assume the FTSE 100 index is a bellwether for the UK economy, but that is not so. National stockmarkets are no longer good proxies for their home country. In China, for example, the economy has expanded 16.9 times in nominal US dollar terms in the past 20 years, but this strong economic performance has not been reflected in its stockmarket. From its inception in December 1992 until to August 2011, the MSCI China index fell by 10 per cent in US dollar terms.
In spite of economic turmoil, a good proportion of companies in the UK are in good financial shape, perhaps surprisingly good. They were quick to react in the downturn by cutting costs and repaying debt, something governments are only just getting round to.
Capita Registrars recently released its quarterly UK Dividend Monitor, which showed how dividends were defying market turbulence. Encouragingly, more than £20bn was paid out by companies during the third quarter, and the forecast is that more than £67bn will be paid in dividends during the whole of 2011, an underlying annual increase of 18 per cent.