M&A could propel UK equities

Against a backdrop of global uncertainties, low interest rates and high volatility, getting the right asset mix in a portfolio focussed on the UK market is tough.

Against a backdrop of global uncertainties, low interest rates and high volatility, getting the right asset mix in a portfolio focused on the UK market is tough.

At the time of writing (February 2), the FTSE 100 had been the best performer when compared with the FTSE 250 (ex investment trusts) and FTSE All Small (ex investment trusts) over one year.

The blue-chip index returned 0.67 per cent over the period, compared with a loss of 2.14 per cent for the FTSE 250 and a 9.34 per cent loss for the FTSE All Small indices.

However, according to James Griffin, manager of Fidelity’s Moneybuilder Growth fund, over a decade, the FTSE 100 has underperformed the FTSE 250, leaving many larger companies at very appealing valuations.

He says: “In the bull market years, a common criticism of large companies was ‘elephants can’t run’. A large company supposedly had more limited room for growth compared with more nimble, smaller companies. As a result many of these larger companies derated in the past decade. For example, the share price of Glaxo is the same as it was in 1997. The price to earnings of the FTSE 100 is close to half what it was a decade ago.”

“Of course, a great company doesn’t make a great investment if the share price already discounts a lot of the future growth prospects. Valuations of tobacco companies, for example, are now at significant premiums to historical levels.”

According to Jack Malvey, chief global market strategist for BNY Mellon Asset Management, equities could rise in the 10 to 15 per cent range in 2012 as the probability of stronger economic growth becomes more apparent during 2012 and corporate earnings growth remains positive, although not advancing as quickly as in 2011.

Other factors that could propel equity prices in 2012 would be merger and acquisition escalation, equity buybacks, dividend increases, and asset allocation shifts from bonds to equities.

“Investors are focusing more on what can go wrong instead of the potential upside,” Mr Malvey explains. “The past few years have been rough on equities. Folks are doing a lot of rearview mirror gazing, looking to make same trades as in 2011, which may not be a good idea.”

Mr Malvey notes the interest rates on bonds have been driven so low that dividend yields are now more attractive.

“The fixed income asset class is not likely to be as generous to investors as in most years since 2000,” he adds. The Global Aggregate Bond index is likely to return some place between a negative 3 per cent and a positive 3 per cent due to a combination of flat-to-slightly higher medium and long-term government bond yields, bulging government bond supply, and concerns that monetary policy will become normalised.”