We believe that UK equities will continue to be underpinned by an attractive dividend yield of 3.4 per cent on the FTSE 100. Valuations look reasonable, especially in the small-cap sector, and the ongoing economic recovery with real wages picking up. The election result was a positive for the market in that it removed an uncertainty, but this has now been replaced by the unknown timing of a European Union referendum, as well as the prospect of the first interest rate rise. But with headline inflation now negative this has been pushed well into next year.
The outlook for eurozone equities remains positive due to the European Central Bank’s aggressive quantitative easing (QE) programme, the fall in the value of the euro and the gradual pick-up in economic activity. Valuations remain reasonable but are no longer compelling. The market may have got a bit ahead of itself earlier in the year but has now had a healthy setback, which could prove to be an opportunity to add exposure. Recent volatility in the eurozone sovereign bond markets was unsettling, while the saga in Greece is an unwelcome problem.
We have recently adopted a more positive view on emerging markets (EMs), where valuations remain reasonable, in contrast to equities in most developed markets. With attention this year having focused on markets such as the eurozone, EMs have lagged and have become somewhat ‘under-owned’. But on a very long-term view they may be attractive with global economic growth recovering. The stabilisation of the oil price is a positive factor, though the outlook for commodities is uncertain, while looming US Federal Reserve rate rises are a potential headwind.
We continue to have a negative view on US equities due to valuations such as the price-to-earnings ratios, which are starting to look more stretched. The US first-quarter earnings season has almost concluded and has on average positively surprised. But we remain concerned that the quality of earnings growth is not that high, being driven more by lower costs than revenue growth. Furthermore, the rise in the dollar from last year will be a headwind for the market, while there also remains uncertainty on the timing of the first US interest rate hike.
We maintain a positive view on UK commercial property in spite of the attractive gains seen in 2014. The sector is supported by attractive yields versus government bonds, healthy inflows, capital values on average still below 2007 peak levels, and we are now seeing good rental growth. There is also low supply, with the level of available office space in the City at its lowest for more than a decade, which will support rents, although property development is picking up. We don’t expect the same returns as in 2014 and favour the secondary market away from the south east.