Woodford Investment Management  

Woodford reveals which sector is most overvalued

Woodford reveals which sector is most overvalued

High-profile fund manager Neil Woodford has revealed the sector of the UK market he thinks is presently most overvalued.

Mr Woodford’s £9.2bn Equity Income fund has had a torrid year, losing 0.3 per cent during a period when the average fund in the IA UK Equity Income sector has returned 10 per cent.

His £795m Woodford Income Focus fund has lost money over the past three months.

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The fund manager believes the market is being too pessimistic on the prospects for UK economic growth, and too positive on the outlook for the Chinese economy, leaving sectors exposed to the Chinese economy, particularly commodity companies, particularly over valued.

He said: “As the summer has progressed, global stock markets have become increasingly narrowly focused, returning to the themes that drove behaviour in the second half of 2016.

"Markets have appeared singularly fixated on stocks that are seen as proxies for Chinese credit growth – in the UK that basically means mining companies.

"We do not believe this behaviour is fully justified by what is really happening in the economy nor do we believe it is sustainable. Nevertheless, it has been a considerable further headwind to performance (of the fund)."

He is not currently invested in any of the UK's miners. He said the sector has performed well over the past 18 months.

Mr Woodford said: “For example, Rio Tinto’s share price started 2016 at £19.80. Since then it has risen almost 90 per cent to end August at £37.47.

"Mining companies like Rio Tinto have benefited from a significant increase in the price of the commodities that they produce.

"We have missed out on those gains, in part because we did not anticipate the rally in commodity prices, but primarily because we do not believe the increase in commodity prices that we have seen is fundamentally justified."

He said at the headline level the shares of UK mining companies do not look expensive, because earnings, cashflow and dividend forecasts have increased generally in line with the share prices.

He said the problem arises if commodity prices fall.

Mr Woodford said the rise in commodity prices has not merely been driven by underlying demand for commodities in China, but also by speculation in the movement of commodity prices, and a rally based on speculation, rather than fundamental demand, is more volatile.

He said: “For example, the amount of iron ore volume that is traded in China every day now regularly exceeds the country’s entire annual output of that commodity.

"Meanwhile, global supply growth has continued to outstrip global demand growth across many commodities, including iron ore and copper.

"This fundamental dynamic is naturally more likely to result in commodity price declines, rather than increases, which suggests that something other than fundamentals has been driving price behaviour across the commodity spectrum."

He said fundamental demand for commodities in China is driven by credit growth, with the economy needing to borrow five units of debt for every one extra unit of growth created, according to the International Monetary Fund.