17/03/2008
UK Equities supported by strong cash flows and attractive valuations
Bulls
- Positive earnings and dividend growth as companies continue to control costs
- Strong cash flow and share buy backs provide positive valuation support
Bears
- Oil and resource companies vulnerable to falls in commodity prices
- Concerns remain about the housing market, bad debts and further sub-prime effects
Valuations of UK equities already appear to reflect severe earnings downgrades, the credit crisis, slowing consumer demand and falling house prices. In this environment, there are early signs that the UK equity market has begun to look through the various negative factors weighing on investors’ optimism.
UK earnings expectations have been heavily downgraded over the past few months, falling to single digits after the surging growth of the last few years. Banks, general retailers and house builders have all suffered from negative earnings revisions which have been partially offset by upgrades in oil and mining-related sectors.
The high income sector has been particularly hard hit by the downgrades and the high-yield index has underperformed the wider market by over 5% over the last year.
This has made it more difficult for high income funds to perform well relative to other funds, while also sticking to a set yield target.
High yield equity sectors such as banks, general industrials and retailers all suffered while lower dividend sectors such as mining, oil & gas and healthcare all outperformed. This has reversed the long-term trend of high yield stocks outperforming growth stocks on average.
Investors are now looking for reasons to come back into high income equities. Possible triggers include the resolution of the credit crisis, further merger and acquisition activity or more interest rate cuts.
Many high yield sectors now discount significant bad news, for example the banking sector is trading on a price/earnings ratio of 7-8 times, compared to so-called defensive sectors such as beverages, food retailers and health care, which are twice that on average. We believe that this situation is unsustainable in the long term and will correct in 2008.
We’ve already seen some signs of positive change in high yield sectors, for example large dividend hikes from major UK banks Barclays, HBOS and Royal Bank of Scotland. Given such high yields, the value for income investors is there.
Although our UK Equity High Income Fund is underweight in HSBC due to our negative view on US credit, we have overweight positions in Royal Bank of Scotland and Barclays. We also remain positive on mining where we expect upgrades and further consolidation.
Overall, we believe the high income sector within UK equities will perform better this year, however, stock selection will remain critical.
Karen Robertson, Manager of Standard Life Investments UK Equity High Income Fund
This was published in Investment Week on 17th March 2008.
Standard Life Investments Limited, tel. +44 131 225 2345, a company registered in Scotland (SC 123321) Registered Office 1 George Street Edinburgh EH2 2LL.
The Standard Life Investments group includes Standard Life Investments (Mutual Funds) Limited, SLTM Limited, Standard Life Investments (Corporate Funds) Limited and SL Capital Partners LLP. Standard Life Investments Limited acts as Investment Manager for Standard Life Assurance Limited and Standard Life Pension Funds Limited.
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