week in focus
December 18th, 2013
The UK is unlikely to be the most exciting part of the globe in which to invest in 2014. The UK recovery, robust though it appears to be, has already been well-reflected in UK equity markets, which saw a significant revaluation in 2013. That said, most advisers will need to have a view on the UK even if it does not present the most exciting growth opportunities.The performance of UK equity markets in 2014 will be far more dependant on corporate earnings. At the start of 2013, UK equity markets enjoyed a valuation tailwind, but this has now disappeared. Corporate earnings have to come through more strongly in 2014 to support the current, relatively optimistic, view priced into markets. “Many of the larger capitalisation stocks are due their time in the sun and the 2014 global recovery may just usher that time along.” Perhaps the most important choice for investors will be between large and smaller companies. Larger capitalisation domestic stocks have lagged the wider rally in UK markets because many are exporters – most obviously, oils and pharmaceuticals – and so have found earnings growth thwarted by the strength of sterling. In contrast, many smaller companies have performed extremely well. This leaves the UK investor with a dilemma. In a recovering market, mid and smaller capitalisation companies would normally be the right choice but, such is the valuation difference between small and large-cap stocks now, that may no longer be the case. The average UK smaller companies fund is up 33% over the year to date, while the average UK All Companies fund is up 21%. In the same period, the FTSE 100 is up just 11%. This suggests large-caps may be a more fertile hunting ground over the next year than small and mid-cap stocks – although, having said that, Morningstar OBSR’s Andy Brunner comes to a different conclusion in his 2014 asset allocation briefing. Either way, some selectivity is still needed. As an illustration, Thomas Moore, manager of the Standard Life UK Equity Income Unconstrained fund, has warned that the valuation in some large-cap defensives has moved ahead of their earnings potential. He gives the example of AstraZeneca, where the share price has rallied but earnings have not followed suit. In his view, M&S and Tesco have also run too far.One option for 2014 may therefore be an active manager focusing on larger capitalisation stocks – but with discretion. Of course, as Brunner suggests, the market may keep running with the smaller and mid-cap companies that are likely to be key beneficiaries from the strong recovery in the UK economy – it tends to overshoot on both sides. But many of the larger capitalisation stocks are due their time in the sun and the 2014 global recovery may just usher that time along.