On the contrary, says Richard Buxton, expect more quantitative easing from the Bank of England in 2012.
Richard Buxton, head of UK equities, Schroders
The only immediate driver of equity returns in 2012 is any rerating of the market resulting from a positive resolution to the uncertainty surrounding Europe and the survival of the euro. Call it the equity risk premium if you want to, or the elusive chimerical ‘investor sentiment’ if you prefer, but the biggest driver of returns next year is likely to be a positive uplift in risk assets as and when the acceleration in the eurozone debt crisis is arrested. As with any binary outcome, the reverse will also apply if this does not occur.
UK economy to continue to flatline.
The Olympic Games and the Queen’s Jubilee should be modestly positive for activity. But public spending cuts will still bite, with further public sector job losses just as the pace of private sector job creation is slowing. A recession in Europe, which looks unavoidable, will hardly be positive since it remains the UK’s biggest export market. On balance, we do not expect a severe contraction in activity but more of the same: growth effectively flat, modestly either side of zero. In other words, a sluggish environment that feels recessionary irrespective of whether the statisticians tell us that it is or not.
Debt reduction and bank deleveraging – long-term headwinds
While we do not envisage a sharp contraction in the economy in 2012, it is important to remember three years on from the financial crisis of 2008 that its shadow will hang over us for several more years yet. History suggests at least six years is needed for banks to work out losses from previous crises – and this is the biggest yet. Irrespective of one’s view on the wisdom or long-term consequences of tackling a problem of too much indebtedness in the Western world with central bank money-printing, it is clear that what has been called the post-war debt supercycle has reached a turning point.
Governments, banks, individuals and nation states are having to retrench and this means economic activity will be low. As a result, growth is more vulnerable to shocks and, with regret, short-term equity returns will remain volatile and subject to ‘risk on, risk off’ shifts in mood.
Valuations extremely supportive for long-term investors
Ten years ago the market stood on a price/earnings ratio of 24x. Today, it trades at a valuation of 9x earnings. Crucially, starting valuations are the key to future returns – not the economic backdrop. From a 24x multiple ten years ago, one would have struggled to make money from equities even if the macro-economic environment had been a panacea. If history is any guide, then from today’s valuations the next ten years should provide double-digit real returns, despite the economic headwinds we face.
So where to invest?
Mark Hall, manager of the Franklin UK Select Growth and UK Managers’ Focus funds
A recession in the UK in 2012 is all but inevitable given the outlook for our major trading partners in Europe and the ongoing fiscal squeeze in the UK. Given the high dependence of the UK economy on consumer spending (two-thirds of GDP) we desperately need to seethe spending power of the consumer restored by falling inflation and in particular lower energy prices. Oil below $100 per barrel would be a good start.
In the very short term, we continue to favour defensive areas of the market such as tobacco, pharmaceuticals and utilities but expect the next 12 months to provide some excellent medium-term buying opportunities in the more cyclical areas of the market such as industrials.
Jeremy Thomas, chief investment officer UK Equities, RCM
The valuation of the UK market looks fairly attractive on a long term basis, especially compared to government bonds and discounts many of the known risks. However it is worth noting that certain cyclical sectors, including mining and industrials, are making high or record profit margins which could be vulnerable in the event of a significant economic slowdown. Across the market as a whole bottom-up analyst forecasts still imply robust earnings growth and margin expansion across most sectors next year, which we consider unlikely to happen.
In our view some of the more recent new issues to the UK market have been of questionable quality, but fortunately we can find many attractive companies in which to invest, where low valuations offer genuine support to the long term investor, and dividend yields which are particularly attractive in a low interest rate environment.
As a result we are increasingly building portfolios less constrained by the make-up of the UK stock market indices. We continue to bias portfolios towards high quality, attractively valued multinational businesses with strong balance sheets operating in relatively defensive or less cyclical industries such as pharmaceuticals, telecoms, utilities or household products. However, there do remain opportunities in other sectors,including selectively financials, whilst we also favour businesses with structural growth potential, for example those with exposure to emerging market consumers, as we think growth should be valued at a premium in this environment.
GlaxoSmithKline, Reed,Tesco, Bunzl and Unilever are amongst the stocks that look likely to continue to perform well in a tough 2012 and are a central part of our portfolios.
