pa congress analysis arguing for domestic bliss

The UK market has been feeling its way in the dark when it comes to interest rate rises, but market demand is likely to continue.

pa congress analysis arguing for domestic bliss


But whether rates rise at the end of this year or in the first half of next year is actually less of a concern for investors than it may seem, because despite interest rate hikes there will still be demand in the market, particularly for property.

This was the view of the members of the panel discussing the threat of interest and inflation rates at PA Congress UK 2014.

In the opinion of Gerard Callahan, head of the UK equity team at Baillie Gifford, coming from an equity perspective the policy of forward gains on interest rates is shambolic.

“It hasn’t worked, and this whole debate about, ‘Will it be in November or January next year?’  Who cares?  Obviously interest rates are going to go up, and the evidence is they don’t know when, and we’re all feeling our way in the dark,” he said.

“If you're going to tell people you're going to do it in the second half of the year then why not crack on and do it?  If you don’t you're going to look quite ridiculous and your credibility will be shot to pieces.”

When asked if this affected him as a stock picker in UK opportunities, Callahan said it did not particularly affect where or what he buys.

His concern was that in any point in the yield curve bonds look scarily overvalued and that at some point there will be a correction.

“The broader debate is what that means for the equity markets and for underlying earnings,” he added.

From a fixed income perspective, Ben Lord, UK corporate bond fund manager at M&G, agreed that it did not matter whether rates rose in November or January.

“The timing doesn’t really matter.  I would agree with what everyone has said, that the rates are unsustainably low, and that they will have to normalise,” he said.

According to Marcus Phayre-Mudge, fund manager at Thames River Capital, he has already anticipated interest rate rises and was “quite surprised” at how naïve the market reaction was to the governor’s Mansion House speech, particularly the impact on UK domestic stocks related to housing.

He added that the real estate world was in the beginning of a long process of lending again and he agreed that the rising rate cycle is overdue.

“The good news for the real estate world is that it is not making the same mistakes as last time, of lending on speculative development. We are very much controlling the new supply, and that’s what is forcing up rents. We have this situation where, once again, property rents are going to exceed the standard indexation, if you believe those stats,” he said.

UK Growth versus company earnings

According to Callahan, the issue of UK growth did not make a great deal of difference to much of the UK equity market given the international competition. He said the UK economy was quite detached from many of the factors that drive the UK stock market, referring specifically to the issues in the Eurozone, the American recovery and China which affect the international companies domiciled in the UK.

Meanwhile, in the fixed income space, Ben Lord, said his purchasing decisions were not hugely influenced by the source of a company’s earnings.

“We got nervous in 2011 about being too exposed to companies that had peripheral European exposure and I think we are probably getting back to that stage now, where we’re looking to reduce exposure to those credits again.”

It is a natural assumption that companies sitting on cash in the equity sphere have to invest to grow and create value. But, according to Callahan, the better question is actually how likely are companies to invest that cash and where will they do so.

“The share prices are there to reflect the underlying economics of these assets. That’s why we invest in these real assets,” he said.

“I don’t think people should be too fearful about companies who are spending wisely and investing for the future, because that’s what wealth creation is all about. My view is that the pendulum has swung too far the other way and people are too fearful about investment because what you want to find is companies with a broad array of investment opportunities that attract a rate of return.  It doesn’t happen too often, but when you find it it’s worth an awful lot of money,” he added.