Jan 17 2007
The UK has entered 2007 with an interest rate rise and the possibility of more. However, while inflation remains well above target and speculation increases that the coming year could see interests hit six per cent, the economy remains in a positive situation with fund managers upbeat about prospects after a good 2006.
The Invesco monthly update [Report] first points to the UK equities market capping off a good year with a rally.
It stated: "Healthy economic data released over December in the form of strong retail sales, better-than-consensus consumer-price inflation figures, strong employment data and a buoyant housing market created a favourable investment environment for the UK equity market to thrive."
The update adds: "In terms of housing-market news, latest figures from Nationwide building society revealed that house prices rose by an average 1.2 per cent month-on-month in December (the annual rate returned double-digit growth of 10.5 per cent year-on-year for the first time in nearly two years), demonstrating that the prolonged upsurge in property prices is continuing."
Across the sectors, Healthcare Equipment and Real Estate were among the best performers, while the Pharmaceuticals & Biotechnology and Leisure Goods sectors "lagged".
Edmund Brandt of JPMorgan Asset Management [Report] points to the end of 2006 showing that come 2007 manufacturing could well slow but carry on its expansion, while the service sector could continue ebulliently .
He writes: "Manufacturing economic data was thin on the ground, although the release of manufacturing surveys in the UK and the eurozone for December gave the first indication of the state of the economies in 2007. Manufacturing in both areas slowed, but still registered an expansion in the last month of 2006. Also in the UK, the service sector grew at its fastest pace for nine years and further evidence arrived of a robust housing market."
Richard Dunbar, Scottish Widows Investment Partnership UK Income Fund [Report] sees the investment opportunities in the UK as being "broad and glorious", with even interest rates creeping up unlikely to hold back companies borrowing.
He says: "With interest rates in the UK as a start point, it seems likely to me while interest rates may go slightly up or slightly down, they are unlikely to move in extremis, so UK plc and consumers should have some certainly to the price of money over the next few months."
Although some parts of society may feel stretched with rising interests having borrowed too much, Mr Dunbar explains, the majority are in a good position. "We've seen [concerns over some borrowing too much] with bank results and concerns over IVAs - this is likely to continue, but those with a house and a job and likely to continue to feel that they have money to spend and companies are responsible confident about the outlook for the global economy."
In the arena of M&A activity 2006 saw increased levels of activity - linked to the price of money and overseas banks willing to let private equity to leverage up to, what Mr Dunbar describes as, "quite astonishing levels" in some cases. Into 2007 high levels of M&A activity are expected for both private equity takeovers and at the corporate level with more corporate to corporate transactions. Corporate takeovers are expected due to the low inflation and competitive environment with consumers becoming more price sensitive. Companies merging to cut costs is expected to be a powerful driver for M&A activity.
On the equity income investor front Mr Dunbar sees 2007 as "reasonable place" for investing. The themes for investing for the SWIP UK Income Fund are construction and house building, where they continue to see value, and the specialty finance area.
Areas that the SWIP fund is being cautious include the utilities sector, where the valuations are "puzzling" and some investors "could become a cropper".
Generally, companies in the UK are "reasonably optimistic" about outlook and paying cash to shareholders, paying dividends and investing in businesses.
Threadneedle Globetrot-UK, [Report], points to utilities - along with technologies - performing well at the end of 2006, as well as the increased merger speculation adding an extra flourish to the market.
It states: "Lower capitalisation stocks outperformed once again as merger and acquisition activity continued. During the month, bids were tabled for Gallaher, Corus, Huntley and RHM. The utilities and technology sectors were areas of particular strength, while retailers were buoyed by signs of a pick-up in consumer spending in the immediate run-up to Christmas. Healthcare and oil & gas stocks lagged the market."
Looking forward to 2007, Stephen Whittaker, joint CIO and manager of the New Star UK Growth Fund, says: "There are strong reasons to remain bullish on UK equities given a benign UK economic backdrop. The housing market remains strong and employment levels are higher than they were a year ago. Inflation is being kept low as technology and a pool of labour from developing markets drive down the price of goods and restrain wage bargaining.
"My favoured sector for 2007 is financials. I believe UK banks are cheap because their share prices are discounting a recession, which I believe is not going to occur. Life insurers also look attractive as their business models are returning to growth and the sector appears set for a round of consolidation."
One of the biggest changes to the UK economy over the last six months has been the move by the Bank of England to raise interest rates three times over the last six months - after just two changes over the preceding two years.
Rates rises have come as inflation has remained solidly over the government target of two per cent since April 2006 - as oil prices and utility bills brought up the consumer price index (CPI). However, while headline CPI is high, core CPI shows inflation may not be such a threat.
In the bank's commentary with the January rate rise it states: "In the UK, output continues to rise at a firm pace. Domestic demand has grown steadily and credit and broad money growth remain rapid. The international economy continues to grow strongly.
"Sterling has risen and oil prices have fallen back. But the margin of spare capacity in the economy appears limited, adding to domestic pricing pressures. CPI inflation was 2.7 per cent in November. It is likely that inflation will rise further above the target in the near term, but then fall back as energy and import price inflation abate. Relative to the November Inflation Report, the risks to inflation now appear more to the upside."
The rising inflationary risks have also led some analysts to speculate that interest rates could rise further - even to six per cent - to keep a lid on rising prices before dropping again come 2008.
The UK markets looking into 2007 look set to face some challenges - as interest rates rise among others - but on the whole fund managers are looking positive, although not without caution in some sectors.
