UK equities: fundamentals still supportive
Headlines have described the recent equity correction as being the worst since October 2008, with $5 trillion wiped off global stock markets. After years of strong equity returns, investors will now contemplate whether the next bear market is underway or if the sell-off represents a healthy and necessary adjustment at this stage of the market cycle.
Historic highs for equities
Since the global financial crisis, risk assets have significantly outperformed the growth in the economy, boosted by a plentiful supply of easy money kindly delivered by central banks. Not even Brexit, political risks in Europe, chasms within the Trump administration, tensions with North Korea or the monetary tightening by the Fed could derail the investment optimism. The global economy is enjoying a synchronised recovery, while profit upgrades are both broad and plentiful. Demographics and technological disruption have tempered inflationary pressures, enabling interest rates to stay lower for longer. US tax reform, hopes of fiscal stimulus and investors’ fear of missing out (FOMO) have added impetus, helping to drive equities higher and volatility lower. Investment returns have been good.
The return of market volatility
Many reasons have been offered for the recent market jitters: stronger US employment data, rising inflation, surging bond yields, complicated (and levered) ETFs, Janet Yellen’s departure from the Federal Reserve and investors being too uniformly positive. Whatever the cause, the volatility genie has finally been released from the bottle. Yet for some, it is the improvement in the global economy that could ultimately prove a headwind for equities. Increased confidence in capital expenditure and consumption may prove inflationary, resulting in rising rates and volatility, impacting the relative attractiveness of equities.
Looking beyond short-term events
We should put this into context. Equity markets, by nature, are volatile and corrections happen. Markets do get ahead of themselves. Indeed, recent events were arguably overdue and provide a timely warning against complacency. Importantly, the correction does not yet reflect a worsening of fundamentals; rather the market drivers are gradually transitioning from significant central bank liquidity to more solid economic and corporate foundations. Previous systemic risks from the banking, technology and commodity sectors have faded, while Chinese growth and European sovereign debt are not currently troubling investors.
UK investors meanwhile have the added complexity of navigating domestic political uncertainty and bruising Brexit talks. Accordingly, UK equities remain under-owned and somewhat unloved despite low interest rates, low unemployment and upgrades to the domestic economy. The outlook for UK corporate profits, the potential to participate in global themes at undemanding valuations, appears attractive.
Equities can be volatile and investors should expect this. It is very difficult to consistently predict the outcome of macro events and how assets will subsequently respond; hence it might seem foolish to try. We continue to concentrate our efforts on identifying well-invested companies that should deliver robust, reliable, consistent and repeatable growth over time.
A focus on long-term sustainable growth
We asked our Framlington Equities team to highlight some of their current holdings to illustrate this approach.
In terms of domestic stocks, George Luckraft draws attention to Forterra, a UK manufacturer of clay bricks and concrete blocks. The UK economic outlook is improving and there is an explicit Government commitment to build more houses. The pricing environment looks favourable and with limited capital expenditure needs, the stock enjoys attractive cash generative exposure to the trends in UK infrastructure and housing.
Jamie Hooper highlights the holding in TP Icap, the world largest interdealer broker, which specialises in illiquid, non-standard episodic transactions in fixed income, FX and real world commodities such as oil, iron ore and coffee. The company should benefit from meaningful synergies following its acquisition of the ICAP business and has a sizeable opportunity in addressing broker remuneration. The company has high barriers to entry, driven by regulation, a strong balance sheet, while their clients’ activity typically increases with market volatility and rising bond yields.
Small Cap holding Future plc is singled out by Dan Harlow. Seeking to avoid short-term market noise he is keen to use market weakness to add to conviction names. The company owns a number of high-value brands such as ‘Tech Radar’ and ‘Digital Camera’, providing multi-media content to a global audience at a scale that has substantial value to marketeers. The company’s considerable investment in technology provides unique differentiation in advertising and ecommerce capability against media peers, driving a considerable international opportunity.
Nigel Thomas highlights the global leader in industrial threads, Coats Group. With a market share of 20%, the business is three times larger than the nearest competitor. The company is increasingly focused on value added speciality threads, such as fire resistant and super tensile. Selling to the apparel, footwear and performance material sectors, technology and innovation lies at the core of the business, forecast to produce healthy and superior rates of growth.
Matthew Huddart considers Gym Group1 which represents a simple but effective roll out story. With over 6,700 gyms in the UK market, there are only 500 currently that are considered to be low cost, but this sub-sector has been growing at a five year CAGR of 44%. Gym Group’s attractive monthly fee of £17 differentiates its proposition from more traditional gyms. Their efficient model should see Gym Group in a good position to deliver strong growth in a sustained profitable manner.
Finally, Chris St. John highlights the online travel agent, On The Beach, which specialises in dynamically packaged holidays. It is growing strongly, benefiting from online holiday bookings, market share gains and increasing revenue per customer. It owns no physical outlets, takes no inventory risk and uses a bespoke IT platform to manage its operations. This is helping to drive more traffic directly to its site, resulting in expanding margins. Longer-term opportunities will come from international expansion, as the UK business model is rolled out throughout Europe.
 Gym Group Capital Market Day, June 2017
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