UK equities facing a challenging year, according to analysts

UK equities are facing a tricky year due to the frailty of the economic recovery, high government debt levels and a rise in the cost of capital across the private sector, it is claimed.

 
Last year UK equity investors were rewarded almost regardless of which part of the market they placed their money as equities staged a broad based recovery from March onwards following the heavy sell off due to the credit crunch, according to the latest investment briefing from Legal & General Investment Management.
 
But the company’s equity strategist Georgina Taylor says that 2010 is likely to be a far trickier year for UK equity investors than 2009 with equity gains for the market as a whole likely to be far more modest.

However, she said it is important to distinguish between the economy and the equity market.
‘The UK equity market performance is no longer simply dependent on the UK economy. More than 70% of UK FTSE 350 company sales now come from outside the UK. So the fortunes and earning power of UK companies are greatly influenced by factors such as the strength of the global economy and the value of sterling,’ she explained.
 
But the risks which UK companies face include the fragility of the UK recovery, high Government debt levels pushing up the ‘risk free rate’ and a rise in the cost of capital across the private sector.
 
But despite these risks, Taylor believes that there will be opportunities for attractive returns from those UK companies who have pared costs during the downturn and are now likely to be highly cash-generative. In addition, larger companies with greater exposure to the expected higher growth emerging markets are likely to outperform.
 
‘In 2009 it was a case of just investing in the market, spotting these companies will be the key to earning good investment returns in 2010,’ she said.
 
However she added; ‘Iinvestors will continue to be surprised by just how long it takes for the world to emerge from the recent economic downturn and financial market chaos. With economic data and news flow likely to send mixed signals over the coming months, we expect the investment environment to remain challenging.’
 
According to Leigh Harrison, head of UK Equities at Threadneedle, the forthcoming general election provides an additional layer of complexity. ‘Recent poll data has raised the spectre of a hung parliament. This outcome would be negative for equities, as it increases the risk of policy stasis. Each of the political parties has its own take on the optimal balance between supporting growth, providing public services and tackling the debt burden,’ he explained.
 
‘While we acknowledge the economic and political challenges facing the market, we believe that equities can make progress over the next two years. Following the rally of the past year, valuations are no longer compelling at the aggregate level, but they are still on the right side of fair value,’ he added.