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Fund Managers Warn of Overvalued UK Stocks

Fund managers from Evenlode, Jupiter Asset Management and Franklin Templeton give their views on the UK stock market outlook for 2017

Emma Wall 3 January, 2017 | 10:48AM

All this week, Morningstar.co.uk will be bringing you a Guide to Investment Ideas for 2017; stock picks, market reactions and political forecasts from the investment professionals.

Colin Morton, Franklin UK Equity Income

Many large caps are at the highest valuation levels that I have seen in my career, trading on price-to-earnings ratios that would normally make investors cautious. With alternative sources of returns, such as traditional bonds, looking so unattractive, it is understandable why investor behaviour has driven UK equity valuations higher. For some, these large caps offer perceived safety because of their solid pricing and powerful earnings.

Equally, with these companies able to borrow at historically low interest rates, many seem to be putting their faith in the ability of these large caps to grow their dividends. We are seeing stocks that we would consider reliable cash generators trading at P/E ratios of around 20, which some investors might consider too richly valued in normal conditions, but nonetheless these stocks have been the drivers of overall market returns.

As a result, investors may choose to swallow hard and continue to hold stocks they usually would not under normal market circumstances. We recognise that making a decision based on relative prices can be a dangerous game. As the market discovered during the dot.com bubble of the late 1990s, there is little benefit in identifying one stock that is cheaper than others in the same sector if they are all dramatically overvalued.

With this in mind, our investment strategy will continue to keep a foot in both camps. This means retaining some exposure to quality names, even as their valuations ramp up, while at the same time looking for interesting new opportunities, however few and far between they might seem at the moment.

Hugh Yarrow, Evenlode Income

When investor time horizons shrink as they have done at several points over the last year, and inevitably will do again in 2017, it is worth remembering that shares are part stakes in real companies, not just prices on a screen. Ultimately, if a company can deliver long-run growth in per share cash flows and dividends, the share price will follow. Patient, business-perspective investment is more relevant than ever in a world that sometimes feels overly obsessed with short-term noise, momentum trends and sector rotation.

The outlook for dividend growth remains relatively muted in the UK market, though much will depend on the outlook for sterling and inflation over coming years. Our focus as we head into 2017 will as usual be on asset-light companies with sustainable competitive advantages and long-run growth potential. These characteristics tend to help produce sustainable dividend streams, thanks to healthy, growing free cash flows, and equip companies to cope relatively well in both deflationary and inflationary conditions.

Steve Davies, Jupiter UK Growth

Investor sentiment towards the UK is at rock-bottom at present, for perfectly understandable reasons, but the same was true, albeit for different reasons, in emerging markets a year ago and we’ve seen what asset prices have done there since. Anything that suggests we are heading for a softer Brexit and with an extended transitional period could trigger a bounce in sterling and a re-appraisal of the attractions of UK domestic companies whose valuations I believe now look very appealing.

There have been some positive signs for financials in the latter part of 2016, thanks to rising bond yields and improved financial results from the banks themselves. Again, valuations here remain cheap by historic standards and many banks have considerable scope for self-help even without further tailwinds from the market. Further clarity on regulatory capital requirements and the settlement of outstanding litigation issues will also be required for the sector to kick on again, but it definitely starts the year at the forefront of investors’ minds.

The flipside of rising yields is that “expensive defensives” or “bond proxy” sectors such as consumer staples have finally started to underperform. After such a long bull run, it would not surprise me if the reversal of this trend persisted for more than just a few weeks.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
Evenlode Income A Acc269.14 GBP0.87
Franklin UK Equity Income W Acc2.01 GBP0.73
Jupiter UK Growth fund344.92 GBP0.91
About Author Emma Wall

Emma Wall  is Senior Editor for Morningstar.co.uk