2015 turned to be a better year than expected for active investors that provided plenty of opportunities to make money in UK equities.
Despite falling commodity prices, the Greek debt crisis and China’s economic slowdown, many stocks posted positive gains.
But What About 2016?
“Potentially, 2016 could be a far better year for the UK should commodities rally. On the other hand earnings forecasts and hence dividend projections may still be too high should commodity prices remain under pressure,” said Andy Brunner, head of investment strategy of Morningstar.
Poor fundamentals in commodities markets have led many investors to steer clear of the sector in 2015. However, global oil production will soon be lower than it was 12 months ago and this means that prices have a good chance of recovering from current levels.
At the company level, Alex Wright, portfolio manager of Fidelity Special Values views Shell (RDSB) as the most attractive stock in the oil sector, trading on a dividend yield of around 7%.
Shell just announced on Monday that its deal with BG Group (BG.) was approved by regulators and a merger prospectus would be sent to their shareholders for votes on the deal. Once the deal is completed, it will significantly improve Shell’s ability to generate cash.
However, Morningstar analysts warn that the company's chronically poorly performing downstream also has been a consistent drag on returns on capital.
It is not all doom and gloom however; across the mining industry, many mines remain profitable despite plunging prices, because mines need little in the way of ongoing investment once they are open.
Reasons to Be Cheerful
There are other reasons to be optimistic for the year ahead. Steve Davies, manager of the Jupiter UK Growth Fund says that the travel industry should start to see real benefits of lower oil prices and they are either passed on to consumers or benefit their bottom lines.
The UK economy is in good shape and this bodes well for consumer confidence in the UK. Oil prices falling equals more cash in the hands of consumers, meaning spending in the UK should remain strong. Food retailers are likely to be a benefactor of this.
Fidelity’s Wright expects wage pressures will continue to rise as the labour market tightens and inflation remains quiet. He says this should be positive for companies that benefit from discretionary spending.
What Next for Interest Rates?
The UK economy is getting stronger: job creation is strong, unemployment is falling and house prices are rising. Under these circumstances the Bank of England should implement a gradual interest rate rise, following the example of the US Federal Reserve.
Interest rates will not rise too high however, as inflation remains low.
“We expect the UK inflation rate to remain below target for much of the coming year,” said David Marchant, manager of the Canlife Portfolio Funds.
“While CPI inflation is low, we are beginning to see evidence of underlying inflationary pressures. By the end of 2016 we expect CPI inflation to rise to 0.5%, giving the Bank of England the justification it needs to gradually move towards a normal interest rate environment.”
What About Brexit?
One uncertainly next 12 months hold within the UK is the EU referendum.
Jupiter’s Wright said the referendum was probably negative for company’s investment plans as it would create a lot of political uncertainty. He added that would hold back confidence in the UK economy.
2016: A Year for Stock Picking
2016 will be another year for backing earnings-growth stock picking.
Morningstar’s Brunner concludes that the strong performance of many individual stocks over the past year has ensured the UK market excluding mining stock is not particularly cheap, and the FTSE 100 excluding financials, oils and mining currently 20% more expensive than its historic average.
“With aggregate valuations more or less in line with historical means, UK equities look neither dangerously nor attractively cheap,” said Wright.
But digging a little deeper reveals significant differences in valuations at the company and sector level.
“As we enter 2016, investors would do well to ensure that their portfolios do not rely on recent trends continuing indefinitely. If there is one lesson the stock market teaches us over and again, it is we must be prepared for change,” Wright concluded.
