Market Update: FTSE 250

Mark Martin: Good morning, Emma.

Wall: So, I thought we'd start by talking about how well your sector has done over the last couple of years, but of course having a stellar run through 2012 and 2013, mean that perhaps you're struggling now to find value in that arena. Is that the case?

Martin: Well, certainly 250 has performed very strongly over the last five years, but actually really important point is that earnings have kept up pretty strongly in the 250, and in fact on a relative forward P/E basis, compared to the FTSE 100, the FTSE 250 actually right now is cheaper than it has been since 2010 relative to the FTSE 100.

So, obviously, we focused very closely on the sustainability of those earnings, but purely on a valuation basis, the 250 actually looks quite attractive right now.

Wall: That might be a surprise to some investors, because if they look at the FTSE 100, it's basically gone nowhere over the last 15 years, but you said this is purely an earnings thing?

Martin: I know a lot of people are concerned about the fact that the FTSE 100 is approaching nominal new highs, but it's really important to remember that since 2013 we have seen significant upgrades across the market. So rather than being a cause for concern, in my mind, the fact that 100 is approaching new highs, you've got to focus on the fact that valuations are still very reasonable.

If you look at the All Share, we're about 14 times forward P/E and history demonstrates over the last 30 years or so, that a 14 times forward P/E is associated to roughly 7% to 8% real returns per year for the next 10 years.

Wall: Pretty good.

Martin: Yes. So that would be pretty attractive. The other interesting thing we're seeing at the moment as well is actually a bit of M&A. So, clearly the AstraZeneca (AZN) Pfizer (PFE) deal hit the headlines, but actually we've had some success in the fund year-to-date with M&A with a company called Wolfson Microelectronics (WLF) being taken over. Salamander Energy (SMDR) also being approached. So I think that also shows there is still attractive valuations to be found in the market.

Wall: M&A is a good indicator of economic recovery. We're very much bedded into the recovery now in the U.K., does that continue to have a beneficial effect on the FTSE 250 because although it does have some international revenue streams, it is a lot more domestic focused than the mega cap sector.

Martin: It is more domestically focused and that is something I still find attractive about the 250 that domestic exposure. So one of the things that we've seen in recent years is places like China actually starting to slow down slightly from their formerly very high rates of growth to slightly lower rate of growth and that actually has been a great tailwind for the U.K. consumer and for the domestic economy because it has helped keep inflation under control.

So usually at this stage of the recovery we'd expect energy costs and food costs and things like that to be, starting to rise quite substantially and that might necessitate an increase in interest rates, but partly because of this slowing down of the Chinese economy, we're actually seeing inflation staying under control, which has meant that interest rates have been able to stay lower for longer.

Wall: I mean interest rates although they're probably not going to go up in this political term, because it would be very unpopular, there are rumors and there is pressure for the Bank of England to raise interest rates, which in turn will put pressure on the U.K. consumer and presumably on the FTSE 250. Is that something you're concerned about?

Martin: It's certainly something we're aware of. I'm not particularly concerned about it. Clearly one thing that will be very important is the nature of the interest rate path. So if we see interest rates rising faster than expected and sooner than expected, I think that probably would be a negative particularly for the FTSE 250 because it is more cyclical, it is more interest rate sensitive. But our current expectation certainly is for interest rates if and when they do rise only to rise slowly.

And I think actually interest rates rising is in fact a sign of sort of economic success and as you say economic recovery. So, interest rate rises are actually something that we would embrace particularly if they're slow and gradual.

Wall: What then are you concerned about, the election next year perhaps?

Martin: Yes. So, I think political risks are a concern certainly and geopolitical risks as well. Sadly, all sorts of places around the world right now we're seeing geopolitical tensions starting to rise and that is a concern.

As you say, yes, political risks…

Wall: When you say political risk, I mean, what we mean is perhaps, for example, if Labour do win the election, they have already been quite vocal about some of the restrictions they will put on sectors, the energy sector, for example. I mean, is that the sort of thing that you mean?

Martin: Yes. That sort of thing. I think we have seen kind of capitalism being viewed kind of solely as a good thing over the last 20 years, and there are some signs that maybe – people may be kind of rearing back against that, but I actually suspect that – maybe someone like Ed Miliband, if he were to come to power, I suspect his bite wouldn't be as quite as bad as his bark is. So it's certainly something we're aware of, but it's not something we're too concerned about at this stage.

Wall: Watch the space then?

Martin: Yes.

Wall: Mark, thank you very much.

Martin: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.