Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Colin Morton, Portfolio Manager, Franklin UK Equity Team, comments on the outlook for UK equities in 2015.
Our outlook for 2015 is more of what we’ve seen over the past several years. We remain very solidly in an era of low interest rates, low bond yields and modest returns. The US economy is performing very well but Europe continues to struggle, aside from the UK. Japan has a big quantitative easing programme aimed at getting long-term inflation up towards two percent but there’s very little success so far. Emerging-market economies are generally also finding times quite tough with growth slowing and some countries having debt issues – although there are exceptions and these markets should not be viewed as a single block. More recently, economies that are exposed to oil have been starting to feel the influence of its price collapse as well.
In summary, while the US looks okay, Europe is flat with the UK hopefully continuing to be the exception, albeit perhaps with some bumps in the road ahead.
One such bump for the UK could be the forthcoming General Election, expected in May 2015. Investors have limited scope to prepare for factors arising from the election outcome and, whoever’s in power, you would hope and expect most of the macro decisions to be relatively similar. However, with this election there is a real chance of something that we haven’t seen in the UK for a generation which is a coalition involving more than two political parties – which presents the risk of compromised decision-making and ongoing political tension. This is a prospect which could cause a lot of uncertainty in terms of the potential impact on the bond market and on sterling.
With regard to equity returns overall, with 10-year bond yields somewhere below two percent and cash yields around one percent, we’ve got to be realistic about equities. Over the long term, the real return on equity markets has been four to five percent, which implies nominal returns of six to seven percent – and that’s the background scenario we are currently using when selecting stocks.
One sector that we have avoided for the last 12-18 months is food retailers as it became clear that a structural change was being driven by changing shopper behaviour. This has proved to be an important decision for fund performance as some stocks have dropped dramatically and, following that, we are now looking at the sector again very carefully.
The rapid decline in the oil price frankly has surprised us along with most other observers. It was trading at $110 to $115 in the summer and has been above $100 for a number of years and we’ve seen this big collapse down to sub-US$70 at one stage recently. In essence, moderating demand for oil has combined with continued strong supply and an absence of supply shocks which might have been anticipated from geopolitical factors in Russia/Ukraine and the Middle East. We remain very much of the view that the oil price should be higher than it is today, and whilst we can’t make a prediction over 6-12 months, in the medium term we should see a recovery in the oil price back above the cost of actually extracting it.
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