This week Morningstar.co.uk is bringing you simple solutions from the experts about where you should put your money and why.
Bond-like equities are “deeply dangerous” according to revered UK equity income investor Clive Beagles. The JO Hambro Capital Management fund manager warned at the Morningstar Investment Conference in London that for too long investors had sought out bond-proxy stocks, pushing up their value and creating a bubble within the market.
“In 2014 the best performing UK stocks were those which offered a steady stream of income but no share price growth. Defensive stocks such as healthcare companies, real estate businesses and tobacco giants,” he said. “The worst performing stocks last year were cyclicals – such as commodity companies and industrials.”
As a result these unloved equities are now cheap compared to historical values and the defensive sectors are at high premiums.
Despite the FTSE 100 breaking through its historic high and reaching the much sought after 7000 mark in March, Beagles called the current stock market high the “least euphoric” he has known. He says this is because the rally has been driven by demand for defensive stocks rather than the economic recovery.
Interest Rates Will Rise and Stocks Will Fall
When Mark Carney was first appointed as governor of the Bank of England he laid out forward guidance plans which would help borrowers and lenders predict when interest rates would rise. Although these plans were subsequently abandoned when Britain’s unemployment rate dropped at a significantly quicker rate than expected, the barometers dictated by Carney back in the summer of 2013 still have weight.
Used as a general guide the dual indicators of unemployment and inflation both now support an interest rate rise. Employment is at never-before-seen levels, and while headline inflation looks low, pushed down by falling oil and food prices, wage inflation is predicted to be 3% for 2015.
When rates rise Beagles suggests there will be a fall out in equity markets – with bond-like equities behaving just like their lookalikes and falling in value. The undervalued, cyclical stocks will then be the better place to be.
Four Areas for Undervalued Income
One of the sectors poised to benefit from higher wages is domestically focused stocks – but some of these companies already have this priced in. Beagles is steering clear of hotel company Whitbread (WTB) and retailer Next (NXT) for these reasons, but likes construction companies, advertising and even tips the down-trodden food retailers.
The fund manager also drew attention the “extraordinary value” to be found in small caps.
“A lot of investors have been forced to move up the risk curve because of the yield drought – but those coming to equities for the first time have gone into larger companies – FTSE 100 ETFs for example,” he said. “As a result my fund’s small cap weighting is the highest it has ever been.”
Continuing the contrarian theme, Beagles likes commodity stocks which have taken a bashing over the past year as the oil price has halved. Morningstar equity analysts also consider the sector to be undervalued at present – they have awarded BHP Billiton (BLT) a four star rating, meaning they consider it to be trading at less than its current fair value estimate.
Perhaps his most controversial tip however is UK banks. After avoiding them for more than five years, Beagles says that it is time to reconsider the high street lenders. He points to Lloyds (LLOY) which recently confirmed it would be reinstating its dividend, and expects that other banks are not too far behind.
