The major UK indices lagged those of rival overseas bourses though 2017, though the FTSE 350 still exited last year at a then record high of 4,277, an 8 per cent annual gain, and has continued rising through the early part of this year. Depending on how you measure these things, the ongoing advance in equities is now either the second- or fifth-longest on record, but it has been achieved concurrently with what’s been described as “the biggest monetary experiment in history”. By any measure, we’re in the late cycle stage of the bull market, the only question is how much longer is it sustainable? We might find out soon enough now the US Federal Reserve has started reducing its vast balance sheet built up in the aftermath of the global financial crisis.
Though rising valuations across the Atlantic are explicable in terms of the Trump administration’s tax reforms and infrastructure spending proposals (the latter measures have yet to receive Congressional ascent), investors’ weighting of equities to US government treasuries are at their highest level in several years. Yet bond yields have been creeping up in the US, as investors anticipate that the Trump stimulus will compel further policy tightening from the Federal Reserve later this year.
Nevertheless, investors have been benefitting from one of the strongest starts to a trading year in decades, ploughing further capital into risk assets. The trouble is any rise in interest rates, or even an acceptance that a certain amount of liquidity will be withdrawn from markets, would add to concerns over existing equity valuations, increasing the risk of a ‘technical’ sell-off. Of course, any pull-back in US equity prices has negative implications for domestic pricing.
The good news, at least in relative terms, is that the FTSE 350 has tended to trade in a narrower band than comparable indexes abroad, reducing the peak-to-trough effect when markets turn sour. So, last year’s relative underperformance means that UK equity valuations have become more attractive relative to those in the US and the major European markets, with certain sectors, most notably financials, looking good value on a standalone basis.
Of course, if you pursue the tried and tested strategy of simply staying invested, you will ride-out the coming correction with relative impunity. But there may be opportunities worth investigating on a sector-specific basis. As mentioned, UK financials fall within this category, perhaps even the benighted banking sector, whose travails have been endlessly documented since the collapse of Lehman Brothers. The UK domestic banks, though encumbered by tightening regulatory strictures, have significantly wound down their risk assets, switching the focus to driving improvements in the core businesses. So, if we’re entering a higher interest rate environment (by no means a given), with its attendant implications for banking profits, then this seminal driver of the UK economy could warrant renewed attention on the part of investors.
Another counter-intuitive opportunity that could be worth pursuing is oil equipment & services. A 17.9 per cent decline over the past 12-months hardly inspires confidence, but there are signs that the period of retrenchment in oil exploration budgets may have bottomed out at the very least.
Indices | 1-year % change |
FTSE 100 | 6.99 |
FTSE 250 | 13.86 |
FTSE All-Share | 8.34 |
FTSE Aim 100 | 30.21 |
FTSE Aim All-Share | 21.62 |
Reduced exploration and completion budgets have translated into lean times for the specialist businesses supporting the sector, some of which have been absorbed within larger engineering groups, or have exited the market altogether. Analysis from Wood Mackenzie suggests that global upstream capital spending will fall by 22 per cent to $740bn from 2015 through 2020 – the consequent loss in future barrelage will be keenly felt once the supply/demand dynamic starts to rebalance (there are already indications that OPEC spare capacity is in decline).
And as with banking, a rising interest rate environment could have beneficial effects for the wider oil & gas market by driving out marginal production. As central banks start to pull the reins on quantitative easing programmes, while tightening monetary policy, it’s possible that higher capital costs could drive up breakeven levels for producers, thereby reducing incentives for the new swing producers (North American shale), which would reduce the risk of the kind of supply glut that precipitated the collapse of prices in 2014. It should also be noted that Donald Trump is proposing the most aggressive offshore drilling plan in the US since the days of the Reagan Administration, so even with the range of government commitments to electric motoring in 2017, the oil market – and by extension, oil services – moves into 2018 in better shape than a year ago.
FTSE 350 | |
Sector performance | |
Industrial metals & mining | 90.1 |
Electronic & electrical equipment | 34.7 |
Auto & parts | 29.3 |
Industrial engineering | 23.8 |
Beverages | 23.8 |
Software & computer services | 20.4 |
Mining | 18.9 |
Life insurance | 18.8 |
Personal goods | 17.6 |
Real estate services | 17.5 |
Non-life insurance | 17.4 |
Financial services | 16.5 |
Chemicals | 16.3 |
Support services | 15.9 |
Travel & leisure | 14.6 |
Industrial transportation | 14.4 |
General industrials | 11.9 |
Banks | 11.3 |
Household goods & home construction | 10.3 |
Forestry & paper | 10.0 |
Aerospace & defence | 9.3 |
Oil & gas producers | 8.1 |
Real estate investment trusts | 8.1 |
Food producers | 7.6 |
Mobile telecommunications | 7.6 |
Food & drug retailers | 7.2 |
General retailers | 3.1 |
Tobacco | 3.0 |
Healthcare equipment & services | 0.4 |
Construction & materials | -2.0 |
Media | -5.3 |
Pharmaceuticals & biotechnology | -6.4 |
Electricity | -14.4 |
Gas, water & multiutilities | -16.5 |
Oil equipment & services | -17.9 |
Fixed-line telecoms | -29.0 |
For James Norrington's assessment of the Best of the FTSE350 and his latest portfolio selection from the index, click here.
For each sector review, click on the headlines below:
Banks set for further margin pressure
Financials under the regulatory cosh
Asset managers at risk of market correction
Life assurers strong on income
Rates set to harden as catastrophe claims rise
General retailers feel the burn
Food retailers ride the inflation wave
Navigating fickle consumer spending
Clothing chains face a difficult 2018
Beverage companies come to terms with sugar tax
Pubs and restaurants still face cost pressures
All eyes on tobacco regulation
Environmental issues to the fore in 2018 for packaging and paper sector
Sterling's loss is engineering's gain
Strategic defence imperatives and a more collaborative MOD
Brexit turbulence on route for airlines
Public transport franchises on the horizon
Consolidate the broadcasters and regulate the telcos
US tech continues to batter the might of the media
More consolidation in software and tech?
Despite strong data, electronics are pricey
Signs of solace beneath the scandal for oil equipment & services
Divestments and diversions in metals & mining
Mixed outlook for business services
Outsourcers braced for accounting change
Recovery in the air for industrial transporters
Big pharma braced for rocky year
Look overseas for healthcare opportunities
More clarity needed on post-EU chemicals regulation
Good opportunities still exist for real estate outside London
More of the same, but less of it for housebuilders
Builders' merchants face tougher trading
It will pay to be selective on Reits
Regulatory screws to tighten on utilities