If the past 12 months have taught us anything, it’s that forecasting is hard. Particularly when someone writes down your predictions and revisits them a year later to show how well, or badly, they’ve fared.
This year seems doubly so, with many of the world’s biggest economies teetering on the brink of recession and central bank governors still fretting about inflation. The FactSet consensus view of economists is that the UK’s economy will shrink by 0.9 per cent this year.
In terms of interest rates, most analysts think the Bank of England’s policy rate will peak at 4.25 per cent over the summer, before easing to end the year at 4 per cent.
Such a scenario would be a boon for banks, said Roger Lee, head of UK equity strategy at Investec.
‘Goldilocks’ scenario?
Current consensus estimates are for Lloyds Banking Group (LLOY) to achieve a return on tangible equity (ROTE) of around 13 per cent for 2022, rising to 14 per cent this year. NatWest (NWG) ROTE is forecast to grow from just under 12 per cent to 15 per cent.
“When I started in this business 30-odd years ago, if a bank was delivering 15 per cent ROTE it would trade at 1.5 times book value.”
Yet Barclays (BARC), Lloyds and NatWest currently trade at below book value, which suggests the market expects a fairly severe recession, leading to sizeable loan book impairments, according to Lee. However, he said such fears are misplaced, given the continued strength of labour markets. In almost every recession since the second world war, unemployment rates have increased to around 6 per cent, he noted. The UK’s unemployment rate currently stands at 3.7 per cent and there are more than 1.1mn job vacancies, according to the Office for National Statistics.
A repricing should therefore occur if a recession proves to be mild. Barclays shares trade at about half of their book value and are Investec banking analyst Ian Gordon’s favoured tip.
Interest rates settling at around 4 per cent would also be good news for housebuilders, whose share price movements are closely (inversely) correlated with interest rate expectations, Lee added. A more optimistic economic outlook since the start of the year has tempered rate rise fears, leading to gains of 15 per cent or more in less than a month for the likes of Barratt Developments (BDEV), Redrow (RDW) and Vistry (VTY).
Broker Liberum’s outlook forecasts a 75 basis point fall in 10-year gilt yields (which ended last year at 3.7 per cent). It says every 100 basis point fall in gilt yields historically translates into a 9.4 per cent increase in the value of the FTSE 350, but this gain could be cancelled out by an anticipated average drop in earnings of about 28.5 per cent as recession hits. Miners, energy companies and Reits are expected to suffer the steepest earnings declines, meaning Liberum expects last year’s outperformance by large caps (the FTSE 100 generated a total return of 4.7 per cent, while the FTSE 250 returned a negative 17.4 per cent) to reverse.
Its analysts think the fall in yields will benefit consumer discretionary stocks the most, highlighting housebuilders, retailers and personal goods companies as the sectors set to outperform. Its individual picks include Card Factory (CARD) as a “deep value” play after it halved net debt, while SSP (SSP) has suffered because people fear its exposure to rail disruption, even though train station outlets comprise just 10 per cent of its revenue. The industrial action that has also hit Trainline (TRN) shares should prove to be a temporary phenomenon, it added.
A year of two halves
Berenberg analysts also expect small caps to outperform, although it prefers defensive and value stocks for the early part of the year, switching to recovery and growth stocks in the second half once earnings expectations have reset.
Tritax Eurobox (EBOX), Investec (INVP) and specialist lender OSB (OSB) are its favoured income plays, while builders’ merchant Grafton (GFTU), sausage maker Cranswick (CWK) and housebuilder Berkeley (BKG) are useful plays on the recovery of the UK economy, it said. Veterinary group CVS (CVSG) is the broker’s favoured growth play.
OSB also appears in RBC Capital Markets’ top 10 Europe-wide small and mid-cap picks, which otherwise leans towards energy and industrial stocks. Energy services group Hunting (HTG), IMI (IMI) and Coats (COA) are among its top choices.
Perhaps the best method for picking shares from recommendations, though, is to trust the wisdom of crowds.
A screen of the brokers’ price targets for the 400 biggest UK-listed companies reveals they are most bullish about a rebound for air services company Esken (ESKN), formerly known as the Stobart Group. Brokers’ consensus price targets suggest a 230 per cent upside for its beaten-down share price (although its losses are only forecast to get bigger). Other favourites include contractor Kier (KIE), gambling company 888 Holdings (888) and greetings cards maker Moonpig (MOON). By contrast, brokers are most bearish about German tour operator Tui (TUI) and Chilean copper miner Antofagasta (ANTO).
