World investment outlook 2017: UK

The World Investment Outlook is written by Russ Mould, AJ Bell Investment Director and contains a wealth of information on the world financial markets and events to help with your investment strategies in 2017.

Here he considers the outlook for the UK.

The UK is now in a post-referendum, pre-Brexit state of grace where initial panic is giving way to relief. Sterling is bearing the brunt of the uncertainty but also helping the UK to adapt and rebalance, even if this raises the risk of inflation.

The three key issues for 2017

  • Brexit and how quickly and smoothly Article 50 is implemented, to provide visibility on what it actually means
  • The dollar and whether the market will continue to prefer overseas earners to domestic plays
  • Oil prices and whether crude can help BP and Shell afford paying out a fifth of the UK’s cash dividend payments between them

Politics

The next General Election is not due until 7 May 2020, barring a vote of no confidence, but this date may be influencing Prime Minister Theresa May’s timetable for Brexit. Invoking Article 50 in spring 2017 would give her two years to unravel that Gordian knot and leave her with 12 months to then prepare for her first election fight as PM, which some say may be helped by that boundary review, which could eliminate up to 30 safe Labour seats.

Article 50 and the EU represent the new PM’s biggest foreign policy challenge, as she seeks to control immigration yet maintain the best possible trade relations and keep passporting rights into the economic bloc for the financial services industry.

Other issues in the PM’s in-tray will include managing the national debt, international relations with the US and China, education, the State of the Union and economic growth. It remains to be seen whether calls for more infrastructure spending and a kinder form of capitalism prompt the UK’s economy to hit top gear under the May-Hammond team.

Economics

No-one knows what Brexit will ultimately mean for the UK economy, although the International Monetary Fund is sticking to its view that the prevailing uncertainty over trade, immigration and foreign direct investment will lead to a (temporary) loss of momentum. After GDP growth of 1.8% in 2016, the IMF expects a further deceleration to 1.1% in 2017.

IMF expects annual UK GDP growth to slow further in 2017

IMF expects annual UK GDP growth to slow further in 2017

Source: International Monetary Fund

The pound’s post-referendum collapse suggests the markets are far from relaxed about the outlook, although the Bank of England did what it felt was necessary to steady the ship with August’s interest rate cut and reintroduction of quantitative easing. Sterling’s slide could even help Governor Mark Carney by boosting exports and boost competitiveness, in turn fuelling growth and stoking inflation.

Sterling fell hard and fast after the EU referendum result

Sterling fell hard and fast after the EU referendum result

Source: International Monetary Fund

For the moment, however, the UK economy appears to be hanging in on there, during this post-referendum, pre-Brexit period. Unemployment stands at an eight-year low, retail sales volumes grew at their fastest rate in 14 years in October and corporate confidence is bouncing back after the initial shock caused by the EU vote, if the purchasing managers’ indices are any guide. Any score here above 50 tends to speak of rising confidence and future growth, while any reading below it can warn of a slowdown or recession.

Corporate sentiment surveys are bouncing back

Corporate sentiment surveys are bouncing back

Source: CIPS/Markit, Thomson Reuters Datastream

Markets

While the post-referendum rally in stocks may seem odd, given the prevailing uncertainty, sterling’s weakness means this is largely a matter of elementary mathematics. Around 60% of the FTSE 100’s earnings are generated overseas and some 40% of its dividends are declared in dollars. Throw in a higher oil price, some improvement this year in copper, iron ore, coal and gold prices and the UK benchmark’s composition no longer looks such a handicap.

The biggest sector contributors for consensus forecasts for earnings, dividends, earnings growth and dividend growth can be seen in the table below:

Key sectors in the UK for 2017 are financials, oils and consumer staples

  FTSE 100 % of 2017E earnings   FTSE 100 % of 2017E dividends
Financials 24% Oil & Gas 23%
Consumer Staples 17% Financials 21%
Oil & Gas 15% Consumer Staples 15%
Consumer Discretionary 11% Health Care 10%
Industrial goods & services 8% Consumer Discretionary 9%
Health Care 8% Telecoms 7%
Mining 7% Industrial goods & services 6%
Telecoms 4% Utilities 5%
Utilities 4% Mining 3%
Real estate 1% Real estate 1%
Technology 0% Technology 0%
  FTSE 100 % of 2017E earnings growth FTSE 100 % of 2017E dividend growth
Oil & Gas 36% Financials 29%
Mining 24% Consumer Staples 24%
Financials 20% Consumer Discretionary 17%
Consumer Staples 5% Industrial goods & services 12%
Health Care 5% Mining 11%
Consumer Discretionary 5% Telecoms 4%
Telecoms 3% Utilities 3%
Industrial goods & services 3% Real estate 1%
Utilities 1% Technology 1%
Technology 0% Oil & Gas 0%
Real estate 0% Health Care 0%

Source: Digital Look, consensus analysts’ forecasts

That then raises the question of whether UK stocks are good value or not. One proven metric suggests the UK market remains cheap and while another implies the market could be expensive, relative to its history.

  • Market cap to GDP suggests the UK looks pricey, trading near the top of its historical range with a market cap that represents 120% of GDP. The good news is this can be justified, as UK corporate profits stand at a record high to GDP as well, so assuming they stay there (or go higher) the FTSE All-Share may not be riding for a fall. If profits slide, however, then there could be trouble ahead.

The UK looks expensive on a market-cap-to-GDP basis

The UK looks expensive on a market-cap-to-GDP basis

Source: Thomson Reuters Datastream/

  • Dividend yield. In a yield-starved world UK stocks look quite attractive, offering a prospective dividend yield for 2017 of around 3.6%. That handily beats cash and the benchmark 10-year Government bonds, or Gilts, where the yield rose to 1.4% in the autumn amid hopes for the return of inflationary growth.

That 2.2% gap between equity and Gilt yields remains historically high and could help support stocks – providing Gilt yields do not keep rising and companies do not cut their dividends in large numbers. Dividend cover for the FTSE 100 overall is thin at 1.6 times – a number nearer 2.0 times would be more comfortable.

The All-Share’s forecast dividend yield easily outstrips the 10-year Gilt yield

The All-Share’s forecast dividend yield easily outstrips the 10-year Gilt yield

Source: Thomson Reuters Datastream

That gap between equity and Gilt yields is historically high and could help support stocks, although risks remain, since Gilt yields could keep rising, while companies could cut their dividends if trading gets tougher. Dividend cover for the FTSE 100 overall is thin at 1.6 times – a number nearer 2.0 times would be more comfortable.

Top performing funds

Best performing UK equity income OEICs over the last five years

OEIC Fund size £m Annualised 5-yr performance 12-month Yield OCF Morningstar rating 
Miton UK Multi Cap Income Institutional B (Inc) 677.1 18.1% 4.36% 0.82% *****
Chelverton UK Equity Income B (Inc) 434.8 17.3% 5.18% 0.92% ****
Royal London UK Equity Income M 1,634.1 15.8% 4.04% 0.66% *****
Marlborough Multi Cap Income P (Inc) 1,446.2 15.8% 5.11% 0.80% ****
Schroder Income Z (Acc) 1,058.4 15.5% 4.00% 0.91% ****

Source: Morningstar, for UK Equity Income category.
Where more than one class of fund features only the best performer is listed.

Best performing UK equity income investment companies over the last five years

Investment company Mkt cap (£m) Annualised 5-yr performance*  Dividend Yield OCF**  Discount to NAV Gearing Morningstar rating
Chelverton Small Companies Dividend 32.5 23.3% 4.1% n/a -9.2% 0% ***
Diverse Income 347.1 18.6% 3.1% 1.18% -0.3% 0% *****
Finsbury Growth & Income 878.5 17.5% 2.1% 0.78% 0.8% 3% *****
Lowland 385.3 16.3% 3.1% 0.87% 0.6% 7% ***
British & American 21.3 15.4% 9.7% 3.28% 57.4% 106% *

Source: Morningstar, The Association of Investment Companies, for the UK Equity Income category.
* Share price. ** Includes performance fee

Best performing UK Large-Cap Blend Equity ETFs over the past five years

ETF Mkt cap (£m) Annualised 5-yr performance Dividend yield Total Expense Ratio Morningstar rating  Replication method
Lyxor UCITS ETF FTSE All-Share 12.3 9.93% n/a 0.40% *** Synthetic
db x-trackers FTSE All Share UCITS ETF (DR) 1D 77.3 9.85% 3.88% 0.40% *** Physical
Lyxor UCITS ETF FTSE 100 C-GBP 722.3 9.20% n/a 0.15% *** Synthetic
iShares Core FTSE 100 UCITS ETF (Dist) 4,128.1 9.14% 4.39% 0.07% *** Physical
db x-trackers FTSE 100 UCITS ETF (DR) Inc 1D 173.1 9.06% 3.00% 0.30% *** Physical

Source: Morningstar, for UK Large-Cap Blend Equity category.
Where more than one class of fund features only the best performer is listed.

Read more from our world investment outlook 2017 series:

World investment outlook 2017: USA