The 25 per cent gain in UK equities last year is unlikely to be sustained in 2017, argues Invesco Perpetual head of UK equities Mark Barnett, as he says sterling movements will remain the key area to watch this year.
Barnett, who has a long-term track record managing the £863m Invesco Perpetual UK Strategic Income fund, says the markets have had a “decent run”, but gains won’t be the same going forward.
He says: “Returns have been stronger than ever. There’s been an improvement in earnings, and there has been more optimism especially in the fourth quarter of 2016 and this year there’s also more optimism [among investors].
Despite rising markets, UK equity funds suffered £5.1bn outflows since January 2016 and £3.8bn since June, when the EU referendum took place. However, flows improved in the last two months of 2016 despite falling back into a negative place in January with £505m outflows, according to the Investment Association.
Barnett says despite 70 per cent of UK market earnings are in non paid in sterling, the UK currency is the key measure to look at for this year.
He says: “Given the sharp move in sterling of last year, it will continue to have a big impact in the direction of the market.
The fund manager says the influence of macro economic factors on UK equities has been “significant” over the past year, especially on the back of a worse outlook for fixed income.
Barnett says: “Gilt yields collapsed in 2016, and although it retraced in the second half of the year, it was a big driver of equity returns.”
Barnett says investors were optimists about reflation following the election of Donald Trump as well as some of his policies proposals.
However, he adds: “If [this level of returns] is sustainable? It fills up to events, but gains of the same order will be difficult to achieve in the coming months.”
Barnett says since the EU referendum he sold some of his international stocks and bought more into domestic businesses.
But despite not changing his investment approach, he argues stock selection might be challenging for investors because of a “very tight” sector correlation, but he sees more differentiation within stocks going forward.
For example, he takes the view of niche financial services firms in his portfolio, while maintaining the largest weighing in the oil sector, as he expects the oil price to increase from $50 to $70 a barrel on a one to three year period.
However, Barnett would give a “word of caution” to investors for the coming months. He says the fall in the S&P 500, which yesterday fell 1.4 per cent, looks like “another headwind” for equity return.
He says: “With a combination of high rates and high bond yields, if we make the assumption monetary policy has allowed equity to re-rate, the reverse might not be as good for equities.”
Barnett sits in third position as best fund manager for total return generation over the past 10 years, according to Hargreaves Lansdown. He returned 117.1 per cent over the past decade, and he is three positions ahead of his Invesco Perpetual predecessor Neil Woodford, who generated a return of 104.2 per cent for the same period.