Lowes’ Milburn: ​Themes to watch for in 2014

Milburn Paul Lowes

2014 is being heralded as a year where investors should be “riding the bull”.

The strong performance of equity markets at the beginning of the year has buoyed up the optimism felt by investors. This alongside clear signs of the recovery of the UK economy signals particular themes that represent interesting opportunities for investors.

UK equities

The UK recovery is clearly underway and it looks like this year will be a good one for UK equities. Interest rates are not going to rise anytime soon, despite the better than expected fall in unemployment, but even if this was the case, quality companies should continue to perform well. What we need to see from UK corporates is profits driven by top-line growth, rather than cost-cutting, and reinvesting cash in the development of the business. We also expect more M&A activity this year, as businesses move to deploy their cash.

One area of the UK market which has done extremely well is UK Smaller Companies, which has led commentators to suggest that we could be near to the peak for this particular sector. However, we still think smaller companies funds could continue to show strong performance.

Cyclicals

On the subject of income, many of the valuations of the defensive stocks have been driven quite high by investors rushing for ‘safe haven’ stocks. However, now that risk-taking appears to have come back, the tide is turning and more cyclical names look set to perform well in a recovering global economy.

An improving global economy makes the valuations on which defensive stocks currently trade look quite expensive. Beverages and consumer discretionary are two examples. Also, regulatory and political pressures on more defensive sectors, such as tobacco and utilities, needs to be considered.

The move into cyclical stocks is being carried out by the Cazenove UK Opportunities fund. Manager Julie Dean’s top 10 stocks comprise of typical cyclical sectors such as industrials. Dean has a proven track record of selecting companies which are better positioned to benefit over the long term as market cycles change.

Property

Investing in property has been a difficult ride, as while the yield has been attractive, we have seen little or no capital growth from commercial property. However, there appears to be improving optimism in the commercial property sector, which is our preferred method for gaining exposure as this removes the equity market risk of investing in property shares.

One of our holdings in the UK, the Henderson UK Property Trust, has found that anticipation of rental growth in the market is mainly restricted at present to London and the south-east. The fund has 70.3 per cent (as of end of December 2013) of its exposure in the south-east.

Emerging market equities

Emerging market equities have had a difficult time over the last year. The Federal Reserve hinting of tapering in May was one of the factors influencing their poor performance, as those using ‘cheap’ dollars to invest in this sector reversed their decisions in anticipation of rising rates. However, with volatility, there is opportunity and valuations in emerging markets look relatively attractive compared to those of the other developed markets and to their own history. Two of our holdings in emerging markets are First State Emerging Global Markets Leaders fund and the Aberdeen Emerging Markets fund.

However, as these are soft-closed, all new money is now invested into Somerset Emerging Markets Dividend Growth fund. This fund invests in those companies paying a dividend which tend to be of greater quality than others in this area due to their increased transparency.

Frontier markets could outperform but this potentially comes at a greater risk due to the relative immaturity of the market and illiquidity. Stockpicking can therefore make a huge difference in emerging markets.

Paul Milburn is an investment analyst at Lowes Financial Management