Equity markets now face the threat of both rising inflation and slowing growth. Inflation will squeeze companies’ margins and raise logistics costs. Higher oil and food prices will threaten growth around the world. We recommend defensive, large-cap stocks with emerging market exposure and strong balance sheets. European mining and telco stocks are still good value; consumer staples and utilities look expensive.
Barclays Wealth, 28 July 2008
Barclays Wealth Research has just published the August edition of Signpost Equities. This is a new publication focusing on equity markets, particularly the UK and Europe. The first issue focuses on the problems posed by the recent rise in inflation around the globe, and how our analyst portfolios are positioned to take advantage of the current turbulence.
Earlier this month, Barclays Wealth cut its global growth forecast to just under 3% for 2009 and its overall overweight exposure to equities from 7% to 4%. Rising inflation is expected to be negative for equity markets overall. However, this is already reflected in valuations and we still expect equities to fare better than bonds. Some sectors of the market appear more able to cope with higher input prices than others.
Amanda Purton, Head of Equity Research, Barclays Wealth, said: "In the current turbulent markets, our recommendation to focus on large-cap, defensive stocks has worked well, as has our preference for companies with exposure to higher-growth emerging markets and strong balance sheets, and we will stick with this approach.
“The domestic economies of UK and Europe will slow this year. So, we prefer companies with emerging market exposure – for example, Standard Chartered and HSBC in the banking sector. In the UK, our large-cap bias leads us to overweight our analyst portfolio with FTSE100 companies at the expense of FTSE250 stocks. In the European analyst portfolio, we have an even more pronounced large-cap bias. We also recommend an underweight position in Spanish equities, in line with our strategic view that Spain’s economy faces a hard landing.
“Inflation is now causing more volatility in equity prices, but our defensive approach should help equity investors survive the storm. For example, food producers, food retailers, aerospace and defence firms and utilities are especially likely to suffer from margin squeezes caused by inflation. Furthermore, more cyclical areas, such as advertising and media, general retail and leisure are particularly vulnerable to a slowdown in the wider economy. We prefer mining stocks in the UK, and telecoms and general financials across Europe, where valuations are low and companies more able to cope with rising prices.”
Barclays Wealth has extended its momentum-based strategy models to equity sectors. The resulting portfolio performs well, but at the cost of high volatility. Some of the results oppose our current strategy, emphasising the difficulty of deciding whether to ‘go with the flow’ in a momentum-driven market or buy cheap for the long term. Investors with plenty of risk appetite are best going with the latter, but those of a more nervous disposition may prefer to put some more weight on a momentum-based strategy.
At a sector level, Barclays Wealth has a Strong Outperform rating on the materials sector in the UK. Mining valuations are still compelling with low double-digit PE multiples.
We also have a positive recommendation on telecoms (Strong Outperform in the UK and Moderate Outperform in Europe). The sector has relatively low exposure to cost push inflation, with only around 30% of its costs related to labour and energy.
Our other outperform sector is financials, with our Moderate Outperform rating on the banks sector. In the UK, we still recommend banks with an Asian bias, such as HSBC and Standard Chartered, but see upside on all stocks in the sector following the sharp recent underperformance.
In the oil & gas sector, the operating environment for oil majors will remain challenging. For structural reasons, we think a Neutral recommendation is sufficient – despite the boost provided by high oil prices.
The pharmaceuticals sector, while rated neutral due to long-term structural issues, also looks attractive as an inflation hedge. Consumer healthcare businesses stand to benefit from better pricing, while healthcare demand is not cyclical. So, it should be broadly immune from an economic slowdown.
Industrials is another neutral recommendation which could eventually benefit from rising inflation, if past cyclical patterns repeat themselves.
Finally, Barclays Wealth continues to carry underperform recommendations on consumer staples and utilities due to valuations looking expensive.
Download the full report:
Signpost Equities August 2008: Surviving the storm [PDF, 950 KB]
You will need Adobe Reader or similar installed on your computer to view the file.
For further information or a hard copy of the report contact:
Barclays Wealth
Nicola Hankey, Head of PR
020 7114 9813 / 07775 548418
nicola.hankey@barclayswealth.com
Jignasa Patel, PR Manager
020 7114 9813
jignasa.patel@barclayswealth.com
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