The UK market has out-performed the rest of Europe during the past month. UK equities continue to gain support from the commodity-related sectors, and the latter have also supported the large cap segment relative to the FTSE 250 and the FTSE Smallcap. Looking ahead, we believe that the the market upside is likely to be capped in the short term.
Yet, we stress that the UK market looks cheap and we stick with our year-end target of 6900 for the FTSE 100. The market has de-rated in the recent sell-off and valuation multiples are now back to levels not seen since a year ago. Indeed, the UK market's low valuation is the chief factor making it attractive relative to other markets (a suggested Overweight) according to our models. Earnings momentum, for instance, is inferior to that of the rest of the pan-European market.
We maintain our Overweight on UK equities in a pan-European context, although we have trimmed our active weight this month as we believe the UK economy is among the most vulnerable given the higher cost of credit.
In terms of positioning, we continue to prefer large caps to small caps. This is in line with our preference for exposure towards economic growth in emerging markets, notably Asia. The FTSE 100 is likely to benefit from this given its large exposure to the Oil & Gas and Basic Resources sectors. In addition, as long as uncertainty prevails in the market, investors are likely to prefer large caps which are often perceived as being safer assets than small and mid caps. Hence, we think that the valuation premuim of the small and mid caps is unjustified.
Sectorwise, this month we are reducing exposure to Banks (to Underweight). In our view, Banks are likely to face the risk of earnings downgrades going forward. Our analysts are also negative towards UK banks, many of which could be vulnerable to the tight money market. We are halving our Underweight in Utilities and are also adding some weight to Personal & Household Goods, focusing on names with relatively less exposure to the UK. Utilities and Consumer Goods have improved on our models during the past month.
