RLAM upbeat on UK equity market despite lowering earnings forecast

Royal London has scaled back its UK earnings forecast, following the BP oil spill, though it believes UK equities look attractive over the longer term.

Following its most recent quarterly forecast meeting, RLAM's equities team predicts UK corporate earnings will grow by 19% in 2010, down from 23%. For next year its prediction is 8%.

Head of equities Jane Coffey says the potential reduction in BP's earnings and dividends has had a big impact on its outlook for the UK.

"Our forecasts are based on a trade weighted index and BP represents a large part of that so we needed to pare back our forecasts," she says.

"Even with these changes, we are looking at a market which is trading at the low end of its price to book levels."

Coffey disagrees with the view the cut in BP's dividend means yield for the UK market is on a long-term decline.

"Even with historic dividend yields versus bond yields, over the longer term the UK equity market is still looking good," she says.

"The last time equities yielded more than the 10-year gilt was March 2009, but I would argue now that BP has temporarily suspended its dividend you would have to pretty bearish to believe dividends will not go up over time."

Royal London's equity team is also less confident about the prospect of rate rises this year, originally predicting the base rate to be at 2% by the end of 2010.

"Interest rates are much more likely to stay lower for longer than we originally thought," Coffey says.

"We think the Bank of England may just get in one rise of 0.5% this year."
Meanwhile Royal London remains most bullish on Europe, despite its ongoing difficulties.

"There are a lot of issues in Europe and we have revised down our GDP growth forecasts marginally," she says.

"However, the euro has fallen a lot which, from an earnings perspective, should really support countries like France and Germany."

Despite the problems surrounding sovereign debt in the eurozone, the group believes the single currency will survive.

"We are not predicting a catastrophic end; a breakdown in the euro," Coffey says.

"Greece and the other peripheral countries in Europe will be restricted over the next three years, but by that stage we are hoping that through the fiscal deficit trading they are doing now, they will be able to get by.

"Our central scenario is Europe will muddle through."

However, Coffey realises this thesis is not without risk and, consequently, Royal London's suite of equity funds are carrying a higher cash weighting than usual.

"The risk our prediction goes against us is now much higher than it was six months ago," she says.

"In the short term, we have more fears about which way markets are going so we are running a reasonably high cash position against our benchmark.

"We will be looking to put money back when the market is at its most bearish; when people are almost at the point of capitulation."

Coffey says the equity portfolios are generally positioned for rising markets.

In UK equities, Royal London is overweight mining, industrials and underweight banks. Its European portfolios are overweight financials and more economically sensitive areas of the market, and underweight defensives.