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28 September 2011: SH: UK equities: volatility is an opportunity

Strong balance sheets and cheap valuations provide capital protection and significant potential upside.

Kevin Murphy; Nick Kirrage; (Specialist Value UK Equity Fund managers)

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    Fuelled by dispiriting news from both sides of the Atlantic, equities have fallen significantly in recent months. A number of leading short-term macro-economic indicators, on which the market places great significance, have begun to weaken – leading to fears that the economy will slide back into recession.

    Given the global profit cycle is being driven by many diverse factors, forecasting the shape of the current recovery is exceptionally difficult. As long-term investors, we have learned that trying to second guess short-term trends, and using these to position portfolios, seldom delivers returns. Instead, we try to stand back from the market and attempt to identify long-term trends that we can use to create long-term value: placing emphasis on cash-generative businesses with robust balance sheets, strong management teams, and cheap valuations.

    The impact of falling markets on business and consumer confidence is not to be ignored, but equally neither is the significant improvement in corporate health. Many businesses have cut costs, improved cash generation, repaired their balance sheets, and are delivering robust profits, leaving them in far better financial shape than they were in three years ago. This financial strength provides a ‘margin of safety’, enabling companies to weather tough trading conditions without permanent losses of value. The economic outlook is cloudy at best –  and poor at worst – yet valuations in many parts of the market now discount much of the bad news. In aggregate terms, the valuation of UK equities appears to offer reasonable, if unexceptional, future returns from today’s levels. However, this hides certain stocks and sectors with securely financed balance sheets, offering reasonable growth and rising dividends that trade at extremely attractive prices.

    Historically, profit cycles have proved to be an extended phenomenon. However they can be uneven, with profits slipping back before they resume their improving trend. We remain convinced that many domestic companies will be able to achieve significantly higher profit levels in the coming years, and that current share price pressures present an opportunity rather than a risk.


    Important Information:

    The views and opinions contained herein are those of Azad Zangana, European economist, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. For professional investors and advisers only. This document is not suitable for retail clients. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Schroders has expressed its own views and opinions in this document and these may change. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA, which is authorised and regulated by the Financial Services Authority. For your security, communications may be taped or monitored.

     Source: IFAWorld – Schroders

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