Despite economic and geopolitical uncertainty, there is a case for the UK equity market becoming an attractive hunting ground for investors in 2023.
Alex Wright, portfolio manager of the £2.8bn Fidelity Special Situations Fund and the £909m Fidelity Special Values PLC outlines his outlook for UK equities in 2023:
“There is clearly a lot of economic and geopolitical uncertainty globally, as economies are grappling with levels of inflation not seen for several decades. Most indicators point to a slowdown or recession, particularly for the consumer as inflation and rising interest rates take their toll.
“Whilst this sounds relatively bleak, many of the most affected areas of the market have sold off heavily and some stocks are starting to look interesting. In the past, periods of extreme uncertainty have turned out to be great buying opportunities that have allowed us to pick up stock specific stories that had been overlooked in the general panic.
“After years of being relatively unloved, the UK market started 2022 looking like good value, and now looks even cheaper. While the near-term outlook is uncertain, these valuation levels and the large divergence in performance between different parts of the market create good opportunities for attractive returns from UK stocks in the next three to five years.
“In our opinion, the UK market with its higher dividends offers a better prospective return than many other asset classes, including global equities.
Positioning for what lies ahead in 2023
“Many businesses and investors have yet to adjust to the new reality of higher interest rates and bond yields. Whilst some market commentators think this higher cost of finance will fade away, we are more sceptical. The current market environment of higher rates and stickier inflation is more representative of the longer-term pattern seen prior to the Global Financial Crisis.
“A rising rate environment has the potential to be transformational for banks, and indeed, profits for banks such as NatWest could double next year, which is a compelling story in an environment where markets are seeing earnings downgrades and fears of more.
“The backdrop is also positive for life insurers, whose earnings have proved resilient during the pandemic and should benefit from an acceleration in the pace of pension fund re-risking.
“Companies that can hold up well in a recessionary environment should prove good investments. The likes of government outsourcing business Serco or tobacco firm Imperial Brands, two of our largest holdings, should be relatively unaffected by an economic downturn.
“Conversely, we are wary of highly leveraged companies, and have negligible exposure to real estate and limited exposure to utilities. We have also meaningfully trimmed our UK housing exposure on concerns momentum in the residential market will slow and consumer facing stocks given the cost-of-living crisis.
“Over the past decade, there have been similar periods of heightened uncertainty such as around Brexit, the election of Donald Trump and the Covid pandemic. It is environments like these that throw up the best investment opportunities as market participants get overly preoccupied by anticipated headwinds. So, we aim to stay agile and will continue to be on the lookout for new opportunities. Gearing in the portfolio remains low, leaving us with plenty of dry powder to reinvest should opportunities arise.”
To read Fidelity International’s full Investment Outlook for 2023, please click here.