Which UK equity sectors are the winners and losers in an ultra-low interest rate environment?

By Tim Cockerill, Rowan Dartington, Gavin Haynes, Whitechurch Securities, Rob Gleeson, FE Research and Joe Walters, Royal London.

Money Marketing By Money Marketing on Sep 19, 2016 0 0

Tim Cockerill, investment director, Rowan Dartington

The Bank of England’s decision last week to leave interest rates unchanged was not a surprise, nor was its reiteration that they could go lower. In the wake of Brexit the BoE believes it needs to support the economy. As we have seen, sterling has fallen in value and the Bank’s action will keep it down. But sterling’s devaluation will cause a price spike and signs of this are already clear.

How this translates at the company level will depend a lot on where they source inputs from and where their end markets are. Currency devaluation is a double-edged sword. UK companies selling overseas have already benefited: overseas earnings have become more valuable and with the major uncertainty around the UK’s exit from the EU impacting domestic earners this pattern looks set to continue.

With this in mind, the winners should continue to be sectors such as technology, general industrials, pharmaceuticals and tobacco. The losers are banks, retailers and real estate but valuations will play a part and could upset the pattern.

From a market cap perspective, large-caps have more overseas earnings than small-caps, with mid-caps sitting between them. That said, company specifics are critical in this assessment.

Gavin Haynes, managing director, Whitechurch Securities

There are a number of sectors likely to be boosted by ongoing record low interest rates. Housebuilders will benefit from the increased availability of low cost borrowing for buyers and the extra spending power low rates provides will help consumer discretionary stocks.

The thirst for yield from those who can earn nothing from savings will also help boost demand for traditional dividend producing areas of the market, such as utilities, pharmaceuticals and property stocks.

On the other side of the coin, banks will remain under pressure as margins are squeezed in a low interest rate environment. Sterling is also likely to remain weak, which will be detrimental to retailers that rely on imports. Finally, it is bad news for some of the blue chip companies with large pension deficits due to the effect of ongoing low gilt yields.

Rob Gleeson, head of FE Research

I imagine the Bank of England’s interest rate cut from 0.5 per cent to 0.25 per cent last month was more of a signaling move than anything. The eurozone was close to collapse when European Central Bank president Mario Draghi said he would do “whatever it takes” and that reassured everybody. I assume this is BoE governor Mark Carney’s “whatever it takes” moment to boost the UK economy.

That said, the macro impact of the lower rates is quite minimal. They were effectively at the floor anyway. The limits of monetary policy do not go away; it has not solved anything.

I do not think much will change for asset classes either. There was not a lot of expectation for a rate rise priced into the market anyway, so it will not have come as a huge shock. Obviously, it reduces yields even further on assets such gilts, which would force any income investors left in them into equities. However, I think many already did the switch when rates were at 0.5 per cent.

The current rate and any further lowering will probably sustain the valuations we have at the moment. If you look at the past five years, equity markets have gone up quite a lot even though there has been no fundamental improvement in the underlying factors. This has all been due to central bank support. The fact the support has not been unwound is very positive for equity investors.

Joe Walters, manager of the Royal London UK Growth Trust

When assessing the impact of lower interest rates on stock selection it is important to consider the current economic climate. The Bank of England’s decision to reduce rates in August comes after years of sluggish growth, with pessimistic forecasts for the UK economy going forwards.

Firms that can compete globally and grow revenues against a backdrop of low inflation and anemic growth are set to benefit in this environment. The consumer staples giants meet these criteria, particularly firms whose products are household names. In particular, Reckitt Benckiser, with strong healthcare brands such as Nurofen and Strepsils, will benefit from global demand for its products.

By contrast, the impact of lower rates on bond yields has further skimmed margins for financial firms, which are facing intense competition, particularly in the banking sector. The recent cut further squeezed the level of interest rates banks can offer on deposits, with RBS even charging some corporate clients for holding cash. While there may be a contrarian opportunity for buying financial stocks, the outlook remains challenging as long as rates remain low.

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