UK equities set to shine in 2012 despite dull domestic economy

The UK’s combination of a business-orientated financial centre, stable government and a high level of overseas sales is the correct mix for carefully selected equity portfolios to thrive, writes Simon Brazier of Threadneedle Investments

The UK stock market has had to contend with a series of significant challenges over the past 12 months, from the earthquake, tsunami and nuclear emergency in Japan to social unrest in the Middle East, concerns about Chinese growth and the possible collapse of the eurozone. Against this difficult backdrop, the FTSE All Share has delivered a creditable performance.

This performance placed the UK second among the major markets last year, and can be attributed to a number of supportive factors. These factors are likely to remain in place throughout 2012, providing scope for healthy gains.

High-quality, defensive market

Successive UK governments have understood the importance of business to the UK’s prosperity. The current leadership has continued this trend by placing the corporate sector at the heart of its structural reform programme. The government’s dedication to supporting UK businesses was amply demonstrated by prime minister David Cameron’s recent veto of the EU’s intergovernmental accord.

During the past decade, low levels of corporation tax have encouraged high-quality, global businesses to locate in the UK.

These factors, together with London’s heritage as a global financial centre, have helped to create a broad, highly liquid market, characterised by strong management and good corporate governance, and featuring truly multinational corporations as well as small and medium-sized businesses.

The UK index offers significant exposure to defensive sectors, with oil and gas, healthcare, consumer goods, telecoms and utilities accounting for half of the market in capitalisation terms. This defensive nature stands the market in good stead during uncertain times.

Credit Suisse data shows the UK has historically outperformed other global markets when the ISM Index of economic activity falls below 50, a level typically associated with recession. The defensive profile of the UK market has undoubtedly been a key driver of its recent outperformance.

Access all areas

To sell the UK market merely as a defensive play does it an injustice. As greater numbers of multinational corporations have located to the UK, the earnings profile of the market has a greater international focus. Today, more than 75% of UK companies’ sales are derived from overseas, compared with 39% for Europe ex-UK, 33% for Japan and 29% for the US.

An insulated stock market

This profile partially insulates the UK stock market from the current tough domestic economic conditions and gives investors access to robust demand from fast-growing markets, such as China.