Citywire AAA-rated Chris St John (pictured) warns that following an extensive rerating, the market could be ‘vulnerable’ if earnings growth does not start to come through.
‘In the short term it’s difficult to know where valuations will go because they are driven by macroeconomic news flow,’ the AXA Framlington UK Mid Cap fund manager said.
‘What we have seen is a big rerating, so the price to earnings ratios have expanded. The question is, will the earnings come through?
‘As far as the stock market has been short term, people are focusing on companies making these numbers, and if they do not, the market looks vulnerable.’
But St John added that initial indicators ‘look quite promising’, with recent manufacturing data stronger than expected and a Bank of England report suggesting corporate liquidity is the highest in 50 years.
However, he has decreased his weighting towards housebuilders, one of the biggest beneficiaries of the improving economy.
This is partly because valuations are stretched following their rally, but also because capital is being restricted as the government seeks to ‘take the heat’ out of the housing market.
St John has sold out of Barratts, noting that it has become tougher to apply for a mortgage as the burden of proof has gone up, while the government’s Funding for Lending scheme has been scaled down.
Elsewhere, he has been unimpressed by the recent flurry of initial public offerings (IPOs), which he said were ‘overvalued.’
He refrained from taking part in the recent float of appliances website AO.com, which he said was a good business on too high a valuation, a problem ‘symptomatic of the IPO market’ as overseas buyers drove demand higher.
One IPO he did buy into was Poundland. St John had been impressed by chief executive Jim McCarthy’s previous work at T&S stores, and felt that it offered a very high return on capital.
And looking ahead, he thinks the outlook for IPOs is improving, as share prices fall.
‘I think in four to six weeks we will see more attractive IPOs. A lot have gone to a premium of their first trade and then gone to discounts, which encourages realism,’ he said.
In the three years to the end of March, the £72.8 million fund has returned 88.3%, compared with 59% for the FTSE 250 index. In one year it has returned 31%, compared with 22.1% for the index.