What will 2021 bring for investors? A Covid fightback and inflation 1

What will 2021 bring for investors? A Covid fightback and inflation

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UK markets have had a decent year yet enter 2022 still cheap and scorned by many investors.

It is widely noted by financial experts that, if no one else, foreign predators are very much alert to the value of homegrown firms.

We can therefore expect a further wave of takeover bids, even potentially raids on household names like BT and Sainsbury.

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Looking ahead: UK markets enter 2022 still cheap and under-appreciated by many investors

Looking ahead: UK markets enter 2022 still cheap and under-appreciated by many investors

The sudden arrival of Omicron means the world is still under the pall of Covid-19 at the turn of the year.

The successful vaccine roll-out puts the UK in a better position to battle the virus in 2022, but the threat from Omicron and perhaps further new variants means an end to the crisis remains out of sight.

Meanwhile, the pandemic fallout is very much with us in terms of supply chain disruption, inflationary pressure and the probable need for a series of interest rate rises.

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The impact of Brexit is still playing out as well. 

We round up views from investment pundits on where we are heading, and some share and fund tips for the coming year below.

What do investment experts predict for the UK in 2022? 

UK market still looks good value

‘The UK has had a V recovery,’ says Ben Yearsley, investment director at Shore Financial Planning.

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‘However the rebound slowed over the summer during the “pingdemic,” and Omicron will dent it further.’

Yearsley reckons the UK market still looks decent value relative to other markets.

‘Profits and dividends rebounded nicely in 2021. However, it is M&A [mergers and acquisitions] that is possibly the thing to watch for next year. 2021 has been one of the most active on record for takeovers of UK listed businesses.

‘Private equity and other overseas companies clearly see value in UK plc.’

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V-shaped recovery:  UK saw a bounce in the summer but igrowth will be faltering now as we face up to Omicron

V-shaped recovery:  UK saw a bounce in the summer but igrowth will be faltering now as we face up to Omicron

Yearsley wonders if there will be a big headline grabbing takeover next year, of the likes of BT, Sainsbury, or M&S.

‘They are the three that get talked about the most,’ he notes. ‘However could a leftfield takeover occur. Vodafone maybe or even the life companies that trade on low multiples and have high free cash flow.

‘Returning to the theme of profitability and dividends, there is still some post-Covid catch up going on so the outlook for next year should be good – special dividends are in vogue and the likes of Aviva will be paying large ones.

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‘You also have the oil sector generating huge levels of free cash flow, a large part of which will be returned via dividends (and buybacks).’

How did UK markets do in 2021? 

 

UK has plenty of firms that are resilient against inflation

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‘Investors need to be much more risk aware than they’ve needed to be over the last couple of years given rising borrowing costs, especially as valuations in parts of the market are stretched,’ says Jason Hollands, managing director of Bestinvest.

‘Growth sectors, such as technology and biotech, which have been the standout winners of the last decade, typically struggle in such an environment whereas the attractions of companies churning out solid profits today and reliable dividends become more apparent.

‘The UK market continues to trade at a significant discount to global equities overall – an opportunity not lost on international private equity firms who have been highly active bidders this year. I expect to see this continue in 2022.’

Hollands says that while UK market lacks major tech companies, what it does have in abundance is exposure to financials, industrials and commodities, which are the sorts of sectors that prove resilient in an inflationary environment and as interest rates rise.

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‘I therefore think investors who’ve ignored the UK in recent years, might want to take another look at the opportunities on their own doorstep, he adds.

Pandemic: Sudden arrival of Omicron means the world is still under the pall of Covid-19

Pandemic: Sudden arrival of Omicron means the world is still under the pall of Covid-19

Cheap UK valuations are ‘completely unwarranted’

‘UK shares remain cheap because of the perceived significant political and economic risks of Brexit, which continue to linger and depress the valuation of the UK stock market,’ says Sue Noffke, head of UK equities at Schroders.

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.’We believe the extent of the valuation discount is completely unwarranted. The ratings of all variety of UK-listed companies are being negatively impacted.

‘As a result UK-listed companies continue to be picked off by overseas private equity buyers and overseas industry peers are taking advantage of valuation differentials in a wave of merger and acquisition activity.

‘Somebody’s buying UK shares, it’s just not stock market investors at present.’

Noffke believes activist investors could help to prompt a reappraisal, as they target firms that already set out sensible and detailed improvement strategies long before the new-found attention.

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‘At risk of ceding control to activists, some of whose proposals appear of quite a short-term nature, boards may be catalysed to deliver on existing plans with even more urgency,’ she says.

‘In other cases, activist stakes are seen as the possible prelude for a bid.’  

Takeover wave: Foreign predators are very much alert to the value of homegrown firms

Takeover wave: Foreign predators are very much alert to the value of homegrown firms

Where will the FTSE 100 go in 2022?

Last year, Ben Yearsley of Shore Financial Planning said that the FTSE would end this year at 7,500.

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‘Until Omicron I was on course to at least get close and to be honest I’ll take a 2-3 per cent miss!’ he says now.

‘I am going to suggest a figure of 8,000 for the end of 2022 on the basis that UK profits are looking good (and profit growth should continue into next year), buybacks will remain strong, and that the energy crisis with the knock on impact on inflation and cost of living will abate.

‘As ever though take any FTSE prediction with a large pinch of salt.’

The Association of Investment Companies polled fund managers in November, and found half thought London’s top index would close between 7,500 and 8,000 at the end of next year.

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‘Only 5 per cent thought it would close below 7,000 and an optimistic 5 per cent predicted a close above 8,000,’ says the AIC. 

Shares to watch in 2022

Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, suggests the following shares are worth a look.

Anglo American  

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The firm sits in the big mining league, and as countries have started to reopen several key commodity prices have ballooned, says Streeter.

‘Rises in iron, rhodium and copper all fed into record profits at Anglo’s half year mark, and if they remain elevated in 2022, Anglo’s profits should reap the benefits.

‘But what goes up can come down, and we’ve already seen iron ore prices return to pre pandemic levels. In times of a severe downturn, the high fixed costs that help boost performance in the good times have the opposite effect and profits can fall faster than revenues.’

Streeter says having a diversified income stream helps in such a scenario, with profits less reliant on any one group of metals.

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Lloyds Banking Group 

‘Interest rates are expected to rise in the coming months, and as Lloyds relies on traditional lending more than other banks, rising interest rates would be better news than for those with more alternative sources of income,’ says Streeter.

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‘The group also has one of the UK’s largest bank branch networks, which is an opportunity for cost savings if it decides to close further branches, and an impressively low cost:income ratio, making it more resilient in tough times.’

Street says other cost savings are being achieved through increased digital services, while ‘spades of excess capital’, possible interest rate rises and growth opportunities are a tempting mix.

But she notes that if interest rates remain low, Lloyds could struggle to improve profitability.

Polar Capital Holdings 

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The fund management group is listed on the Alternative Investment Market, and at the end of September had £23.4billion of assets under management across 30 funds and three investment trusts, says Streeter.

‘The group’s particular expertise in technology and healthcare has served it well in recent years, as not only has tech as a sector performed well, but Polar’s funds have also outperformed.

‘Investing in Polar Capital is one way to participate in the tech boom, while reducing some of the stock-specific risks, although Polar’s heavy reliance on the sector means a change of sentiment or rising interest rates could be very painful.’

Smith & Nephew 

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‘The medical device maker has the potential to stage an impressive recovery in the year ahead,’ says Streeter.

‘All three of the group’s main segments – orthopaedics, sports medicine and wound management – were stymied by the pandemic as the number of elective surgeries fell sharply and long-term care facilities closed to new patients.

‘While it’s been hampered by supply chain issues, the picture is looking brighter now some of the problems have eased.

‘If the pandemic recedes in 2022, Smith & Nephew, with its new leaner cost base, should be able to capitalise from the backlog of elective surgeries postponed in 2020 flooding the market.’

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Streeter says the group has also got a relatively strong balance sheet, with net debt roughly two times last year’s cash profits, in case the group needs to weather another difficult year.

Tate & Lyle 

‘Last July the group announced plans to sell a controlling stake in its north and south American primary products business for £0.9billion,’ says Streeter.

‘This is easily the least profitable part of the business, with margins of 9.4 per cent compared to 18.3 per cent in food and beverage solutions and 36.8 per cent in Sucralose.

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‘The sale is expected to complete in early 2022, with management planning to return £500m as a special dividend, which would be on top of a dividend yield over the next 12 months of 4.4 per cent and a progressive dividend policy going forwards.’

She says the remainder of the money will be used to strengthen the balance sheet, leaving the group with minimal net debt.

‘Recovery stocks are risky – and this is no exception. However, following the disposal management should be firmly focused on the most attractive parts of the business and the strategy could deliver an appetising return.’

John Moore, senior investment manager at wealth manager Brewin Dolphin, suggests the following shares are worth considering for your portfolio next year.

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AstraZeneca 

The firm is recognised as one of the drug producers that made the most of its new-found importance during the Covid-19 pandemic, says Moore.

Yet he notes the business’s shares do not look overly expensive, trading on around 16.8-times forward earnings.

‘This doesn’t feel right for a company which will learn from the experience of the past two years and will be well placed to deal with the next development of its type.

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‘AstraZeneca has undertaken joint ventures and holds valuable intellectual property, giving it a reasonable moat over competitors as a drug discovery business.

‘With a dividend yield starting at around 2.5 per cent, and set to grow, AstraZeneca looks to be in a strong position regardless of what happens next with Covid-19.’

Smith & Nephew 

Moore joins Streeter in highlighting the recovery potential of the medical technology company, which he says has been hurt by the different variants of Covid-19, elective surgeries falling and supply chain shortages.

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‘It has been a difficult year or two for the business, but its long-term prospects look much better – the need for hips and knee replacements are unlikely to stop.

‘Smith & Nephew is a high-quality business trading on a valuation of 17.1-times earnings – it instinctively feels like an example of a stock that lends itself to the old Buffett-ism of “buying when others are fearful”.

‘Dividend growth from 80 cents per share to 95 cents next year is not an insignificant uplift and provide security for any short-term volatility in the share price.’

Prudential 

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‘The last year has underlined how tricky China can be as a direct investment proposition,’ says Moore.

‘But, Prudential, the savings and insurance group, provides an alternative way of gaining exposure to the country, along with Asia more generally, after its restructuring.

‘As these parts of the world become wealthier, more people will need the type of products that Prudential provides.

‘The company trades on a valuation of 15.3-times earnings and, although the dividend yield is relatively low at just shy of 1 per cent, it has room to grow as the business finds its feet in its new shape.’

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Barratt Developments 

This is fundamentally a play on future demand for homes in the UK, according to Moore.

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‘Barratt looks to be among the best placed of the major UK housebuilders, yet trades on just 9.6-times earnings and yields a dividend of 4 per cent, with cash left on the balance sheet to invest.

‘Part of the reason for the company’s relatively low valuation is concern that the housing market will turn.

‘Arguably that is already built into the price and, seemingly, whatever happens to house prices there appears to be strong underlying demand.’

Moore reckons Barratt has a ‘strong, positive sales trajectory’ which will support the business in the immediate term.

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Funds to watch in 2022

Jason Hollands, managing director of Bestinvest, tips:

Artemis UK Select (Ongoing charge: 0.91 per cent) 

‘The managers, Ed Leggett and Ambrose Faulks, target “undervalued growth companies” rather than cheap companies per se,’ says Hollands.

What is an ongoing charge? 

The ongoing charge is the investing industry’s standard measure of fund running costs.

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The bigger it is, the costlier the fund is to run, and for investors to buy and hold it.

He notes it is a multi-cap fund that invests across the UK market, with most of its holdings in larger companies and mid caps, 3 per cent in small caps and 3 per cent in cash. Some 34 per cent is in financial stocks.

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Fidelity Special Situations (Ongoing charge: 0.90 per cent) 

‘This is Fidelity’s flagship UK fund, managed by Alex Wright,’ says Hollands. ‘He is a contrarian who seeks to spot sound but out-of-favour companies trading at bargain prices with bounce back potential.

‘Wright invests in companies across the size spectrum.’

Hollands says more than three quarters of the fund is invested in UK equities, though can invest up to 20 per cent overseas (and it does).

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The fund has roughly equal proportions of large, mid and small cap firms, though the latter make up the biggest proportion of holdings.

Nearly half of of the fund is in cyclical stocks, which are more likely to benefit from an economic recovery.

Jupiter UK Special Situations (Ongoing charge: 0.70 per cent) 

‘Manager Ben Whitmore is a value investor, but crucially also incorporates a quality overlay into his process which helps avoid “value traps” of companies whose shares are cheap but deservedly so,’ says Hollands.

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‘Some 27 per cent of the fund is in smaller companies, 39 per cent in mid-caps and 32 per cent in larger companies. The main themes are consumer discretionary (21 per cent), financials (20 per cent) and industrials (15 per cent).’

Nick Wood, head of fund research at Quilter Cheviot, tips:

Finsbury Growth & Income (Ongoing charge: 0.62 per cent) 

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‘This investment trust managed by Nick Train has gone through a difficult period performance wise, making it an ideal entry point for investors,’ says Wood.

‘It is always best to buy a manager after a dip in performance if you think they still have skill, which Train clearly does if you look at his long-term record.’

Wood says the trust is invested in the UK which remains overlooked by international investors, and underlying holdings include global leaders like Diageo, Unilever and Burberry.

‘With inflation no longer looking transitory and prices likely to be reset at a higher level, these companies have pricing power potential. Coupled with the fact they are firms that you can be comfortable buying and holding, the trust looks attractive at its current price.

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‘With it also trading at a rare discount, we see 2022 being a much more positive year for the trust as the market environment evolves and the recovery continues apace.’

Ben Yearsley, investment director at Shore Financial Planning, tips:

JO Hambro UK Dynamic (Ongoing charge: 0.57 per cent) 

‘There are many factors at play making the UK an interesting market to watch again and I will stick with my suggestion from last year,’ says Yearsley.

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‘The fund has a mix of special situations and recovery plays and is likely to be a beneficiary of a recovering UK economy, increased dividends and buybacks and M&A.’

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