UBS Wealth Management likes the look of the UK economy and expects that British firms’ share prices should perform relatively strongly this year, but for that reason is putting its faith in mid-caps rather than large-cap stocks as the latter tend to be dominated by firms earning revenues from abroad.

UBS Wealth Management likes the look of the UK economy and expects that British firms’ share prices should perform relatively strongly this year, but for that reason is putting its faith in mid-caps rather than large-cap stocks as the latter tend to be dominated by firms earning revenues from abroad.

The issue of how the FTSE 100 Index of blue-chip stocks tends to be “top-heavy” with international firms with relatively little dependence on the domestic economy was highlighted when the Swiss bank set out its investment stance for 2014 this week.

Although priced at a 10 per cent premium to its long-term average price-earnings ratio, at 15 times forward earnings, the FTSE 250 Index of mid-cap stocks looks a better way to play a UK domestic recovery story, Caroline Winckles, deputy head of the UK chief investment office research team, told journalists at a presentation in London.

The UK equity market in general is back to near long term valuation averages after a strong rally in 2013, driven in part by a re-rating of valuations, she said; further gains need to come from underlying earnings growth from companies.

“On the UK side, she said, we have a preference for the 250 index as it is a more domestic and more cyclical [indes],” she said, noting that a large share of mid-caps are in cyclical stocks (which typically outperform in an economic upswing).

Her colleague, Bill O’Neill, who leads the CIO team at the Swiss bank, said the overall economic backdrop for the UK was now “very positive”; improved credit market conditions, asset price growth and rising business investment pointed to an uptick in GDP growth this year. UBS forecasts that UK GDP will increase by 2.5 per cent in 2014 after logging a 1.9 per cent growth rate in 2013 (fully revised official data for the UK economy last year have yet to be released).

O’Neill said consumer price inflation in the UK is “off the radar” as a concern at present; there was still sufficient slack in the economy for the Bank of England to hold fire on any move to tighten monetary policy. UBS has also stated in its recent forecast report that fears of UK household indebtedness are exaggerated.

On the fixed income side, UBS expects 10-year government UK bonds, gilts, to have yields at around 3.3 per cent on a 12-month horizon; yields will rise as the UK economy continues to expand, bringing closer the point when the Bank of England changes from its current very accommodative monetary policy.

As far as the global economic environment is concerned, the outlook is for continued expansion in the US and some recovery in the eurozone, albeit with concerns about the plight of countries such as France, UBS says. In asset allocation terms, while UBS is positive on equities in general, it has a preference for developed markets, and those equities with a cyclical exposure within the DM space. As far as fixed income concerned, the bank prefers to hold select corporate bonds, rather than sovereign debt.