UK equity funds continued to take the strain of poor macro news as fund flows remained negative and investors looked elsewhere for more positive momentum. For the second month in a row domestic inflation numbers surprised on the upside with the services sector and rising wages being the main culprit. Commentators now appear fixated about how high UK interest rates will have to go before authorities can get on top of the inflation problem and estimates as high as six and a half percent are being talked about. This is a significant step up from the expectations just a few months ago and is the root cause of the current ‘risk off’ attitude towards domestic equities. We believe and history suggests that it can take up to eighteen months for the full effects of interest rate rises to be reflected in inflation numbers and our worry is that there is a fine line between controlling inflation on the one hand and overly tightening and tipping the economy into recession on the other. In the meantime there are some parts of the economy such as housing that will feel the full force of rate rises almost immediately as mortgage rates rise and buyers become more cautious. Not surprisingly Mortgage Advice Bureau, Marshalls, Crest Nicholson and Bellway were amongst our worst performers over the month. At current prices, we believe all of them represent very good value over the medium term.
Despite the travails of the economy investors can glean some comfort from a cross selection of bottom-up news within our portfolio. Morgan Sindall issued a very positive trading update leading to high single digit earnings upgrades as profits are expected to be above previous estimates. The continued strong performance of fit-out was a major positive. Despite the much vaunted trend to working from home office fit out continues to be in high demand as space needs to be reconfigured to adapt to new working practices. Telecom Plus and XPS released good results, as did Severfield where their JV in India is making good progress. Ocean Wilsons responded to press speculation and announced a strategic review of their Wilson Sons business, the largest integrated port and logistics operator in the Brazilian market which may ultimately release value for shareholders. Whilst the negative view of the UK prevails company share prices are not being rewarded for good news. We look forward to the start of a period of falling inflation which should go some way to rectifying this.