Monthly Market Report - January 2015

22nd December 2014

With commentary from David Stevenson

As we draw towards the end of the year its worth contemplating why the UK equity market is so thoroughly miserable. The UK economy is looking to be in good shape but UK equities have consistent under performed their US peers - a subject we examine in another section.

Part of this relative under performance can be attributed to the UK market's focus on cyclical resource stocks, with the dropping oil price a major driver of share price declines. Again we examine this theme below.

But I also think that many foresight investors have held back from investing in UK stocks - probably decent value when compared to US equities - because they are worried about political risk. Put simply the UK General Election in May 2015 has the potential to create significant uncertainty, which may last for many years all the way through to an EU referendum in 2017.

This potential politically-induced uncertainty isn't reflected though in FTSE 100 volatility measures. A recent note from options analysts at SG observed that UK equities weren't pricing in this risk. The French bank's analysts observe that: "Volatility stands only slightly above its long-term lows (6-month ATM volatility at 13.2% is on its 21% tile over five years) and skew is mid-range (6M 90%-110% at 6.1pt vs 6.9pt on average over 5 years), lower than on the S&P 500 but still steeper than for many other markets. Moreover, term structure shows no abnormal spike between March 2015 and June 2015 that could indicate that election risk is taken into account."

Cut through all the derivatives based jargon, and I think there's a very explicitly warning here for investors - UK equities may be cheap relative to US shares but collectively we're too complacent about the risks of coalition haggling, yawning public sector deficits and the possibility of the UK leaving the EU.

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