Investing in large cap UK equities, such as the FTSE 100, also offers investors good exposure to faster growing emerging markets ? over 70pc of FTSE 100 earnings are from outside the UK. Energy and basic materials are two sectors which provide excellent global earnings exposure. Energy should continue to benefit from high oil prices and also offers a competitive dividend yield at nearly 4pc.
The sector has performed well recently (up over 15pc in the last 4 months) but it looks far from expensive ? the energy sector is still trading at a larger discount to the market than the average level of the last 15 years. Materials are a way of benefiting from the higher growth in the commodity- intensive emerging world. Earnings expectations for the sector are continuously upgraded and forecasts for this sector for 2011 remain strong.
For more defensively inclined investors, telecommunications will likely also perform well this year, while still offering a 5pc dividend yield. That compares favourably to both government and corporate bonds, especially when accounting for inflation at 4pc. Telecommunications? earnings expectations are undemanding and should remain well supported, especially as the sector?s margins are not sensitive to oil prices and tend to perform relatively well when interest rates are increasing.
Lastly, financials should not be overlooked by those investors willing to take additional risk. The sector faces varied headwinds (regulation, exposure to Ireland and peripheral Eurozone countries), but with banks trading at one times their book value, these risks are in the price. Additionally, banks are less affected by higher oil prices than most sectors and typically perform strongly when interest rates are rising.
Consumer sectors, such as retailers, are less likely to do well. Although employment is growing, it is unlikely to accelerate in the months ahead. Households seem likely to take the brunt of the fiscal tightening. Higher oil prices, higher VAT, lower benefits and wage growth at only 2pc despite inflation at 4pc will all squeeze household expenditure. Household spending won?t grow at the pre-crisis pace and consumer oriented businesses will suffer. We are already seeing that companies are finding it harder to pass higher input prices onto consumers.
For the UK equity investor there are risks ahead. But those willing to tough-out near term uncertainty should be rewarded (especially relative to bond investors) for the rest of the year by focusing on sectors exposed to higher emerging markets growth which are less oil and interest rate sensitive.
Bill O'Neill, chief investment officer at Merrill Lynch Wealth Management
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