UK equity markets experienced a volatile fourth quarter, amid concerns surrounding subprime-related losses, poor credit conditions and signs that economic growth, and crucially house prices, may be stalling. However, the stock market ended the three-month period approximately unchanged, while risk aversion caused large cap to outperform small.The fund underperformed its benchmark over the quarter. Stock selection and an overweight position in the nonlife insurance sector detracted most, including an overweight holding in Brit Insurance. The Lloyds of London insurer said the environment was challenging, and suffered from analyst downgrades.Overweight positions in the industrial engineering and household goods sectors also detracted. In contrast, an underweight position in the banks sector significantly boosted performance, including underweight holdings in HSBC, Barclays and Royal Bank of Scotland, as subprime-related losses weighed on the sector.
The UK market is attractively valued but question marks remain over the economic outlook.In recent months sterling has appreciated substantially against the US dollar (while recently falling against the euro), the US housing market related credit crunch has created stress in financial markets, and energy prices have marched inexorably higher.These factors suggest that UK growth will slow over the following months, and the Bank of England is likely to cut rates from their current 5.5% level in the near future. Crucially, however, the outlook for the UK is highly dependant on the US economy managing to avoid declining into recession.