The outlook for UK investors continues to be highly uncertain. Brexit talks are now ongoing, and the weakness of the pound is perhaps the best evidence that the market is unsure about the future performance of the UK economy. Higher inflation and lower GDP growth appear to be likely features of the medium term. This makes defensive shares such as National Grid (LSE: NG) more attractive, while riskier recovery shares may prove to be less popular.
Defensive appeal
National Grid is one of the most defensive stocks in the FTSE 100. Its business model is exceptionally stable and resilient, with the transmission of electricity being a relatively dependable operation. This defensive appeal is likely to prove popular at a time when consumer spending is set to come under pressure. Inflation is now above the rate of wage growth, and this could mean that the profitability of a range of UK-focused shares is at risk. And since the Bank of England has downgraded the forecast growth rate for the wider economy, stocks with robust business models may become even more popular among investors.
Income potential
Higher inflation also means that dividends are likely to matter more to investors over the medium term. The continuing weakness of the pound is set to put further upward pressure on inflation, and a rate above and beyond 3% is now a very real possibility.
National Grid has a dividend yield of 4.7%, which is likely to remain positive in real terms even if inflation continues to move higher. Since its payouts are covered 1.4 times by profit, they have a high probability of at least matching the rate of inflation in future years. This should mean that the company’s investors will see their income return increase in real terms, which could boost the attraction of the stock. This could lead to a higher rating, with a price-to-earnings (P/E) ratio of 15.8 being relatively low for a utility stock.
Recovery prospects
While defensive shares may become more popular, recovery stocks such as Hunting (LSE: HTG) may become less so if investors adopt an increasingly risk-off attitude.
The international energy services group reported interim results on Thursday which showed it is making progress with its new strategy. For example, its revenue increased by 40% and it returned to an underlying profit after being lossmaking in the same period of the prior year. Furthermore, its order books across multiple divisions are showing growth, while the appointment of a new CEO could act as a positive catalyst on its share price. As such, it could deliver a rising share price in the long run.
However, with a forward P/E ratio of 25.9, a lack of a dividend and considerable risks ahead, Hunting does not seem to have the investment appeal of National Grid at the present time. The utility company appears to be a more likely stock to win favour among investors at a time when uncertainty and inflation are on the rise.
