Trading Strategies: why stock market gains could be ahead

The stock market’s near-term prospects may seem to be rather downbeat. After all, inflation spiked by 90 basis points to 3.5% in April as the cost of housing and utilities rose at a faster pace.

This means that the prospect of further interest rate cuts over the coming months may appear to have diminished, given that inflation is now 150 basis points higher than the Bank of England’s 2% target and 10 basis points above the central bank’s April forecast.

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Separately, the Bank of England expects the economy’s 0.7% growth rate from the first quarter of the year, which was 60 basis points higher than the previous quarter’s expansion, to plummet to just 0.1% in the second quarter.

And with it being too soon to assess the full impact of increased employer national insurance contributions on the economy, as well as the potential for further global geopolitical risks caused by the imposition of tariffs on US imports, the short-term prospects for UK equities remain uncertain.

Long-term growth potential

On a long-term view, however, the FTSE 350 index could deliver attractive returns. The Bank of England expects the current spike in inflation to be only temporary and to ultimately give way to a persistent decline.

In fact, the central bank anticipates that the rate of price rises will peak at 3.7% in the third quarter of this year before falling to 2% by 2027, with inflation set to remain close to that figure thereafter.

This means the central bank may be able to justify a continuation of its programme to loosen monetary policy, even while inflation is significantly above its 2% target. This could provide a further boost to the economy’s performance and, in turn, to the operating conditions of those UK-listed equities that generate a sizeable proportion of their revenue domestically.

Furthermore, the prospect of a sustained period of modest inflation thereafter should allow for the continuation of an accommodative monetary policy over the coming years. This may have a further positive impact on equity markets over the long run.

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Additionally, the current cycle of monetary policy easing is still in its relative infancy. The first interest rate cut, for example, only took place in August last year, with the most recent reduction occurring earlier this month. This suggests that cuts to Bank Rate have not yet had their full impact on the economy due to the existence of time lags.

When combined with the prospect of a further loosening of monetary policy, investor sentiment towards FTSE 350 stocks could improve ahead of a perceived strengthening in the UK’s economic performance.

Low valuations

Companies that are relatively reliant on the UK economy’s growth rate could stand to benefit the most from its upbeat long-term prospects. Cyclical stocks have, of course, proved to be relatively unpopular over recent years due to the difficult operating conditions they have typically faced.

This means that, while not necessarily dirt cheap, they may currently trade below their intrinsic value when their long-term growth potential is taken into account. As a result, they could offer the potential for an upward rerating alongside the prospect of higher earnings that result from an improved operating environment. Together, this could lead to stronger share price performance.

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Clearly, the market valuations of cyclical stocks could become increasingly volatile in the short run, as investors react to a period of rising inflation and a potential slump in GDP growth during the second quarter. But on a long-term view, those companies that have a solid financial position and a clear competitive advantage could overcome short-term difficulties to deliver worthwhile capital gains as the economy’s performance gradually improves.

Strong performance

Source: ShareScope on 23 May 2025. Past performance is not a guide to future performance.

For example, FTSE 100 member Sage Group (The) (LSE:SGE) appears to offer an upbeat long-term outlook. The technology company, which provides payroll, accounting and HR services to small and medium-sized businesses, recently released half-year results that showed it is performing relatively well.

Revenue rose by 9%, with operating profits up 16% because of a 1.4 percentage point increase in the company’s profit margin. It was boosted by disciplined cost management and now stands at 23.2%. This indicates that the company has an improving competitive position, with it expecting to deliver a further increase in profit margins in future.

For the full year, the firm remains on track to post organic revenue growth of at least 9%. Although its business model is inherently cyclical – because it’s reliant on price rises and new product sales to companies whose financial performance is typically heavily influenced by the economy’s growth rate - a reliance on recurring revenue provides a degree of stability.

Indeed, around 97% of Sage’s revenue is recurring. Alongside this, a net debt-to-equity ratio of 68%, as well as net interest cover in excess of 17 in its latest full year, highlight its solid financial position. This allowed the firm to extend its £400 million share buyback programme, which is largely complete, by up to a further £200 million. This could provide further support to its stock price over the near term.

Sound finances also mean the company has the capacity to invest in new products, including those which utilise artificial intelligence (AI). Additionally, it provides scope for further acquisitions to complement its brisk organic growth rate following the purchase of several businesses in its latest financial year.

A fair valuation?

Sage generated around 22% of its revenue in the UK and Ireland last year. It also has significant exposure to the US and Europe, with them contributing 39% and 26% of revenue, respectively.

Although inflation in the US and in the eurozone has proved to be sticky and is currently above central bank targets, interest rate cuts implemented over the past year in both geographic areas are yet to have their full impact on economic growth due to the existence of time lags. And with inflation likely to moderate over the medium term, the prospect of further monetary policy easing in both regions could have a positive impact on economic growth and the operating environment of Sage’s customers.

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Clearly, it could be argued that the company’s market valuation factors in its upbeat long-term outlook. The stock currently trades on a price/earnings (PE) ratio of 32.5. While this is undoubtedly significantly higher than the earnings multiples of many FTSE 350 shares, the stock had a PE ratio of 32 when it was first discussed in this column during October last year. Since then, it has posted a 22% capital gain. This is 16 percentage points ahead of the FTSE 100’s rise over the same period.

In the long run, the company seems to be well placed to post further profit growth that translates into share price gains. It has a strong competitive position, sound finances through which to invest for growth, and is likely to experience an improved operating environment.

Therefore, despite facing an uncertain near-term future as sticky inflation and its potential impact on interest rates and economic growth weighs to some extent on investor sentiment, the firm’s long-term prospects appear to be sound.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.