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There’s no denying UK equities have been out of favour for more than two years. Indeed, since the Brexit referendum in June 2016, the outlook for shares of UK companies – and the country’s economic prospects in general – has seemed uncertain at best, and gloomy at worst.
Key data has been mixed: business confidence and investment have fallen back, but consumer spending and employment figures have been stronger than anticipated. Most notably, the nation’s gross domestic product (GDP) has managed to stay in the black, if just barely at times – but the fact is, that’s a far more positive scenario than many feared shortly after the Brexit referendum.
And with the fate of the final deal to leave the European Union (EU) still undecided at the time of writing, the Brexit story is far from over.
In the meantime, what has all of this uncertainty meant for shares of UK companies? A persistently negative view among investors has taken a toll on the prices of UK shares, and since the referendum, investors in UK equity funds have pulled about £780 billion from the market. While the international exposure of the companies listed on the FTSE 100 has meant they have fared relatively well, domestic shares have borne the brunt of investor pessimism. In fact, in April of 2018, a BoA/Merrill Lynch survey of global fund managers revealed that investors considered UK equities the least appealing of all asset classes.
There are myriad opinions about why UK equities have been out of fashion – and it’s not just down to Brexit uncertainty. The value of sterling, the escalation of trade wars, a global economic slowdown and less liquidity in markets have all contributed to UK equities’ lacklustre trading. The high-flying technology sector that has dominated in recent years is significantly under-represented in UK indices, while there’s an over-reliance on commodity sector earnings. Moreover, in an environment characterised in recent years by a higher appetite for risk, UK equities have not appeared as attractive as shares in Emerging Markets, the US or Asia, and have underperformed other developed markets for the past five years.
But is there a silver lining? After five years of underperformance, UK stock valuations are at levels last seen around the time of the global financial crisis. And among these are companies with attractive fundamentals and positive outlooks that are well positioned to withstand a global economic slowdown. By a number of measures, UK equities are increasingly looking temptingly low-priced.
Of course, the UK is unlikely to go unscathed in the event of a global market correction, and ongoing Brexit-related volatility seems probable in 2019. However, it’s worth remembering that relative to many other major market indices, the FTSE 100 Index has a higher percentage of defensive stocks. Historically, defensive sectors, such as consumer staples, tend to better weather economic downturns and are less sensitive to increasing interest rates. The companies represented in the FTSE 100 also have greater international presence, meaning the revenues they earn elsewhere are worth more during periods when sterling is weaker relative to other currencies. If ongoing Brexit negotiations cause the pound to lose value, FTSE 100 companies are well placed to benefit from the currency’s weakness.
In addition to the higher percentage of defensive stocks, the companies represented in the FTSE 100 Index include many high-quality, large-cap names that offer global diversification, reliable revenue streams and cashflow, and strong balance sheets.
Smaller UK companies may be more vulnerable to a global growth slowdown or market correction. However, a substantial number of these smaller UK companies have shown that they have the business models and healthy financial statements necessary to weather any short-term storms. In addition, many of these stocks have already priced in the possibility of a recession, Brexit-induced or otherwise, so their share prices look attractive.
Indeed, a number of analysts have pointed to the lower “multiples” of UK equities – a multiple is a way to measure a company’s price per share relative to its earnings, assets or cash flow, otherwise known as its valuation. It is our view as well that the valuations for UK equities are attractive in absolute terms and relative to other developed markets.
Perhaps just as importantly, the case for UK equities is not so much what they are, but what they are not. UK shares are not close to being as overvalued as US equities, at a time when pessimism about global economic prospects is rising. They have less exposure to mega-cap technology-related names such as the FAANG stocks (Facebook, Amazon, Apple, Netflix and Google’s parent company Alphabet), which worked against them in recent years, but could be seen as a positive now, given that the five companies collectively lost $1 trillion USD for the year ended 20 November 2018.
When compared to other developed markets, the UK has been perceived as offering a blander, less exciting assortment of stocks. But against an increasingly uncertain market and economic outlook – even beyond the Brexit issue – this long-undervalued asset class is starting to look much more interesting.
Investment markets and conditions can change rapidly and, as such, the views expressed in this update should not be taken as statements of fact nor be relied on when making investment decisions. Forecast are opinions only, cannot be guaranteed and should not be relied on when making investment decisions.