UK: Doomsters or optimists?

It is no surprise that in the UK the twists and turns of the Brexit saga have seen the equity market and sterling move in and out of panic mode, while GDP growth has struggled as the effects of Brexit stockpiling, apparent ahead of the original 29 March 2019 Brexit deadline, wore off and consumer sentiment dipped.

The cloud of pessimism created by a lack of clarity on the future of the UK’s relationship with the EU – be it a deal or no-deal – has been felt most keenly by the currency. The shock referendum result saw sterling fall 8% against the dollar and 6% against the euro (on 24 June 2016) and still almost three and half years later the currency remains 13% and 10% cheaper, respectively, than levels seen pre-referendum. 

In recent months the last-minute deal from Boris Johnson, followed by his subsequent defeats in the House of Commons and an eventual third extension to Article 50 until 31 January 2020 has seen sterling’s journey resemble that of a rollercoaster. 

However, following Mr Johnson’s crushing electoral defeat of Jeremy Corbyn – and the latter’s pledge to finally vacate the field of battle – sterling returned to the ascendancy hitting an 18-month high against the dollar.

Identifying opportunities

From an investor point of view, however, it hasn’t been all doom and gloom. Buoyed by the weakness of sterling, the UK stock market has performed better than perhaps some might have expected in the last few years, as a significant proportion of the FTSE 100 index benefits from overseas earnings. 

However, it is clear overseas investors have been shying away from UK equities. Since the referendum, they’ve withdrawn almost $30bn from UK funds with more than $4bn being pulled between Theresa May’s departure in July 2019 and the start of September 2019. The UK remains one of the most unloved and under-owned regions globally.

As a consequence of this pessimism, UK valuations are depressed, particularly in the more domestically focused names whose fortunes have been compounded by a weaker currency. But this is creating many interesting opportunities for active managers. It is no surprise that we have seen a flurry of bids for UK companies from foreign investors this year, highlighting the value that has been created, particularly if you can look beyond the near-term noise. 

From an income perspective, the UK equity market cannot be overlooked. With the FTSE All-Share index yielding around 4.5% it is attractive not only relative to other regions, but also relative to other asset classes. Roughly three-quarters of the UK market now yields more than 10-year UK gilts. 

In addition, while the larger companies that inhabit the FTSE 100 index have been the beneficiaries of a weaker sterling, investors should not overlook the smaller companies within the FTSE 250 index, which tend to be more niche and specialised in a way that can potentially offset wider economic uncertainties. Many of these businesses have seen marked de-ratings and as a result are trading on historically low valuations while also offering attractive and growing dividends. 

Predicting the future

Despite the recent election, there are potential challenges ahead that could make trying to predict what will unfold or even how markets will react, extremely difficult. Whilst ‘no deal’ risks have diminished in the near term, there are still a number of uncertainties. 

The focus will now fall on just how Mr Johnson goes about pushing his Brexit deal through considering that, once we leave the EU on 31 January, he’s still committed to leaving the single market and customs union by the end of 2020. This is a tearing hurry and likely to look a lot like a ‘hard Brexit’. However, having secured the biggest Tory majority since 1987, the hope is now that the Tories will be able to negotiate a better deal in Europe with Brussels welcoming the result as removing any further impediments to arriving at an accord.

In the near term, the reduction in political uncertainty should help boost growth but we need to watch developments over the next few months closely. A lot still needs to happen to “get Brexit done”. 

This is not the end, merely the end of the beginning as we move to the next phase; the economic impact of Brexit remains far from clear. As a result, a diversified approach to the UK market seems sensible. Exposure to international FTSE 100 companies alongside some attractively priced small and mid-cap companies with a more domestic focus, will allow a portfolio to adapt to whatever comes next in the UK. 

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