UK equity managers have called for caution over the confidence being placed in UK companies with overseas earnings, with one investor suggesting a disconnect from fundamentals has made such stocks ripe for shorting.
Since the collapse in sterling, as accelerated by the Brexit vote, the fortunes of stocks that earn the bulk of their revenues overseas have switched places with their domestic-focused peers.
Between January 2015 and the referendum vote on June 23, domestic stocks in the FTSE 350 were up 1.1 per cent compared with a 1.6 per cent fall for overseas earners. However, as of October 10 this had reversed to a 6.1 per cent fall and a 4.2 per cent gain, respectively.
While a weaker sterling, which is down 16 per cent against the dollar year-to-date, will increase the fortunes of both dollar-earning and emerging market-focused stocks, UK equity investors have been criticised for focusing too heavily on this dynamic.
Chris Kinder, manager of the £850m Threadneedle UK Absolute Alpha fund, said he was now scanning through overseas earners while wearing his “shorting hat”.
The manager, who also runs the asset manager’s £1.9bn long-only UK fund, said while he accepted the merits of being in overseas-earning stocks in the past 18 months, the spike in valuations had left them vulnerable to downside risk.
Mr Kinder said: “Over the past 18 months or so we were more comfortable with the international earners. [But now] you have to be questioning them. They look rich on a price-earnings and historical basis and you would not normally deal on [these levels].
“With my short-selling hat on, the market has marked up overseas earners, and that is just too simple. It is a really interesting situation to the downside.”
The manager pointed to sectors such as pharmaceuticals and healthcare, typically home to dollar earners, and said the premium being placed on these companies by investors was now about twice the average seen over the past 15 years.
James Sullivan, investment director at multi-manager firm Coram, described the current disconnect between these overseas-earners’ share prices and earnings per share measurements as “remarkable”.
“We have looked at a number of metrics to try to explain, or perhaps understand current valuations, and it is proving to be difficult. The last time we saw fundamentals at current levels, the FTSE 100 stood close to 4,000.
“For the sake of the equity market, the decline of the pound has come at a fortuitous time, and we shall have to see whether it is weak enough to help support the apparent moribund state of the UK stock market,” he added.
Likewise, the punishment being given to domestic stocks has also been called into question. On a value basis, Mr Kinder strongly backed looking at beaten-up stocks focused on domestic earnings.
“When you see a capitulation of that kind of extremity on so little information, intuitively you have to go there,” he said.
However, not all were as concerned over valuation.
Jon Ingram, portfolio manager on the £172m JPMorgan UK Dynamic fund, disagreed and said the increase in valuation for overseas earners was justified given profits for this cohort are set to rise mechanically courtesy of the sterling effect.
“A lot of stocks have increased in line with how much their profits will.
“The areas that are overvalued were overvalued at the start of June [before the sterling collapse] and the increase since then is just in line with earnings. There are some big winners out of Brexit.”
