EquitiesApr 7 2017

Citi: Brexit talks unlikely to rein in UK stocks

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Citi: Brexit talks unlikely to rein in UK stocks

Buoyant valuations and political uncertainty have not stopped strategists from predicting a major upside for UK equities in the coming months, with claims made that earnings upgrades and a persistent “yield gap” versus bonds could lift markets even higher. 

In a Citi Research note, strategists led by Jonathan Stubbs claimed that current high valuations and Brexit-induced uncertainty, symbolised by the triggering of Article 50 last week, were unlikely to prevent further rises. 

UK stocks have enjoyed considerable gains in the last year, with the large-cap FTSE 100 rising more than 25 per cent over a year, according to FE Analytics data. 

However, the authors of the note believe a sense of bullishness remains justified, stating that the index could reach a record level of 8,000 by mid-2018 driven by a combination of company fundamentals and other factors. 

The team suggested an improvement in the earnings outlook could help propel the market to these fresh highs. UK earnings per share (EPS) fell more between 2012 and 2016 than it did during the financial crash with signs of an improving environment, they claimed.

“There are clear signs of a return to EPS growth in the UK and globally in 2017,” the authors added. “This is driven by rising nominal GDP growth, a revival in commodities, improving bank profits and weaker sterling. Bottom-up EPS growth forecasts are around 25 per cent for 2017 and around 10 per cent for 2018.” 

Meanwhile, they believe a return to profit growth is “unlikely to be derailed” unless Brexit results in a domestic recession or sterling, which has been troubled over the last year, rallies very strongly. 

Another factor at play is the bond market, where gilt yields remain low. 

“There is still a yield gap between UK equities and UK gilts,” said the authors. 

“Our rates strategist sees UK 10-year gilt yields remaining capped at low levels by the combination of Brexit uncertainty and stable (for now) UK rates. This suggests ongoing upside for UK shares if growth is delivered.” 

Not all are likely to agree with such an outlook. Investment Association (IA) figures suggest that, as valuations remain high and politics stays on the agenda for UK companies, investors feel uncertain about the asset class. 

These concerns appear to become most prominent regarding UK equities.