After the market volatility of 2018, the outlook for 2019 offers UK investors an equally challenging cocktail of economic, political and market uncertainty.
On top of tariffs and trade wars, heightened debt levels, a weakening global growth outlook, and a shift in central bank policy towards interest rate ‘normalisation’ and liquidity withdrawal, Brexit related issues are also likely to intensify as the March 29 Article 50 deadline looms.
The outcome is almost as hard to predict now as it was over two and a half years ago at the time of the vote.
What is easier to predict, however, irrespective of the path eventually chosen, is continued political infighting, and subdued business investment resulting from the ongoing uncertainty.
Growth in quant-based trading strategies and electronic trading platforms, together with associated crowded trades in illiquid stocks, have all contributed to recent spikes in volatility.Together with a weak indebted consumer, and as evidenced in recent Office for Budget Responsibility forecasts, the outlook for domestic growth remains challenged.
Nonetheless, we believe opportunities still exist for UK equity investors. As long as one is careful with stock selection, and risk is appropriately managed through diversification, there are still grounds for optimism.
Although higher than long-term averages in absolute terms, UK equity valuations are at their deepest discount relative to global equities since 1990, and the FTSE All Share dividend yield, at over 4.5 per cent, is at its highest level since the global financial crisis.
Elsewhere, the FTSE 250 index of mid-sized companies, having fallen significantly since its peak in June 2018, is now pricing in a lot of the bad news associated with the UK economic and political environment.
For small and medium-sized companies with proven business models and strong financial models, current valuations are starting to present some increasingly attractive entry points on a long-term view.
With nearly 70 per cent of revenues sourced from overseas, the UK market is also relatively resilient to domestic pressures.
There are a number of large, liquid, high quality multinational companies in the UK, with globally diversified revenue streams, sustainable business and financial models, structural cash flow and dividend growth drivers, strong balance sheets, and relatively low sensitivity to the economic and market cycle.
Many of these companies also pay dividends in non-sterling currencies, providing further protection against potential sterling volatility. These businesses should be well placed for challenging times ahead.
Finally, growth in quant-based trading strategies and electronic trading platforms, together with associated crowded trades in illiquid stocks, have all contributed to recent spikes in volatility.
However, this can create significant market inefficiencies that, in turn, can be exploited by active stock pickers for longer term gain.
What really matters to long-term wealth creation is a company’s intrinsic value and the durability of its competitive advantage. If there is conviction in these things and therefore a company’s long-term worth, short-term market volatility simply creates a better price to take advantage of the same long-term fundamental opportunity.
Overall, in spite of undoubted challenges and uncertainty ahead, we believe a diversified portfolio with a bias towards high-quality, global cash-generative businesses, that have structural growth opportunities and strong balance sheets, can still do well from here.
As highlighted earlier, however, careful stock selection, a long-term mindset, and a focus on valuation will be required.
Simon Brazier is portfolio manager of the Investec UK Alpha fund
