Last week’s Lords vote highlighted how many uncertainties remain – yet Brexit fears may have created strong UK buying opportunities.
Barely a week goes by in which Brexit doesn’t loom large on the political agenda.
Yet with 11 months to go until the UK’s formal departure from the EU, much about the nature of that exit remains unclear. Just last week, the Lords voted through an amendment that adds to the pressure for Theresa May to consider keeping the UK in the customs union.
Major political uncertainties of this nature undoubtedly have the capacity to impact investor sentiment, particularly in the short term.
“The UK equity market was weak in the first three months of the year, dragged down by continued Brexit uncertainties and some signs that the outlook for UK growth has deteriorated somewhat,” said Nick Purves of RWC Partners, manager of the Equity Income fund. “A significant number of companies, and especially those most exposed to the UK consumer, have reported that trading conditions are also being adversely affected by the decline in real wages, which resulted from the Brexit-induced fall in sterling at the end of 2016 – but, of course, wage growth has ticked up significantly in recent months.”
Indeed, irrespective of any of the merits or drawbacks of Brexit itself, it is clear that some investors are unnerved; primarily by a perceived delay in policy decisions. On that score, the agreement of a transition period undoubtedly acted as a sop to markets – not least bond markets.
“Brexit negotiators agreeing to a transition period until the end of 2020 should be supportive of sterling and domestic credit over the medium term,” said Gary Kirk of TwentyFour, co-manager of the Diversified Bond and Strategic Income funds.
Moreover, although a perceived lag in policy making remains – and may even extend beyond Brexit issues – several fund managers believe that UK equities are undervalued relative to equities in other leading markets. Over time, they expect that disparity to close, as global investors catch up with the corporate reality on the ground.
“UK equities have the potential to close the underperformance and undervaluation that has accrued due to Brexit and politics,” says Adrian Frost of Artemis, manager of the UK & International Income fund. “Over time, worries over these areas may subside. In the meantime, we anticipate that the recent strong upturn in M&A activity will continue. In turn, this may cause the government to agonise further as to its attitude and policy towards such matters. Current policy resembles the Hampton Court Maze on a foggy day.”
Even allowing for any policy fuddle, UK markets have taken a significant hit in recent months. In the first three months of 2018, the S&P 500 fell around 2% and the MSCI Europe ex UK by 4%: the FTSE 100, however, dropped by 8%; although it has recovered more than half of that ground in April.1 Indeed, overseas investors started the year with their allocation to UK stocks at a three-decade low , while sterling struck a 31-year low against the dollar. In this correlated dip in UK asset prices, some managers see an opportunity.
“Financial markets had a strong start to 2018 but the UK remained out of favour,” said James de Uphaugh of Majedie, manager of the UK Growth fund . “Against a somewhat subdued macro backdrop, we see some very attractive opportunities in UK stocks – large, defensive companies, trading on historically low valuations, many of which are undergoing operational change.”
Indeed, corporate earnings in the UK have been strong in recent quarters – including over the first three months of 2018.2 This trend may also imply an underlying economy that is in relatively good shape, despite the dip in the rates of investment and growth seen since the referendum, and the slowing of the growth data in the first quarter of this year.3 Neil Woodford of Woodford Investment Management believes that both UK assets and the broader UK economy have been serially undervalued since the referendum. As a result, he believes opportunities are plentiful, so long as investors can show patience.
“We believe the market consensus is far too cautious about the outlook for the UK economy – the fund has increased its exposure to some very high-quality UK businesses, which trade on eye-catchingly low valuations, and where future growth expectations are too modest,” says Woodford, who manages the UK High Income fund. “These include Barratt Developments and RBS. New holdings that we’ve bought this year for similar reasons include Lloyds and Bovis Homes.”
Artemis, Majedie, TwentyFour, RWC Partners and Woodford Investment Managers are fund managers for St. James’s Place.
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