At the end of 1967 the government was forced to devalue the currency from $2.80 to $2.40. Britain was feeling frankly unloved by many Brits, as well as whole host of non-Brits. Sound familiar?
What we find interesting looking back through history is how often it is the times when nobody loves you and people are queueing up to explain why a given country is uninvestable, that it turns out ex post to have been a great buying opportunity. Furthermore, when a market has either fallen a long way or has been left behind, its ex ante downside risks are also often diminished on a relative basis.
Sentiment versus opportunity
Over the last decade we have periodically highlighted countries which seemed to be cheap on a relative basis – either to their own peer group or their own historical valuations. The counter argument usually takes the form of either ‘they are cheap for a reason’ or ‘but this time is different’. Well of course it is, otherwise, the reasons for them being discounted would cease to exist and the market would likely re-rate it through the uninhibited workings of the market.
Two of the equity market examples in the chart above – Brazil and Russia – are of course very different to the world, US and the UK, but the dynamics of market returns have commonality the world over.
Brazil and Russia have had long-running, complicated and often very negative political backdrops but investors are looking for opportunities to generate returns with their money, not make political statements. Russia is often perceived to be a one-trick investment pony: oil. It’s true, it has largely failed to diversify its investable base, and coupled with that, it has had a punitive sanction regime in place against it for nearly four years. It remains the only place where some managers have told us they are literally too scared to go to speak to companies. All in all, it would be fair to say, it’s not the ideal investing environment.
We have used extreme examples to demonstrate the difference between political and investor sentiment versus where the actual opportunities lie.
An unloved nation
So, back to the UK and a look back at history. Between the end of 1967 and the end of 1972, during a period where we were – to quote Frazer from Dad’s Army – “all doomed”, the UK stock market went up by approximately 80%. Throughout this period the UK backdrop was of terrorism, strikes and power cuts.
What followed in the UK was a darker period still in 1973, and 1974 was a terrible year for returns. However, for those brave enough to invest at the end of 1974, in the following year you made 140%, and if you didn’t sell at the bottom over a two-year period, you were still up overall for 1973-75.
With the current uncertainties around Brexit we are once again, largely, an unloved nation in investment terms. Fortunately, we have our own currency, and this has done much to cushion the blows in a post-Brexit vote world, and that is exactly what is supposed to happen.
Aside from all the politics and endless pontificating about the legitimacies of the vote, companies just want to get on with the day job. Many are, to varying degrees, required to position for the mind-numbing and continuing array of potential outcomes. This is where we must put our trust in the range of managers we use in the UK space, but it’s also another example of why we use multiple funds in each sector.
There is a temptation to time the market cap sectors, but this is not our forte and we prefer to leave the underlying decisions to a range of managers who have got most things right over the longer term. Some of these managers focus on a different investing style such as growth, value or blend and others have a very high quality bias.
None of these styles remain enduringly dominant but a style can stay in vogue for many years. This is why past performance data can be somewhat dangerous if the period being analysed had a predominant style, and that same style could become out of favour.
What is not priced in to UK stocks?
Many domestic facing stocks have struggled due to post-Brexit world expectations. Other stocks have been whipsawed by the currency swings. Further uncertainty is brought about by fears of an anti-business Corbyn government, with threats of nationalisations and heightened levels of general government interference. Paradoxically, one of our fears is one that is not priced in to UK stocks, and that is an existential crisis in the eurozone.
For the next recession the ECB has no ammunition; a new president, a weaker German leadership and budget proposals from the likes of Italy, France and Spain that nobody actually believes are credible. This is not good for anybody, but outside the eurozone itself, it could be particularly bad for the UK.
Whether it’s Brexit or Corbyn, or the frailties of the eurozone, the UK looks attractive to us because of all the reasons to avoid it, none are existential and the companies of Europe want to trade with the companies of the UK. It is very difficult to model the current environment, and always hard to model tenacity and a company’s ability to prevail despite the efforts of politicians and bureaucrats to thwart them.
Ultimately though, businesses will prevail. From an investing point of view, an attractive price entry point is a good place to start and for that you need to be relatively cheap and unloved, and we think the UK has just those characteristics.
Chris Metcalfe is investment director at Iboss Asset Management