Political and economic uncertainty has been driving volatility on a global scale and nowhere more than the UK where both international and domestic investors have been fleeing in their droves as Brexit and government in-fighting has heightened fear even further.
According to December’s Bank of America Merrill Lynch fund manager survey, a well-regarded barometer for global sentiment, investors are net 39% underweight the UK, down 12 percentage points from November. This is the second-largest underweight on record.
Added to this is the return of global volatility, sparked in October by fears of Federal Reserve hiking and trade conflict between the US and China. So-called Red October saw the S&P 500 sink nearly 7%, its worst monthly performance since September 2011, while many markets in Europe and Asia fared even worse.
Banks could return to favour
Despite this backdrop, Merian Global Investors chief executive Richard Buxton (pictured) is optimistic on the UK, arguing British companies are in “pretty good shape” and not expensive.
“They are trading on around 14 times earnings, near the 40-year average, so not expensive,” he says. “I expect the UK economy is going to gently accelerate into 2019. There is a very strong labour market, and the chancellor is prepared to increase public spending.”
He also says overseas companies’ negative sentiment could be turning given some of them are seeing value in UK companies. “We’re not the only ones who see good value,” he says. “Overseas corporations continue to buy UK companies, or parts of them, as we saw with Coca-Cola buying Whitbread’s coffee business.”
Buxton also expects banks to return to favour on the back of rising interest rates and higher volatility which are good for banks. On the other hand, he says growth stocks, tobacco and consumer staples, may begin to come under pressure.
He also sees interesting self-help and turnaround situations, when new management comes in to improve companies, for example at Tesco.
“There will be patches of turbulence here and in the US but we’re preparing for a soft landing. While we’re constantly reviewing our holdings, we’re absolutely comfortable that our portfolio of well-managed companies, trading with attractive valuations and offering consistent returns, is the right one.”
Oil and tobacco attractively valued
Mark Barnett, head of UK equities at Invesco, believes the range-bound nature of the UK stock market will continue into next year, fluctuating within a 10% range, until there is a clear picture on Brexit and the duration of rising interest rates.
However, Barnett is positive on the fact that global market valuation of revenues originating in the UK are currently valued at about half of those in the US (see chart), making them relatively cheap . Domestic sectors will present the most obvious opportunities, he says, because they are at multi-year lows in absolute terms and relative to the market.
UK sourced revenues have de-rated despite earnings stability
Barnett has modestly increased exposure to sterling revenues in his portfolios on the back of the pessimistic consensus towards the UK. He has also upped exposure to stocks which offer an absolute return potential that is not correlated with regular business cycles.
“These themes remain prominent across my funds, alongside a number of global industries —namely oil and tobacco — which remain attractively valued in my view in a market driven by short-termism and an emphasis on new disruptive business models in all industries.”
Low conviction is not a sustainable approach
But for Toby Nangle, global head of asset allocation at Columbia Threadneedle, Brexit remains as uncertain as ever and he is not willing to gamble on an outcome.
“If the UK falls out of the European Union without a transition agreement, the prospect for further steep currency depreciation is very real. But such is the level of uncertainty being priced into markets that just avoiding this bad outcome would likely deliver potentially meaningful currency strength,” he says.
“We have taken the approach of seeking to desensitise client portfolios to Brexit-induced swings in value, lacking an edge in calling the outcome. Undoubtedly the end point will appear blindingly obvious in retrospect, but investing in an area of low conviction is not a sustainable investment approach.”
Fund selector view: risks and opportunities
Like most, Thomas Becket, chief investment officer at Psigma Investment Management, says the outlook for 2019 is as confusing as it has been for some years owing to a slowing economy, unsettled politics and increasingly attractive valuations throwing up a range of different possibilities.
Writing in the firm’s 2019 outlook, Becket says Brexit is presenting both opportunities and risks and the much-hated UK equity market could surprise, particularly if sentiment becomes even more negative over the UK’s departure from the EU.
“It might well be that we wait for a further deterioration in sentiment, maybe wait for the lorries to start backing up on the M20 from Dover, but with UK assets now distrusted and shunned by most global investors and approaching historically cheap absolute and relative valuations, investors should not throw the towel in on their UK investments.”
Psigma’s favoured active funds in UK equities are Artemis Income, which has a value bias, and Royal London UK Equity Income, where the manager favours mid cap companies that could see a reversal next year in the negative sentiment that has afflicted them in recent months.