UK Equities: 'unloved' and out of favour...
Ewan Millar, Senior Investment Manager at Cornelian Asset Managers, looks at the prospects for UK equities.
That UK equities have underperformed global equities (Chart 1) over the last several years should not come as a surprise given the UK’s decision to leave the EU in June 2016. The uncertainty that this decision has caused across almost every aspect of the UK’s political and economic future gives valid reason to be cautious. In the context of a synchronised global economic expansion, the UK stands out as a more challenged economy because of Brexit, the implications of which remain unclear. Particularly from an overseas investors perspective, why take the risk? UK stocks are ‘unloved’ and out of favour (Chart 2).
We think this view, while understandable, is too simplistic and ultimately overlooks several important factors. Over three quarters of FTSE 100 company’s revenues are generated outside of the UK (FTSE Russell, April 2017) and so although these companies are listed in London they are truly multinational businesses that are not necessarily any more at risk from Brexit than multinational businesses that are listed in Frankfurt, New York or Tokyo. Simply viewing these businesses through the prism of Brexit misses the bigger picture.
Corporate profits in the UK are expected to grow almost 20% over the next two years, hardly the reflection of a doom and gloom environment that should be shunned by equity investors.
Corporate profits in the UK are expected to grow almost 20% over the next two years, hardly the reflection of a doom and gloom environment that should be shunned by equity investors. Yet due to selling pressure - UK Equity funds saw outflows greater than 7% of assets over 2016 and 2017 combined (EPFR, Citi Research) - the UK market is relatively cheap, 14x earnings compared to 17x for the US. Indeed, if history is anything to go by, current valuations look attractive. Chart 3 shows the annualised returns that were achieved when you bought the UK market on a given dividend yield. The FTSE All Share currently yields 4%. Historically, buying the UK market at that level of yield would have, on average, generated double digit annualised returns over a 10-year period. An attractive return by any measure. This valuation opportunity has not gone unnoticed amongst corporate buyers, as acquisitions of UK listed companies are on track so far in 2018 to be the biggest year on record, with a run rate of $700bn (Citi Research).
Brexit will continue to dominate the headlines in the months ahead and the outcome is almost impossible to predict, which is likely to lead to some periods of volatility in the UK stock market. However, company fundamentals remain broadly strong and valuations moderate, so from a medium to long-term perspective it seems likely that this is an attractive time to buy UK equities.
Cornelian Investment Team