Greater political stability is expected to boost investor demand for UK equities in 2020
We are likely to see continued near-term volatility, but a long-term recovery in the value of Sterling should benefit unloved domestic stocks, which are sensitive to fluctuations in the currency
As an active equity income investor, I remain focussed on finding attractively valued companies that can deliver diversified, growing income whilst offering capital appreciation over time
18 December 2019 | Mark Barnett, Head of UK Equities
2020 has all the promise of being a good year for UK equities. The past few years have been dominated by domestic political uncertainty, which has proven especially difficult to navigate. Alongside the protracted paralysis in Westminster, we have seen a continued polarisation of company valuations within UK equities. Since the EU Referendum result we have seen an effective 'buyers strike’ – both equity investors and companies looking to invest in their capital base have avoided making investment decisions or chosen to invest outside of the UK.
The clearest barometer of sentiment towards the UK is the value of Sterling – which has traded at sustained lows. Indeed, the differential between highly rated global non-cyclical stocks and depressed domestic economically sensitive shares is substantial.
To my mind this is unsustainable. The most likely catalyst for a market reappraisal is political clarity. The recent General Election result promises to bring the UK’s exit from the European Union to a conclusion in 2020 – with Boris Johnson pledging to pass his withdrawal agreement by the end of January and negotiate a free trade deal with the block by December. Continuing developments are likely to provide further volatility in the days and weeks ahead. Uncertainty still remains around the future trade arrangements with the EU (and indeed the US), whilst the success of the Scottish National Party will also raise the spectre of a possible second referendum in Scotland. However, the Conservative majority within Westminster will provide much needed clarity to the decision-making process. At the very least we are looking forward to five years of a stable Government, able to pass legislation.
As we progress through 2020 it is my belief that UK domestic equities stand to gain from a clarity around our future trading relationship with the European Union, a sustained recovery in the value of Sterling and the re-emergence of our domestic market as a place of opportunity for international investors. 2020 is also likely to be a better year for companies that were at risk of increased direct Government influence (if not full nationalisation), including utility companies and telecoms companies; companies that provide outsourcing services to central and local government; and also UK banks and real estate companies that may be regarded as bellwethers of economic enterprise. The converse is that those companies with substantial overseas revenues whose overseas earnings will be negatively affected (in GBP terms) from the revaluation of Sterling.
The compelling long-term opportunity
Looking ahead, at the heart of my optimism is an unshaken belief in the valuation, and income opportunity, available to investors who are prepared to look beyond the medium-term. Looking at the UK market as a whole, at a blended average of different valuation measures UK equities are trading at a significant discount to their 20-year average. This compares to a global equity market that trades at a significant premium. To my mind the clear valuation opportunity remains in companies that derive their income from a UK revenue base. It is UK sourced revenues, more than just the valuations of UK listed companies, that have suffered the biggest discount in the period of uncertainty.
The foundations for growth in the economy are already there – despite the politically induced uncertainties. There is record employment in the UK, which has been achieved alongside real wage growth, and household economies may now feel liberated. The new Government is also committed to increasing fiscal stimulus and boosting public sector pay. Taken together, I am more optimistic for the real economy in the UK and the prospects for real value creation, than many others might have been.
The emergence of Mergers & Acquisitions activity in recent months also speaks to the value available in UK-listed companies. This value is being recognised by financial and industrial buyers – particularly when it can be financed by accessing the debt markets at very attractive yields. It is hoped that as we enter 2020 these factors will become evident more widely and we will see investors more confident to reengage with the UK equity market once again.
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