Keeping the faith
In terms of a fund management perspective, Callum Abbot, who co-manages the JPM UK Equity Plus Fund, argues there are good reasons for investors to keep faith with the UK.
He says: “With Article 50 due to be triggered at the end of the quarter, heralding the beginning of the EU exit process, the next two years are expected to be volatile and uncertain from a macro and political perspective. In spite of this, we are quietly confident that UK equities will remain an attractive investment for three reasons.
“First, the UK equity market is not a simple reflection of the UK economy. It is truly global, with around 70% of FTSE All-Share earnings coming from overseas. In fact, companies source a similar amount of their earnings from the UK as they do from emerging markets or the US.
“It offers an effective way to invest in the robust global economy through industry-leading companies.
“Second, analysts are forecasting 15% earnings growth next year and 10% the year after,” says Abbot. “A key driver is the rebound in commodities driven by improving global growth and Chinese stimulus, and the UK equity market has a near 20% exposure to this recovery.
“Further, any sterling weakness increases the value of overseas earnings for UK investors, making it a natural shock absorber to the EU negotiations. Equally, if negotiations go smoothly and prove the doomsayers wrong, a robust domestic economy will be a bonus for the equity market as domestic stocks will be well supported.
“Finally, valuation remains compelling compared with other regions and other asset classes. The FTSE All-Share’s dividend yield stands at 4.1% compared with 2.1% in the US, while UK gilts yield 1.5%.”
He adds there are several investment themes that can be tapped into during UK stock selection, while conceding there are some areas that look particularly high risk at the moment.
“Reflation is one of these. Equities offer a natural inflation hedge, with rising prices boosting overall sales. Certain stocks tend to benefit more than others in this type of environment, in particular value and cyclical names that are looking attractive.
“Banks are a primary beneficiary, for example. As rates rise the gap between what they charge for loans and what they pay for deposits widens, increasing profitability. Given the low starting point of rates and the lowly valuation of banks this theme arguably has considerable room to run.
“So-called growth and defensive stocks tend to underperform when rates rise.
Utilities and pharmaceuticals are very good examples of this; the former are bond proxies and the latter have the additional burden of overt criticism about drug pricing from US politicians.
“Opportunities and risks are not just about themes and sectors but also exist at the stock level.
“This can be seen in a sector such as general retail. Retailers that have high import costs and large store estates will likely lose out to online fast fashion retailers.”
