“In investing, what is comfortable is rarely profitable” – Robert Arnott, American entrepreneur, investor and writer
If that statement is even half-true, then the UK stock market should be at the centre of any investor’s radar. As we will set out below, the UK is far from dead and its stock market is astonishingly cheap.
The UK stock market could easily be poised for a dramatic and extended period of outperformance against other markets. We tasted an ‘amuse-bouche’ to this feast of potential returns on Friday the 11th October. All it took was some soothing noises coming from a stately home in Northern England, with pictures of Irish PM Leo Varadkar and British PM Boris Johnson walking together in a friendly and concerned manner down a tree-lined avenue. UK equities returned 1.4% on the day, but much more instructively, UK centric mid-caps increased 4.2%. Putting that into context, UK mid-caps returned in one day almost 9x the total return an investor would receive from holding 10-year gilts. Whilst accepting that is not an ‘apples for apples’ comparison, it should make investors stop and think.
Comments about our current Brexit mess serve no purpose here but as all-consuming as it seems to us in the UK, ‘abroad’ is hardly without its problems either. From US-Sino trade wars to Euro-populism, Hong Kong protests and drone strikes in Saudi Arabia, the world is a worried place at the moment. Brexit is not a glaring exception to an otherwise happy world, but the relative valuation of the UK stock market is much more so.
UK Price/Earnings and Price/Book Ratio discounts at 10 year highs
In a world hunting for yield, the value proposition becomes even more compelling when dividend yield is considered.
As per the table below, the yield from the UK market is 2.9% higher than US 10-year government bonds. The average difference over the last 15 years is 1.1%.
All else being equal, in order for the spread to close to 1.1% whilst US bond yields remain at around the 1.7%, the FTSE All Share Index must appreciate by over 30%. That level of upside builds in quite a risk margin for those investors with concerns.
Finally, from an overseas perspective, once the clouds of Brexit clear, the attractiveness of UK assets will be viewed through the lens of a currency that has been battered and, therefore, offers the potential for additional returns in local currencies. The UK is only approximately 5% of the world stockmarket, so relatively little global capital could make a huge difference to the level of UK share prices.
In general, the UK market is firmly out of favour. As the latest BofA Merrill Lynch Global Fund Manager Survey (FMS) illustrates, Global fund managers expect low returns from the UK and are very underweight in their portfolios.
However, the Hong Kong Stock Exchange’s attempt to buy the London Stock Exchange for almost £30bn; Hong Kong’s richest man, Li Ka-Shing, purchasing Greene King, the UK’s largest pub chain; as well as international private equity firms bidding for Cobham and Sophos all suggest that there is value in the UK and some foreign investors are already making moves.
So what of the UK Economy
The services sector accounts for some 80% of UK GDP; therefore, the UK consumer is vital to the overall health of the economy.
The UK consumer is clearly emotional. Following the financial crash and subsequent Euro crisis, the mood lightened considerably as the world appeared to normalise. Nevertheless, since 2015 the UK consumer has generally ebbed confidence and, since the Referendum in 2016, has sought to save more.
However, on the assumption that either the consumer gets so bored with endless Brexit delays and just gets on with life or (dare we dream) Boris agrees a deal with the EU and it passes UK Parliament, the fundamentals of the UK economy do not look too bad for its inhabitants. Furthermore, wages are increasing nicely ahead of inflation, which boosts real disposable income, and unemployment is at a multi-decade low level.
We can see that this is feeding into the housing market with mortgage approvals in growth territory and houses becoming more affordable for first-time buyers. Mortgage rates are very low and likely to remain so in the medium-term, with the help-to-buy scheme quite possibly being replaced with something similar after its expiry in 2023.
So, although the counter argument would be to highlight weak PMI data, already record low interest rates and the resumption of quantative easing in Europe, a more optimistic investor would see central banks determined to stimulate growth and a natural improvement of these data points on the return of some stability.
Additionally, deal or no deal, we are quite likely to see large fiscal stimulus in the UK (and probably in the US too) coupled with tax cuts to aggressively stimulate growth. Whatever one may think of the prudence of this in the long-term, the UK stockmarket could easily prove to be the most profitable place to invest in the medium-term, notwithstanding how uncomfortable it seems today.
Canada Life Investments
Canada Life Investments offers a UK Equity Fund biased towards growth opportunities as well as a UK Equity Income Fund that provides investors with an attractive yield over and above that of the UK stockmarket. Additionally, we offer a Global Equity Fund which also has the flexibility to access the potential that the UK has to offer.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.
The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Investments. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at www.canadalifeinvestments.com.
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CLI01526 Expiry 29/02/2020