In reviewing 2020, several investors have remarked to me how were surprised they are at the continuing relatively poor performance of the UK equity market. A trend that has been in motion over the past 20 years (it is still lower today than it was in late 1999). The UK is not alone in this respect, the Eurostoxx50 Index of leading Eurozone companies is still 30% below its March 2000 peak. (Source: Bloomberg).
Both indices have similar characteristics that explain their lagging performances. Large exposures to Banks, Insurers, Telecoms, Utilities and Oil companies that have struggled in the 21st century, and small exposure to the faster growing Technology sector, while their domestic economies have lagged the growth in the US and Asia ex Japan.
The question presents itself: will the UK equity market finally have a good relative period in 2021? The UK’s heyday was in the mid-1980s in the Thatcher era, delivering over 263 percent cumulative returns, according to research by Fidelity Investments. Thanks to Thatcher’s policies of privatisation, tax cuts and financial reforms, the UK market delivered annual returns of 11.8 percent. Since then, it has experienced a long period of underperformance, particularly in the past decade. Labour Prime Minister Gordon Brown, had the misfortune of being in power during the demise of Lehman Brothers and the 2008 global financial crisis. It cumulatively lost 18.2 percent in this period.
Compared to Europe, it is still underperforming. The UK market now trades at a c.35% discount in earnings valuation terms to the US, the largest discount over the past 20 years.
Not surprisingly the UK equity market has seen consistent outflows from international investors since the Brexit referendum vote in mid-2016 (some $30bn+ cumulatively), adding to pressure on share prices and valuations. And it is not just the overall UK market that is at a significant discount to the US and Europe. If one looks by sector/industry we find there is also a ‘UK discount’ in most of them:
The chart above is perhaps one of the strongest arguments for investors to re-evaluate the UK. I know what you are thinking: “Why is 2021 picked for a return in UK equity market’s fortunes? Is this not akin to The Boy Who Cried Wolf?” Maybe, but he was eventually correct!
Currently, the UK is out of favour as an investment market, coupled with the scale of the discount of the overall market and its sectors. However, we believe it is these factors that make it tempting for investors to return. Of course, we need signs the UK economy is bottoming out (would help the Oils and Financials) and that the post-Brexit trade paperwork bottlenecks are starting to ease. Hopefully, this will occur in a couple of months.
Within our Global Equity Income Fund, we have exposure to some robust and reassuring UK companies such as Unilever, Diageo and Reckitt Benckiser, as well as some more cyclical companies such as Smith & Nephew, Rio Tinto and DCC. They are all high-quality companies with nice dividend yields that are trading at discount valuations to their US and European peers. Given Reckitt and S&N’s strong brands, smallish market capitalisations, attractive valuations and the availability of almost-free funds for large corporates, we wouldn’t be surprised if a larger competitor tried to buy them. However, we would not list this as a single reason to invest!
Let me finish with a headline from last weekend’s Financial Times: “John Lewis repays £300m COVID-19 funding and raises FY guidance”. Perhaps the UK economy is finally bottoming out and thus ready for a return very soon.
Pramit Ghose is Global Strategist with Cantor Fitzgerald Ireland.
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