Back in 2017 — almost two years to the day — I wrote a column on how to Brexit-proof your investment portfolio, making the point that UK investors need to be smarter about how they invest against a challenging domestic backdrop.
Fast forward two years and very little has changed. Uncertainty has remained the fate of UK consumers, businesses and investors alike. It is a very brave (or arguably, very naive) columnist who attempts to write anything sensible about a known unknown. But here goes.
Let’s start with the known knowns. Since the referendum, the UK has suffered net outflows in virtually every quarter. Global investors have shunned the UK and politics has wreaked havoc with the broader economy, the damage most evident in consumer spending and business investment.
While we will have to wait until the release of official data in early November to be sure, some of the latest economic reports have been ominously consistent with the beginnings of a recession. Judging by recent valuations of domestic companies, it would seem investors already believe the UK is headed for a downturn.
More pertinently, despite employment growing to all-time highs (until very recently) and inflation benign, consumers and businesses have been behaving as if the UK is already in recession. Forecasts have been slashed while consumer confidence and business investment remain moribund.
That’s the bad news — but at least it’s in the price. Investors are currently paying about 12 times expected earnings in the UK, against a forecast growth rate in profits of nearly 7 per cent. The forward-looking yield on the FTSE 100, according to Goldman Sachs’s estimates, is now 5 per cent. This compares favourably with both history and world equities, which yield about 2.5 per cent and trade on 16 times 2020 earnings, according to MSCI data.
For the selective stock picker, today’s lack of visibility could mean the chance to invest in a still-growing market at bargain prices, and we all know the best predictor of future returns remains the starting valuation. While recent poor data shouldn’t be ignored, it has to some degree mirrored declines in the US and the eurozone. For an economy about two-thirds driven by consumer spending, oil prices that consistently fail to sustain gains even in the face of geopolitical shocks, low unemployment and rising wages are all economic tailwinds.
Alexandra Jackson, manager of the Rathbone UK Opportunities Fund, pointed out to me this week that any certainty over the Brexit endgame could release pent up demand from consumers and businesses, providing a welcome boost to the economy. Then there’s the fact that the current chancellor looks set to unleash supportive fiscal spending.
That said, now is certainly not the time for broad UK exposure — a FTSE tracker, for example. Targeting companies with overseas exposure to take advantage of sterling weakness is a well-worn playbook and looking pricey. Whatever the outcome of the Brexit malaise, the tidal wave of structural changes washing over banks, housebuilders and retailers shows no sign of turning.
Stock picking has never been more important and investors today have a choice: like many overseas investors, they could shun the UK, or look at this as a great contrarian opportunity to scoop up good companies. Relative to the US, the UK is 25 per cent cheaper — a valuation cushion that’s hard to ignore.
A more pressing question at this stage concerns style. Should you opt for growth or value? Fund managers such as Nick Train of the Lindsell Train UK Equity Fund have benefited greatly from investors’ continuing appetite for quality and growth over economic cyclicality and value. However, the rotation witnessed in September from growth to value raises some question marks over the ability of the fund to continue its strong run of outperformance, not least given lofty valuations and the concentrated nature of this fund.
Others argue that this rotation might be short-lived. With the global economy remaining soft and trade tensions building, the UK’s open economy will not be immune. Under these conditions, it is hard to make the case for a prolonged value rally. Ultimately, for value to work longer term, investors need to believe we are at the start of a sustained upturn in global growth, requiring higher rates, which will benefit cyclical (in other words, value) sectors. But when growth is scarce and the climate is tough, investors tend to be rewarded by owning reliable growth businesses.
Now could be the time to back another UK stockpicker — Richard Penny of the Crux UK Special Situations Fund. Mr Penny has a stellar record of delivering in difficult markets. He focuses on buying early, buying on bad days and buying mispriced subsidiaries of bigger businesses. His mantra is to separate an investment from its price — you can pick a brilliant business but if it’s too expensive, it’s not a brilliant investment. As he points out, growth stocks are expensive, particularly the dollar earners, which have been very easy to back for too long.
Either way, given the range of uncertainties over Brexit and the economy, perhaps the answer lies in having a good balance of growth and value-focused funds. Differing combinations of the two can provide capital growth, income or, some of each. Whether you think the glass is half full or half empty, there’s no disputing that now probably isn’t the time for a big bet either way.
What will the general election mean for investors?
The pound and FTSE 100 will continue to be caught in a holding pattern as Britain’s departure from the EU gets kicked further into the future.
Attention has now shifted from the details of a Brexit deal to a pre-Christmas general election — the first such winter poll for nearly 100 years. The decision to go to the country represents a huge gamble for Boris Johnson, the prime minister, whose Brexit deal has yet to pass through Parliament.
What will investors make of it? History tells us that the performance of markets in the period before an election has very little to do with which party wins. Instead it is reflective of what is happening in the broader world economy and the level of certainty about who will win the election. With an election offering a range of possible outcomes — including another hung parliament — external factors are likely to play a bigger role than normal.
What UK investors are desperate for is some degree of certainty. The domestically-focused FTSE 250, for instance, rose significantly ahead of the parliamentary vote this week on the general election.
While few welcome an election in the dead of winter — which could affect turnout — a pre-Christmas poll could lead to a resolution of the Brexit stalemate.
Coupled with a brighter global outlook — potentially incorporating a more civil tone between the US and China, with the possibility of a trade deal and global central banks easing monetary policy — stock markets could move away from a focus on domestic politics to home in on an improving global picture and a better 2020 for investors.
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