Happy New Year Investing
• UK equities are now considered cheap, particularly domestically focused ones
• Political relief, low bond yields and recovering business investment underpins market
• Investors should effectively look through Brexit fears
• Globally equity rotation, away from overvalued regions/sectors, will characterise 2020
• London’s AIM set to continue outperforming FTSE 100 in both the short and longer-term
2019 was another profitable year for UK equity investors.
Nevertheless, there were a number of investment frustrations. These were focused mainly around politics, Brexit and Sterling and meant the territory still significantly underperformed many of its international peers.
December 2019’s ‘Boris-bounce’, which followed the Tory’s landslide victory over Jeremy Corbyn’s left-leaning Labour party, helped Britain’s blue-chip stock index, the FTSE 100, jump by 12%, its best annual performance in three years, recouping almost all of the 12.5% slump suffered in 2018!
Yet over the same period, the MSCI World Index, which tracks stocks traded across the developed work, for example, spiked almost 24%, while the US’s big-cap S&P 500 rose 28% and the tech-heavy NASDAQ posted a stunning 35% gain.
But that’s history and we are now interested in 2020. For the UK, which is almost irrevocably headed for Brexit on 31st January, the markets’ new pre-occupation will almost certainly become ‘soft or hard’ and ‘will-they, won’t they’, regarding the final ‘divorce’ conditions and the terms of a subsequent EU Trade Deal.
Given where both sides now find themselves, however, mounting evidence of slowing economic conditions and (now finally) an obvious desire not to shoot themselves in the foot, means that the UK and EU will hopefully be seen to strike a trade accord comfortable for both sides, even if it might still take a year for them to negotiate.
As such, investors should effectively look through Brexit fears and take advantage of market volatility that will inevitably be created by political soundings and sensationalist media reports to spot buying opportunities.
The fundamental story is that UK equities are cheap in relative terms. Immediately prior to the General Election, the FTSE All-Share market valuation stood at roughly a 30% discount to its global peers. This has narrowed marginally over the past month, but exceptional value still remains evident within a market that had found itself shunned by both retail and institutional investors.
In terms of the widening gap between international markets, it is worth noting that one global benchmark, the US’s S&P 500,
currently has a 12-month forward price-to-earnings ratio (P/E) of 18.3x, which is about 15% above its long-run average and contrasts sharply with a number non-US (particularly the UK) indices that trade well below their own.
This alone will be sufficient to commence a phase of rotation, firstly out of expensive geographical locations into regions where there is better value and, secondly, away from a narrow band of dominant and now significantly over-bought equities, such as the tech titans.
Behind their premium ratings, however, numerous clouds (including slowing growth, dovish central banks, geopolitical and trade tensions, etc.) have also begun gathering over the star performing international markets, against which the UK stands out as the obvious pick for 2020. This is not just because of its lowly valuation, but the fact that there is now also a pro-growth government installed for the next 5-years, which we hope will deliver a positive EU trade resolution and ensure Sterling gradually recovers a good slice of the losses it endured following the 2016 Referendum.
The blue-chip FTSE 100 index now trades on a forward earnings multiple (P/E) of just 12.6x, which is near to a six point discount to the S&P 500 and almost a 13 point discount to the Nasdaq Composite; even the German DAX and French CAC indices, with all of Europe’s structural problems, trade higher.
Across the principal sectors, UK equities underperformed global peers by 14% on average since the EU referendum.
For those looking to get involved, however, it is still very important to be highly selective. This is largely because the exceptional uncertainties of the past three years resulted in the UK becoming treated almost as a special situation for investors. As such, the FTSE All-Share Index became dominated by relatively small number of internationally focused companies (largely US$ earning) that were effectively adopted as international proxies within portfolios while, at the same time, forcing a sharp de-rating of domestic facing companies.
This situation has now started to reverse, and the closing of this obvious value gap is expected to become a dominant issue for UK equities this year. As such most compelling risk-adjusted opportunities now appear to lie outside the dominant top tier plays, with focus on Sterling-earning, cash generative, value-orientated companies along with best picks amongst young high-growth and innovative tech businesses.
In this respect, it is worth reminding investors that while the past 20-years has seen the FTSE100 deliver 138% (total returns 31/10/1999 – 31/10/2019), over the same period the FTSE Small Cap index, home to some of the smallest companies, has returned an equivalent 255%. In the one-month since the General Election, the AIM All-Share (the LSE’s home for many of the UK’s youngest and highest growth enterprises), has gained a full 5%, having significantly outperformed the FTSE100 on both a short and longer-term view. We expect this to be sustained during 2020.
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