Time to look again at UK equities

17 October 2019

5 minute read

With so much negative Brexit uncertainty priced in, is it a good time to up exposure to UK equities?

The UK has been the epicentre of European political uncertainty since its referendum on European Union membership of 23 June 2016. As a result of persisting deal or no-deal headline risks and numerous “extensions”, UK equities have lagged their continental peers by close to 15% (in euro terms) since.

Unloved and undervalued

In a vicious circle, the UK’s underperformance has led to significant outflows. Equity investors are thought to have pulled about 10% of their assets from the region over the last three years, leaving them significantly underexposed to UK assets. However, from a fundamentals perspective, little has happened in that time.

In fact, earnings per share reported by FTSE All-Share constituent companies are expected to be 50% higher in 2019 versus 2015. In comparison, eurozone equities grew earnings by less than 20% over that period (see chart).

Strong UK earnings growth, despite Brexit

While a weaker sterling has helped, even on a euro basis UK earnings have outgrown the eurozone’s by more than 10 percentage points. As a result, on a price-to-forward earnings basis, UK equities’ valuation is around 8% below that of the eurozone. This compares to a 2% premium over the past 10 years, on average.

Playing Brexit via domestics versus exporters

Of course, beyond the surface, large performance disparities exist. A basket of UK shares generating most of their revenues abroad has returned 45% since the day of the referendum. In the meantime, a basket focused on the domestic market has returned only 9%.

A weaker sterling has helped exporters, while worries of a possible UK recession have held back domestically-focused businesses. In this context, the trade so far has been relatively simple: favour domestic companies to profit from an expected deal, and prefer exporters when a no-deal, or hard Brexit, looks more likely.

Deal or no-deal, UK offers value

Prospects for UK equities are about to change, and for the better in our opinion. Irrespective of the Brexit outcome (deal or no-deal), we believe that UK equities, wherever revenues are earned, are becoming interesting again. Indeed, the heightened uncertainty that prevented many investors from allocating assets to the region is unlikely to last much longer.

As clarity emerges, we believe that inflows will resume. In a no-deal scenario, the recovery might take longer but, over the medium term and once the currency has adjusted further, we are optimistic that UK companies will adapt. Earnings may suffer in the short term and sterling may not offer as much of a cushion as it did in the past.

That said, monetary and fiscal stimulus, combined with renewed visibility on the path forward for the UK, should be enough for investors to return to the region, seeking to capitalise on the UK’s attractive valuations and high dividend yields.

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