Brexit = a great time to invest

by Adrienne Lawler
March 27, 2019

WhatInvestment.co.uk reports that Richard Colwell head of UK Equities and portfolio manager of the Threadneedle UK Equity Income fund says now may a great time to invest. 

Reflecting on 2018, global equity markets have lurched from optimism to pessimism. At the beginning of the year there was a complacent belief in synchronised global growth. But cut to the fourth quarter and many strategists are speculating whether the United States might soon enter a recession and how Chinese economic growth is slowing as they try to get a grip of their own excessive debt levels. A year ago, only a Brexit-induced UK recession was feared, but now people are cautious about the US economy, China and others besides.

So while investors are becoming more cautious, the good thing is that there is no “hot money” in UK equities. Global funds have been very negative on the asset class ahead of an unpredictable exit from the European Union and a possible neo-socialist Labour government. Instead, asset allocators have been overweight the perceived safe havens of the US, Europe or Japan – from which they are now retreating.

To quote former US Secretary of Defense Donald Rumsfeld, the UK is a “known unknown”. The rest of the world is an “unknown unknown” though, which in the eyes of Rumsfeld would make it a far more worrisome prospect.

In this context, UK equity valuations look cheap on many metrics. Price-to-book ratios, for example, are at a lower level relative to US equities than the extreme level they reached in 1999 at the peak of the ecommerce bubble. While the performance of UK equities cannot entirely escape correlation against other markets, we would hope that the relative valuation of UK companies should allow them to be more resilient if there is further turbulence.

Warning tremors signal volatility

After a decade of easy monetary policy driving a bull market, it is hardly surprising that volatility has risen as this financial liquidity has been withdrawn. For over a year now the US Federal Reserve has been moving from quantitative easing to quantitative tightening, at the same time as short-dated rates have been rising. Yet long-term forecasters largely failed to predict that greater volatility was well overdue everywhere in 2018. The first flare up, in February, was an important marker.

Then the second and more significant tremor happened in October, as the Fed reset expectations for rate hikes, indicating that they could rise above 3%.

This change in discount rate being applied to highly-rated growth stocks, such as the “FAANG” tech stocks meant that their share prices pulled back from very high levels. That was rational, overdue and healthy.

But the market also started to ask when will the US economic cycle end?

To be fair, there is early evidence of slowing revenue growth and cost pressures in some industries that are sensitive to the economic cycle, like car manufacturers and semi-conductor companies. The market always discounts the future. But the huge growth of Exchange-Traded Funds (ETFs) and other quantitative funds, many of which tend to follow momentum, means that topics the market might previously have processed over six months get translated in warp speed. For example, with this recent pessimism quant funds have significantly marked down all industrial stocks, which seems premature.

2019 undervalued opportunities

Looking to 2019, the market seems to be moving away from an era when momentum-fuelled growth stocks led indices higher, an environment characterised by a focus on news flow with the “buying of bullies and selling of victims”. Instead, there is now some well overdue evidence of rotation into value stocks. The UK offers a range of opportunities. We have been adding to businesses that the market has become nervous about, either due to Brexit or perceived structural threats due to disruption etc. We are asking whether in the fog of emotion, the market has punished a share price without appreciating the resilience of the business or their ability to adapt.

A lot of global firms that are listed in the UK but operate internationally are trading on significantly cheaper valuations than their peers listed elsewhere. This reflects the weight of money that has been taken out of the UK due to political and economic uncertainty over Brexit. Nevertheless, the resulting valuation arbitrage has led to shareholder activism reaching record levels. Merger and acquisition activity is also likely to continue at a faster pace as foreign companies take advantage of these cheap valuations.

We want to be investing in company managements with a “can do” attitude, who have been making Brexit contingency plans since the referendum, knowing that waiting for clarity from the politicians is dangerous! They have been building up inventory, adapting their logistics networks, and protecting against skill shortages. While these preparations may have required extra investment, we believe that this should allow businesses to continue to operate, whereas valuations are often pricing in a far more pessimistic outlook.

Timing

The best time to invest is when it feels uncomfortable. The opportunity cost of investing in the UK rather than elsewhere is very different now that markets have worked out that there are issues elsewhere in the world. Brexit is no longer the only risk factor. Now is the time to focus on valuation not just news flow.

International investors are almost as underweight UK equities as they were during the financial crisis of 2008/2009 when the banks were technically insolvent. There is an opportunity to buy under-valued UK stocks. We think that the UK is in some ways like the new Japan, in as much as it is less correlated with other equity markets. We don’t have a strong view on Brexit. Our edge lies in selecting the best stocks based on the company’s fundamentals; not reviewing the comments of politicians.

The research and analysis included on this website has been produced by Columbia Threadneedle Investments for its own investment management activities, may have been acted upon prior to publication and is made available here incidentally. Any opinions expressed are made as at the date of publication but are subject to change without notice and should not be seen as investment advice. Information obtained from external sources is believed to be reliable but its accuracy or completeness cannot be guaranteed.”

At investment platform interactive investor, investors are urged to hold tight. 

Moira O’Neill, head of personal finance, said:  “Whilst MPs scrabble around looking for a spade to dig themselves out of the Brexit hole, investors have no such need to run around in circles. Whether you’re worried about political or market uncertainty, or you’re feeling frozen in fear, the worst thing anyone can do is panic.

That doesn’t mean you can’t be proactive with your investments. “Using as much of your annual tax allowances as you are able is a good start. Make sure that as much of your savings and investments as possible are in ISAs or pensions. And if you’re married, think about using your spouse’s allowances too.

“Reviewing your investments to help keep fees down as much as possible can also be comforting in times of trouble. Above all, take a long-term view. A well-diversified portfolio, invested in UK and overseas stock markets, plus bonds, commercial property and a bit of gold, should be able to withstand bumps in the road, as long as it’s a long journey ahead. Many of us are investing for at least a 30-year period. Even if you’re at the start of retirement, you could have 20 to 30 years left in the stock markets.”

Market impact

Lee Wild, head of equity strategy said: “After two years of negotiations, and with just two months before the deadline, Prime Minister Theresa May’s Brexit plan was soundly rejected by 230 votes on Tuesday night, a record margin for a sitting government.

“A chaotic Brexit would heighten concerns around foreign trade, economic growth, jobs and investment by companies based both in the UK and overseas.

“The immediate impact on financial markets has been limited. Ahead of the vote last night, sterling fell below $1.2700 and FTSE 100 futures prices rose above 6,940. On confirmation of May’s defeat, the pound headed back to $1.2850 and FTSE 100 futures fell below 6,880.

“This morning, the increased likelihood of either a ‘soft’ Brexit or no Brexit at all has the FTSE 100 down over 40 points at 6,850, largely as a result of the rebound in sterling versus yesterday’s lows. Overseas earners are down as the stronger pound means profits made in dollars or other currencies are worth less when translated back into sterling, most companies’ reporting currency.

“Domestic stocks are in favour as a softer Brexit outcome is expected to limit the impact on the UK economy and companies that earn most, or all of their money here. Housebuilders like Persimmon, Barratt Developments and Taylor Wimpey lead the risers. Retailers Marks and Spencer and Next are up too, as are high street banks Royal Bank of Scotland and Lloyds Banking Group.

“Implications for the pound and for UK-listed equities from the range of Brexit outcomes could be more extreme. In the event that Brexit does not happen, it is thought sterling could trade above $1.40 again. If we end up with a ‘hard’ Brexit, the pound could move towards parity with the dollar.

“Smaller companies especially are likely to track the fortunes of sterling as their prospects depend very much on a strong UK economy and favourable Brexit outcome.

“Either outcome is very much still possible, and without further clarity on the shape of a final deal, financial markets are expected to remain volatile.”

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