by Adam Jones
With the global pandemic now firmly in the rear-view mirror we have been reflecting on the performance of various economies and markets over the past 12 to 18 months. Since the pre-pandemic peak in late February 2020 global equities (as measured by the MSCI World Index) have delivered returns of c.17% to UK investors. Europe has closely followed suit (delivering a 14% return) but the clear laggard has been the UK itself, with the FTSE 100 being effectively flat over the same period.
This is perhaps unsurprising given the number of headwinds over recent years, but as the clouds begin to part we find ourselves becoming increasingly optimistic on the outlook for the UK.
Enthusiasm for UK equities, which had already been dampened by protracted Brexit negotiations, has struggled further under the weight of the pandemic given a particularly high market exposure to those sectors most affected by lock-downs.
Even prior to the Brexit vote global fund managers have generally been underweight the UK market, preferring instead to maintain exposure to those markets geared toward secular growth dynamics (US Tech being the clearest example);
This makes absolute sense in a world where economic growth is scarce and interest rates are low. However, for now at least, that does not appear to be the situation we find ourselves in.
Successful vaccine roll-outs are beginning to take hold and continued re-opening looks set to drive a wave of demand from consumers all across the developed world, many of whom are waking up to the fact that their bank accounts are full of unspent earnings and/or unemployment benefits.
Household savings rates here in the UK remain elevated and from our (perhaps optimistic) perspective this provides a supportive backdrop for spending in the months ahead;
The true scale and duration of fiscal support packages is yet to be seen given the politics involved, however there is little doubt that it will come through in one form or another. This provides yet another leg of support for the stool of economic growth.
As a thought exercise we felt it useful to identify and expand on some of the key reasons why we feel the UK market is especially well placed to deliver more attractive returns on a forward-looking basis;
- An increasingly robust intellectual property base – The UK offers an almost unparalleled breadth and depth of IP, spanning its football clubs (almost half of the top 30 global football clubs by revenue) to its universities (3 of which consistently feature in the world’s top 10 universities). This is not to mention the disproportionate impact UK scientists had on the impressive and rapid development of a Covid vaccine.
- Economic strength – Whilst not boasting the headline GDP growth numbers sported by some other countries the UK can hold its head high in having maintained a consistently low unemployment rate (particularly when compared with those in Europe & the US).
- Funding strength – One consequence of higher bond yields (which we have seen over recent months) is that it increases the cost of a governments borrowing. This is likely to become more of an issue over time and it is worth noting the UK has by far the longest average term to maturity of its debt across the developed world (17.8yrs vs just 6 in the US). This essentially means the UK has fixed its borrowing costs for a much longer period and thus has lower refinancing risks than many other economies.
- Falling political risk – Clearly Brexit and the associated uncertainty has weighed heavily on the UK as a whole. However, with the most critical negotiations now behind us we see many reasons to believe that excessive risk premia associated with Brexit should begin to recede. It also feels increasingly clear to us that leaving the EU also allows the UK government to turn its attention more toward stimulating domestic investment and growth.
- Cheap equity valuations, cheap currency – The UK market continues to trade at a significant discount to other developed markets and has more recently traded at lower earnings multiple than the (arguably much riskier) Emerging Market equity universe;
This is a fact that does not appear lost on overseas investors given the significant pick up in M&A activity YTD, with overseas corporate and private equity investors looking to take advantage of this apparent dislocation.
All in all, we can think of far more reasons to own UK equities here than not to. Whilst it is very possible that we are being overly optimistic about the outlook the balance of risk and reward appears to be very much in our favour.
Our investment strategy committee, which consists of seasoned strategists and investment managers, meets regularly to review asset allocation, geographical spread, sector preferences and key global market drivers and our economist produces research and views on global economies which complement this process.
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