Has the UK stock market recovery finally arrived?

UK stocks might finally be back in the good books of global investors. 

Market watchers have long predicted a return to favour, and our attractive valuations, post-Brexit and pandemic recovery and a flurry of high profile mergers and takeovers could now be doing the trick.

With financial experts sounding ever more convinced about the UK’s brightening prospects, we round up their views on what this means for investors and tips on where to put your money.

Out of favour: UK markets have been shunned since Brexit, and the Covid crisis didn’t help – but is the mood changing?

‘It’s now a little over five years since the Brexit referendum and over that period UK equities have found themselves decidedly unloved,’ says Thomas Moore, senior investment director at Aberdeen Standard Investments.

He puts this down to substantial political uncertainty over the UK-Europe relationship, the dominance of ‘old economy’ sectors in the UK market index, and one of the most severe downturns in developed markets in the immediate aftermath of the Covid-19 crisis.

But Moore says UK equities currently offer a great deal of interest on a long-term basis, as times of uncertainty can create opportunity.

Long-term view: FTSE 100 could be heading for the peaks again (Source: Yahoo Finance, 1 September 2021)

Jason Hollands, managing director of Bestinvest, says: ‘It’s fair to say that UK equities have spent a few years in the wilderness, shunned since 2016 due to Brexit and political uncertainties and hammered hard in 2020 because of the market’s relatively high exposure to cyclical sectors such as energy, commodities and financials.’

‘But we are in a very different place now.’

Why do investment experts think UK markets are bouncing back?

Stocks are cheap and yields are high

In recent years, US equities have outperformed other regions by a large margin, powered by some of the world’s most important technology stocks, according to Moore.

US large cap valuations have moved sharply above their long-term averages over the past five years while the UK equity market is just below its long-term average, he says.

‘This is a great starting point for investors because, over longer periods, the starting valuation you pay has been a key determinant of future returns.’

Meanwhile, 2020 was a particularly challenging year for UK dividends given that most payouts are made by a small number of firms and Covid 19 had an enormous impact on economic activity, commodity prices, and companies’ willingness or regulatory ability to pay dividends, he explains.

‘Those companies that were at risk of cutting their dividends have now done so. Dividends are now growing again as the cyclical backdrop improves.

‘Today, the FTSE All Share yields around 3.5 per cent, which remains attractive relative to other equity markets and asset classes.’

Hollands says that with bond yields extremely low across the globe, equities remain the main game in town.

‘UK equities continue to be the relative bargain in a global context, particularly given the very rich valuations now seen in parts of the US market.

‘UK stocks are also an attractive source of dividend income too with many companies who scrapped or froze pay-outs last year, resuming dividend payments.’  

Thomas Moore: The economic backdrop is strengthening for UK plc

Investors are looking beyond Brexit and Covid

Global fund manager surveys over the last seven years show that these investors have been materially underweight in UK equities, says Moore.

‘For much of this period, Brexit has been a major overhang, followed on by the severe impacts created by Covid on the UK economy and stock market.

‘However, with much more certainty on the UK’s relationship with Europe, the release of vaccines in the fight against Covid-19 and continued monetary and fiscal policy support, risk appetite towards the asset class is starting to inflect.

‘With the clouds of Brexit led uncertainty now cleared, combined with the more cyclical, value orientated composition of the UK market, investors are re-engaging.

‘Furthermore, lockdown has created huge, pent up demand with people much less able to spend their money, allowing for the highest and second highest level of net savings on record.’

He goes on: ‘Considering UK plc, the economic backdrop is strengthening supported by rapid vaccination, growing business and consumer confidence, a falling unemployment rate and a likely material boost in consumer spending in the coming months.

‘It appears these dynamics have supported global investors’ moves in the last few months to reduce the underweight to UK equities.’

Hollands says: ‘The success of the UK’s vaccination programme and removal of lockdown restrictions has enabled a sharp rebound in the domestic economy, oiled by over £200billion of excess savings built up during the lockdowns fuelling a surge in consumer spending.’

He notes there is some evidence of momentum fading after the rebound in GDP, but businesses are better able to plan ahead with the lockdowns over.

And he predicts that inflation should peak at 4 per cent by the end of the year before subsiding in 2022.

Jason Hollands:  The frenzy of private equity bids for UK companies is a clear sign the UK is on the radar again

Mergers and takeovers are popular

In terms of the value of deals conducted in the first half of this year, UK mergers and acquisitions (M&A) activity is at a record high, says Moore.

There have been 124 takeovers and purchases of minority stakes worth around £41.5bn, underscored by factors including attractive valuations, the resolution of Brexit and the pace of the Covid-19 vaccination programme, he explains.

‘What is particularly interesting here is that 47 per cent of European private equity deals in 2021 targeted UK companies – almost half of the deals done.

‘With the FTSE All Share trading at a material valuation discount to global equity markets, we are heading for biggest year for UK private equity takeouts since 2007.

‘A clear conclusion is that while public markets have left the UK equity market to one side, private equity is capitalising on the opportunity for global growth.’

Hollands says: ‘The frenzy of private equity bids for UK companies is a clear sign that the UK is very much on the radar again for international investors and so if you’ve looked elsewhere in recent years for investment ideas in your Isas and pensions, it would be wise to take another look at the opportunities right on your doorstep.’

How is the UK market doing versus the US? 

The US stock market led the world out of the Covid crisis and the S&P 500 is close to all-time highs, points out Juliet Schooling Latter, research director at FundCalibre.

Juliet Schooling Latter: We have a plentiful supply of very good firms

‘The big internet giants of Amazon, Microsoft, Apple and the like have all seen their share prices rise exponentially and have taken the rest of the US stock market with them.’

By comparison since the market lows of 23 March 2020, the S&P 500 has returned 71.5 per cent for investors (total returns in sterling, net of fees), while the FTSE 100 has trailed behind with returns just shy of 50 per cent, she says.

‘More depressingly, the FTSE 100 is still trading around the 7,000-mark – a level where it started the millennium more than 20 years ago.

‘Thankfully for investors, there is much more to our economy than our largest 100 companies. There are hidden depths and breadth to the British stock market.

‘We have a plentiful supply of very good firms that may be in less headline-grabbing sectors than those in the US, but which are nevertheless industry leaders. What’s more, we have an abundance of talented fund managers – the skills of which have been displayed perfectly since the stock market plunge last year.’

Schooling Latter says the average IA UK All Companies fund has returned 72% per cent since the market lows – just beating the US market.

What is likely to happen next?

‘The UK equity market is currently trading around the steepest valuation discount to global equity markets in 20 years,’ says Moore.

‘There is clear evidence that investors are re-engaging with the asset class with the UK economy set to continue to recover strongly. World class governance standards support investors looking to generate returns from global opportunities.

‘And record M&A activity highlights the latent value that forward-looking stock pickers can currently find in UK equities.’

Schooling Latter strikes a more downbeat note, saying: ‘I don’t want to paint too rosy a picture of the UK today – there are still things to be ironed out over Brexit, furlough schemes are coming to an end and any subsequent unemployment increase could put a dampener on consumer spending.

‘Inflation is also proving stickier than expected.

‘But with more Brexit certainty, a good vaccine rollout and the fastest economic growth forecasts since the second World War, sentiment is on the up.’

She points to a recent Bank of America global fund manager survey which shows respondents are ‘overweight’ UK stocks for the first time since March 2014.

And Schooling Latter says despite excellent gains made by fund managers since the market lows, UK equities continue to operate at a 40 per cent discount to their peers – a 30 year-low, so there is still a lot of catching up to do.

Which UK funds are worth a look?

Jason Hollands tips: 

Liontrust Special Situations (Ongoing charge: 2.05 per cent)

‘This fund invests across the full gamut of the UK markets, including AIM,’ he says. ‘Currently it is around 39 per cent invested in FTSE 100 companies, 28 per cent in mid-caps and 28 per cent in smaller companies.

‘Despite its high exposure to smaller companies, is notable for its relatively low volatility compared to the wider market while also consistently outperforming over multiple time periods.’

Its top positions include Diageo, RELX, Spirax Sarco Engineering and Sage, he adds.

TB Evenlode Income (Ongoing charge: 0.62 per cent)

The managers invest in businesses for the long-term with a low turnover approach to a concentrated portfolio of high quality companies,’ he says.

These generate predictable cash flows, enabling them to keep churning out dividends or reinvest in their business, he explains.

‘The biggest holdings are consumer brands giant Unilever, RELX and Guinness-owned Diageo.’

Threadneedle UK Equity Income (Ongoing charge: 0.82 per cent)

‘Longstanding income manager Richard Colwell takes a pragmatic approach to target both capital growth and income, rather than prioritising the latter like some income funds,’ says Hollands.

‘He will therefore invest in both in a core portfolio quality growth companies that can compound their cash flows and stocks that he believes are undervalued with recovery potential.’

The fund has big positions in AstraZeneca, Electrocomponents, Rentokil and GlaxoSmithKline.

Juliet Schooling Latter tips:

ASI UK Ethical Equity (Ongoing charge: 0.90 per cent)

TB Amati UK Smaller Companies (Ongoing charge: 0.89 per cent)

ES R&M UK Recovery (Ongoing charge: 1.17 per cent)

Murray Income (Ongoing charge: 0.76 per cent)

This post first appeared on Dailymail.co.uk