Three reasons to believe in the UK market
UK equities have enjoyed strong performance in recent months, with one of the world’s fastest vaccination rollouts helping to boost stocks across the FTSE All-Share. We believe that UK equities have further room to perform, with international sentiment likely to improve significantly in the coming months as UK growth picks up and market valuations remain attractive in both relative and absolute terms.
For the meantime, much of the excitement has focused on sectors which will benefit from the reopening of the economy, or in areas such as banking or mining which stand to gain from global reflation. However, many growth companies also look attractive in our view and this opportunity set appears overlooked by individual investors, even as corporate buyers set a record-breaking start to 2021 in terms of M&A activity.1
1. Growth on sale
Many quality-growth companies have seen strong results over the past year. The likes of Pets at Home, GB Group or Gear4Music have all announced better than expected guidance in recent weeks or seen upwards earnings revisions from brokers.
Despite this, we have seen 10-15% pullbacks in the share price of many quality growth companies from their all-time highs to the end of February. We believe this may offer an interesting opportunity for these types of stocks, many of which are already delivering on their growth plans.
2. Income attractive
Even the largest and most reliable of dividend payers have seen share price volatility in recent weeks. While international earners will be adversely affected by sterling strength, the income opportunity set is becoming more interesting. Unilever’s share price, for example, is down by approximately a quarter from its one-year highs and is trading below its long-term P/E ratio.2
The COVID-19 crisis has not been kind for income investors, but UK equity income appears attractive once again, particularly with many companies having reset their dividends at more sustainable levels.
3. Changing sentiment
UK equities have clearly suffered from negative perceptions over the past five years or so, with Brexit and the FTSE 100’s value bias counting against it. International investors are clearly changing their minds, however, with one survey of global fund managers finding that a net 15% were underweight the UK, a marked improvement on the 29% underweight figure recorded in June 2020.3
We believe this reappraisal of the UK has further room to run, with the UK boasting many innovative and attractively priced companies. While the UK is commonly seen as having a low technology weighting, we would argue that many names are critically dependent on technology within their businesses, including Aveva, Experian and Chemring, to name just a few. Once perceptions begin to shift, things can turn around very quickly. Even legacy sectors such as oil and gas are showing signs of change, with several companies announcing ambitious plans to move into renewable power or carbon capture schemes.
As growth investors, we will always favour companies which can grow their earnings and dividends over time. While this may result in some short-term underperformance, decades of experience has shown us the importance of sticking to our investment process and the rewards that can come with that over time.
Although some expect the rebound in value names to continue, we believe there are reasons for investors to be cautious. To begin with, COVID-19 has accelerated many structural trends, with many value names being on the wrong side of these trends over the past decade.
The greater concern, however, is that ‘reopening stocks’ could become crowded trades, with investors disregarding the underlying fundamentals of the businesses involved. Investment banks are already creating indices of tourism and leisure stocks to give investors an easy way to ‘play’ the reopening of the economy. If these trades prove popular, the volume of money flowing in could drive share prices significantly beyond intrinsic value.
We already see a high degree of optimism in some names within the tourism and leisure sector. A typical example might be an airline with its share price down by a third but whose share count is up by 45%. Such numbers would effectively value the business at pre-COVID levels; although investors might be able to count on a period of ‘super-normal’ profits as a result of pent-up consumer demand, these profits could just as easily go towards repaying the company’s COVID debts. Remember, bondholders get their share of the pie first.
Stick to the process
We have already seen a strong start to the year for the UK, and there are further encouraging signs with the vaccine rollout set to accelerate in March. We should start to see a significant pick-up in growth by the summer, with this momentum continuing throughout the year and into 2022.
As long-term investors, we strongly believe in the importance of selecting companies that can grow their economic output over time. We have a very experienced team across the UK desk, with first-hand knowledge of market crises as diverse as 1987’s Black Monday, the UK’s exit from the Exchange Rate Mechanism, the bursting of the dotcom bubble, Global Financial Crisis and, most recently, the COVID-19 pandemic.
While it can be tempting to look at the short-term darlings of the market, we firmly believe in sticking to our investment process and not chasing the latest market craze. It can be hard watching share price rebounds in lowly valued businesses, but the danger is that these challenged companies swiftly fall back from their temporary highs. Over the long term, most of the return from equities is accounted for by earnings growth. By focusing on businesses compounding their earnings over time, investors can therefore grow their capital regardless of short-term market noise.
If you have any questions on the UK market, now or over the coming months, please feel free to get in touch.
The companies mentioned in this article are for illustrative purposes only and should not be taken as a recommendation to buy or sell a particular stock.
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