Markets hate uncertainty, but where there is uncertainty there is also opportunity. Since voting to leave the EU, the UK has faced an uncertain future, which is why the UK stock markets have underperformed their peers since June 2016. In the aftermath of the vote, the FTSE 100 did rally due to the devaluation of Sterling, but overall performance when compared globally has been poor.
Since the close on 23rd June 2016, for the Sterling investor, UK markets have returned around 17.5% to date, while other markets such as the Dow Jones have returned 45%, and the Japanese Nikkei 40%:
Even on a local currency basis, the UK is still the worst performing market:
It is well known that global fund managers are currently underweight when it comes to UK Equity, but should this really be the case? There is certainly an argument that can be put forth for making a case for the UK stock market. Companies have always needed to continuously innovate and improve their products and services and, importantly for shareholders, to grow their profits and dividends. We believe they will continue to do so, just like the majority have always done. Failure on the company’s part to do this will ultimately result in the company’s failure; it won’t be because of wider uncertainty in the markets. Of course, there will always be external pressures such as Brexit, but why would this be any different from any uncertainty crisis of confidence that has gone before?
As well as continually innovating, an often forgotten fact is that companies don’t like uncertainty, and to avoid any nasty surprises they will take pre-emptive action. One such company for example is EasyJet, which has opened a European headquarters in Austria. The reason behind this was to obtain an Air Operators Certificate (AOC) in another EU member state, enabling it to continue to fly within the EU once the UK leaves the Union. This might have been unnecessary given the extended transitional deal agreed last week and the fact that the EU may have been happy with EasyJet continuing to operate without the need to establish a European headquarters. Furthermore, it has even continued to expand with the acquisition of part of the bankrupt German carrier, Air Berlin. Another such example is HSBC, which already has banking licences in the EU and in France, and as it already prides itself as the worlds ‘local bank’ it too is in an adequate position to continue operating once the UK leaves the EU. Other companies that dominate the FTSE 100 have also made contingency plans for Brexit and, according to the Confederation of British Industry (CBI) the majority of businesses have already examined what opportunities may arise out of Brexit. Of those that have looked, just over half have found potential opportunities. The famed fund manager, Neil Woodford is another supporter of British economic resilience and a firm believer that the best is yet to come for the UK. While his fund has had a lacklustre year, his overall performance over the last thirty years allows his words to continue to hold some weight.
Britain has also always been at the forefront of Research and Development (R&D), and the government will not only increase its funding in this area, but also incentivise investors who would like to invest in small fledgling companies. This was seen in the 2017 budget where the Enterprise Investment Scheme annual investment allowance was raised from £1m up to £2m. In the future we could also see an increase to the Venture Capital Trust Allowance, which currently stands at £300,000.
Having said that companies are generally good at adapting, there is one place where there is evidence to suggest the contrary, and that is on high streets up and down the UK. This is one area to be avoided from an investment perspective. To be completely fair, this is not a failure on the part of the high streets to try and adapt, but moreover a sector in its death throes. Over the last few weeks we have seen companies such as Carpetright and Mothercare issue dire warnings about their future. One can’t help but feel that no matter how much restructuring they undertake, it will be no remedy against the fundamental change being seen in the UK retail sector.
It could also be argued that by coming out of the European Union, British businesses should become more productive. I know many firms in our sector, including Rowan Dartington, have been grappling with new legislation such as MiFID II and the General Data Protection Regulation (GDPR). These regulations have collectively cost the industry billions! These are costs that will have a direct impact on profitability and future innovation. Of course, we are not stating that there shouldn’t be any evolving regulation, but in the highly regulated and sometimes overly bureaucratic EU, increased overregulation can often have a detrimental impact on businesses and their bottom lines.
In light of this article you may think Rowan Dartington is overweight in the UK equity market, but the truth is the opposite. This has served us well over the last year as overseas markets have grown faster than the UK market. However, the UK stock market will be expected to catch up at some point, especially as uncertainty has now taken hold in many overseas markets; due in part to Donald Trump’s looming trade war with China (everyone else seems to be exempt). This is certainly something that we are going to consider over the coming months. Given the meteoric rise of some overseas markets coupled with trade war uncertainty, it could be cause to reconsider the UK as a worthwhile investment opportunity.
Equity Markets Slump on Trade War Fears
Global equity markets were firmly on the back foot last week as the impending trade war between the US and China moved a step closer. The Trump Administration announced plans to impose tariffs of up to $60.0bn on Chinese imports, $10.0bn higher than previously suggested. Restrictions on Chinese investment into the US will also be restricted with Chinese officials stating that they are prepared to fight fire with fire with the introduction of import duties of their own.
Unsurprisingly, the S&P500 was the hardest hit amongst the world’s largest stock markets after a near -6.0% decline. The situation was exacerbated somewhat by the ongoing issues at Facebook which shed more than $50.0bn from its market cap on the back of the Cambridge Analytica scandal. Domestically, the FTSE100 was -3.4% lower for the week with mid cap focussed FTSE250 faring slightly better with a -2.5% decline. European markets followed suit with the German DAX30 and French CAC40 declining by -4.1% and -3.6% respectively with the Nikkei 225 -4.9% lower for the week.
Despite the noise dominating equity markets, sovereign debt markets had a largely uneventful week. UK 10-year gilt yields were 3 basis points (bps) higher at 1.48% with the US Treasury equivalent 2 bps lower at 2.83%. Last week, the Federal Reserve voted for another round of monetary policy tightening with the base rate lifted by 25bps to a range of 1.50-1.75%. As expected, the Bank of England voted to leave its own base rate unchanged although 2 of the MPC’s 9 members voted in favour of higher rates, suggesting a more hawkish stance is beginning to creep back in. Market expectations suggest the next move will take place at the MPC meeting in May.
Dollar weakness continued to persevere with the Greenback losing further ground against both Sterling (+1.7% to $1.42) and the Euro (+1.0% to €1.24). The knock-on effect from that was that Gold had another positive week. The precious metal rose by +2.6% to just under $1,350 an ounce. Oil also had a particularly strong week with Brent crude spiking by more than +6.4% to $70.45 a barrel.
The Week Ahead
Final estimates of fourth quarter economic growth are due this week in both the US and in the UK, Wednesday and Thursday respectively. The States could see an upward revision again in this estimate now that more complete data is available whilst the UK reading is expected to remain unchanged at its quarterly rate of 0.4%. Elsewhere, there is little scheduled for release in Europe this week. In contrast however, Asian markets will see an increasing amount of data as the week progresses with Retail Sales, unemployment, and inflation readings due in Japan. The week draws to a close with the latest Chinese Purchasing Managers Index (PMI) data in the early hours of Saturday morning.