Is the UK market a buying opportunity over the longterm?
Richard Colwell, manager of Threadneedle UK Equity Income, talks us through opportunities in the UK...
It’s been a busy week in UK politics.
As was widely expected, on Tuesday, parliament voted overwhelmingly against Theresa May’s Brexit deal: 432 votes versus 202. No fewer than 118 Conservative Party MPs voted against their own prime minister, while only four opposition Labour Party members rebelled and backed the deal.
Labour Party leader Jeremy Corbyn promptly tabled a motion of no confidence, and MPs went back to the ballot box on Wednesday. This time, MPs toed the party lines and Theresa May won by 325 votes versus 306. This may seem like quite a tight number, but remember the Conservatives are the biggest minority party – not the majority.
And so we are back to square one: no deal agreed and the deadline fast-approaching.
Azad Zangana, senior European economist & strategist, at Schroders has compiled a handy guide to the next steps the government could take:
1) Consult cross-party MPs that opposed the deal, to see what changes would be necessary in order to secure their support.
2) Put those proposed changes to Brussels, in the hope of augmenting the current Withdrawal Agreement.
However, in order for the EU to be willing to re-open the current agreement, the government must be able to demonstrate that there is sufficient support for the proposed amendments to win a new vote in parliament. That means a set of proposals that can change the minds of at least 116 MPs – no mean feat.
3) If the government persuades parliament to ratify the augmented agreement, then the UK will proceed to leave the EU on 29 March, and enter a transition period.
4) In the absence of a deal being ratified, the UK will be leaving the EU without a transition period, and is likely to face significant trade tariffs in accordance with World Trade Organisation rules, along with full customs checks, and a number of other important memberships/associations with EU institutions lapsing.
“Given the fragile state of the UK economy, we would then forecast a recession over 2019,” Azad said.
5) The UK could request a temporary delay, but this would require unanimous backing from the 27 EU member states.
If the UK has not made progress in securing a majority for a deal, then the EU is unlikely to support a delay, without a clear mechanism to break the deadlock. This could come in the form of a second referendum or a general election.
And, as European Parliamentary elections are due in May, the EU is keen not to have the UK’s membership spill over into the new term – unless the UK decides to remain permanently, that is.
6) If the EU does not grant an extension to the Brexit deadline, then the UK could unilaterally revoke Article 50, only to restart the process again at a later point. This is unlikely and would certainly anger the EU and the public in the UK, especially as it would technically restart the two-year negotiation process.
The the outlook for the UK’s trade agreements with the EU remaining unclear, the first main factor for investors to consider in the shorter-term is the impact of this uncertainty on the pound.
This is likely to happen if we get a no deal, or a general election. This would benefit UK investors’ overseas holdings. For example, if you hold Global, US, European, Asian, Japanese or an emerging markets fund, your investments are likely to rise in sterling terms (assuming the currency is unhedged, which most equity funds are for retail investors).
In contrast, domestic UK stocks such as retailers, that rely on a strong pound to import products, are likely to suffer. Cyclical sectors heavily connected to the UK economy, such as banks and house builders are also likely to suffer, with medium and smaller companies feeling the brunt.
Large UK multi-national companies, which get most of their earnings from overseas, should benefit from a weaker currency, as their overseas profits will be larger when they are translated back into sterling.
Bond funds are a bit different. Those funds which sit in the IA Sterling Strategic Bond, IA Sterling Corporate Bond or IA Sterling High Yield Bond sectors are required to hedge at least 80% of their investments back into sterling. This means that, unlike most equity funds, the impact from currency movements is likely to be more limited.
But remember, there are other bond funds outside these sectors which may not be hedged, and these may feel the effects more.
The pound is likely to rally if we see a second referendum, revoking of article 50 or a new deal agreed.
In any of these scenarios, we would expect to see the exact opposite. Unhedged overseas funds may fall in value in sterling terms. Domestic UK stocks should do well, and benefit from a relief rally. Large UK multi-nationals may benefit from an initial improvement in sentiment, but a stronger pound could hurt their profits.
For those willing to look past the short-term uncertainties, UK equity income is looking attractive after a difficult period.
This asset class has been shunned by global investors, who are avoiding the UK over Brexit worries. However, the FTSE 100 now yields just shy of 5% and, with interest rates remaining so low, this will be of interest to income investors.
A good UK equity income fund should also offer a balance between large multi-nationals and more domestic businesses, hopefully off-setting each other in the event of any large movements in the currency.
Managed by Adrian Frost and Nick Shenton this stalwart of the UK equity income sector currently has 80%* in UK larger companies and 17%* in medium-sized ones. It can also invest up to 20% of in overseas stocks.
The manager of this fund invests with conviction in out-of-favour companies of all sizes. In a recent statement the manager said: “I have not tried to position the fund for one particular Brexit outcome. Markets hate uncertainty, and we could well see further bouts of volatility.”
This fund also invests in unloved companies with the ability to sustainably grow their dividends. The manager believes in being patient and not over trading and is not afraid to ignore whole parts of the market.
*Source: Fund fact sheet, as at 31 December 2018.