09 April 2021
By John Husselbee, Co-Fund Manager WS Verbatim Portfolio Growth Funds
Across our funds, we continue to favour cheaper equity markets, including Europe, Japan and Asia/emerging markets, rather than the expensive US. We are now increasingly comfortable favouring the UK as well.
We see the UK as a solid bounceback candidate for the simple reason that if we get a strong economic recovery, global investors will look for areas that have underperformed in the hope of a bigger rebound. As an exception to the overall equity exuberance, the FTSE 100 Index suffered its worst year since 2007 with a 14% decline.
The economic outlook also remains weak, despite the encouraging progress of the vaccine rollout, and no one will be surprised to see figures released in March showing the UK economy back in reverse gear during January, with GDP estimates of a 2.9% contraction versus the previous month. This was actually better than the near 5% decline predicted by economists, with the services sector hardest hit under renewed lockdown but increases in health services from vaccine rollout and increased testing partially offsetting declines in other industries.
While there was no mention of the Brexit effect in the GDP report, separate ONS trade data highlighted the largest monthly fall in goods imports and exports for the UK since records began in January 1997. It charted a 41% decline in exports to the EU during the month, valued at £5.6 billion, alongside a £6.6bn fall in imports from the euro bloc. Meanwhile, the furlough scheme, extended again in the March Budget, is clearly masking the true unemployment picture.
One thing we have seen in recent years, however, is that a healthy macro backdrop is not a prerequisite for decent equity performance.
Before examining the potential for a rebound, it is important to understand why the UK had such a poor 2020, and there are three core reasons. First is the structure of the UK market, which remains heavily weighted towards financial services and commodities, although both are proportionally smaller now after energy fell 40% and banks nearly 35% over the course of last year.
These two worst-performing sectors make up almost 40% of the FTSE 100 whereas the Index has just 1% in technology. In contrast to the much-feted FAANGs, the UK has no large tech stars and our representatives in this sector are considerably more functional: accounting software for smaller business or oil services tech, for example, rather than social media or other ‘stay at home’ leisure stocks.
Second is the dreaded B word, with uncertainty around Brexit and the terms on which the UK would ultimately leave the EU serving to keep a lid on returns since the referendum in 2016. In 2020, investors were conscious we were nearing the end of the process and the risk of leaving without a deal started to crystallise in people’s minds. This led to periods of the UK market selling off, or barely participating in what were effectively ‘better-than-expected Covid news’ rallies, due to stalled talks, missed deadlines and repeated stalemates.
Third, it is arguable that the UK has suffered more from the pandemic than the rest of the developed world bar the US. Prime minister Boris Johnson has not shone during the crisis, going late into the first lockdown and offering mixed messaging throughout, and the worst mortality rate in Europe is hardly an inspiring profile for foreign investors. The UK is not unique in facing lockdowns but the combination of a service-driven economy (slightly more so than the US, for example) and falling levels of spending on, and employment in, travel and leisure has left the country vulnerable to their impact.
Our positive view of the UK is based on the fact many of these factors are already in the rear-view mirror and it feels like most of the negative surprises are priced in, bar any lull in vaccine rollouts or further mutations in the virus. The most significant of these is that a Brexit trade agreement was eventually signed on Christmas Eve and while the full ramifications of leaving the EU will only become clear in the months and years ahead, the deal was symbolic enough to lift the prevailing cloud of uncertainty. This alone could be enough to spark a rebound as UK equities mean revert.
If Covid-19 cases, mortality and hospitalisations continue to fall, leading to the ending of the lockdown, the UK will look more investable, especially at current attractive valuations. Once global investors have confidence in a recovery, it is natural to seek more risk and buy beaten-up stocks, of which the UK has many.
The UK also has one of the highest saving rates in the developed world, which could support a rise in spending when non-essential shops open. A big consumption boom is not our base case but we should see some pick up in holidays, for example, once travel restrictions are eased. Additionally, we have a supportive central bank willing to implement further quantitative easing, a government ready to bring in more targeted fiscal stimulus, and potential enhancements to Brexit trade deals although it may be clutching at straws to hope for the latter in 2021.
The value of investments and any income from them can go down as well as up and is not guaranteed. Your clients could get back less than they originally invested. Past performance is not a guide to future performance. The portfolios' investments are subject to normal fluctuations and other risks inherent when investing in securities. Verbatim Asset Management has taken due care and attention in preparing this document, which is solely for the use of professional advisers. Verbatim cannot be held responsible for any inaccuracies arising out of information detailed within and will not accept liability for any loss arising out of or in connection with its use. The contents of this article should not be construed as advice and is for information only. Individual stock selection should only be performed by suitably qualified advisers.