Election result: What does it mean for UK equities?
Following today’s result we’re anticipating international investors, who have recently begun to re-allocate back to the UK, to move off the side-lines and materially increase their allocations which still remain at historically low levels.
Positive environment for equity flows
According to the latest Bank of America Merrill Lynch Global Fund Manager Survey, the UK equity market had become a consensual underweight for investors, but this turned sharply in November. This election result may add fuel to the fire for UK equity inflows, both from international investors, who are still typically underweight UK equities versus their benchmarks, and from domestic investors, who have been cautious. In the context of continued weakness in a number of global economic activity indicators, the UK may start to look increasingly attractive to asset allocators.
Our view is that the UK equity market also remains cheap relative to other markets. For example, relative to MSCI World, the UK trades at around a 35% discount on a blend of valuation measures.
While the performance of Sterling in the run-up to the election (+10% vs. the Dollar since August) implied that this outcome was already somewhat discounted by markets, a wariness of opinion polls meant many investors remained on the side-lines ahead of a conclusive result.
Sectors to think about
Sterling strength is typically positive for UK importers (e.g. retailers and other consumer facing businesses) as their cost of goods reduces in Sterling terms. These businesses will also benefit from lower ‘imported inflation’, meaning household spending power increases; this could be met by increased consumer confidence and spending. The skill will be to identify which of these businesses can fully capture this tailwind, without the headwind of further market share loss to online retailers.
It is also a potential positive for labour availability (a recent drag on earnings for a number of leisure businesses). Overseas workers may be encouraged to come to work in the UK, although uncertainty over immigration policies post-Brexit may temper this. Furthermore, the trajectory for the National Living Wage poses an ongoing cost headwind, regardless of labour availability.
It is not just the retailers and leisure businesses that have suffered from weak Sterling. Car insurers (who have seen the cost of imported spare parts increase) and veterinary surgeries (who have struggled to find staff to meet demand) will, most likely, also be glad to see sterling strengthen.
On the other side of the equation are the exporters and foreign earners. While the foreign earners should see a one-time step-down in their Sterling reported earnings, many exporters have become sustainably less cost-competitive versus their international peers and will need to invest in productivity improvements to defend margins.
With a number of nationalisations now “off the table” sectors such as utilities, telecoms, mail and rail should revert to trading on fundamentals. But, for a number of these businesses, the fundamentals are not looking great. Any bounces in associated stocks may be short-lived.
What next on Brexit?
A Conservative government, with a refreshed list of MPs, should mean getting Johnson’s deal through parliament become, in theory, little more than a formality at this stage. On that basis, the UK will leave the EU on 31 January 2020 and enter a transition period, with a view to negotiating a trade deal with the EU by the end of the year (which may in itself be a herculean task).
Anthony Lynch is portfolio manager of the JPM UK Equity Plus Fund, JPM UK Equity Core Fund & The Mercantile Investment Trust