The trading year kicked off with a bang as the FTSE 100 finished off the first day of trading in 2021 up over 1.7%. Sterling has also seen a bit of a bounce, reaching above $1.37 for the first time in over two years. Both have served a reminder of two important trends.
First, UK shares look undervalued relative to the rest of the world due to several years of political uncertainty. Secondly, the EU-UK co-operation and trade agreement means that Brexit uncertainty should at last be removed, encouraging investors to possibly rethink about investing in the UK.
Is the UK undervalued?
Investors do not like political and regulatory uncertainty and the Brexit process was a classic reminder of that. In 2020, the UK stock market experienced its worst performance since 2008. In comparison, the US stock market reached a record high. Other markets also put in a good performance.
Schroders, the asset managers, recently created a metric based on the average of three ratios for UK shares: price to book, price to earnings and price to dividends. It showed UK shares were trading at a 30% discount to their global peers, the biggest gap for nearly 30 years.
During the five years since the Brexit referendum, business investment in the UK has been disappointingly weak and it collapsed earlier last year. The latest bulletin from the Office for National Statistics (ONS) showed it is down 19% in the year to September, despite recovering by a record 9% in the latest quarter.
Recoveries in asset prices and investment are being driven globally by an abundance of money printed by central banks (including the Bank of England) and record government borrowing. This is what analysts call “the reflation trade”. Some of the more excited commentators have announced we are going to see a “Roaring Twenties” as we did 100 years ago.
Unlike in other recessions, the Covid-crisis has seen no shortage of liquidity and much of this has found its way into asset prices, though UK shares have lagged other markets.
Is there hope for the UK stock market?
The deal gives the UK and the EU zero tariff and zero quota access to each other’s markets, but more importantly helps the UK co-operate with our biggest trading partner.
The fact that the UK was the first to approve and administer the Oxford/Astra Zeneca vaccine is another boost to market sentiment.
The money and credit figures from the Bank of England this week indicate just how money and credit are available in the economy. There were 105,000 approvals of mortgages for house purchases in December, the highest monthly number for 13 years.
Some households have also used lockdowns to save. The ONS says the savings ratio, which measures the proportion of incomes not spent and instead saved, hit a record 27% earlier this year. And in the third quarter it was still at 16%, about twice the typical level.
Leaving aside the relatively poor performance of the UK in recent years, evidence of how underweight global investors are of UK shares comes from a recent Bank of America investor sentiment survey. It showed the world’s largest investors have the lowest relative weighting of UK shares in their portfolios on record. As they rebalance their portfolios, UK shares could benefit.
Corporates can also see UK shares are undervalued. Already, Entain, the FTSE-100 company which owns Ladbrokes Coral, has rejected an £8bn cash and shares offer from US casino operator MGM Resorts.
Britain’s six million retail investors have preferred global equities to UK equities in recent years. For example, the latest data from the Investment Association shows that global equities was the best-selling sector in October 2020, with net inflows of £869m. The worst selling sector was UK equity income, with net outflows of £782m. If retail investors’ traditional appetite for UK funds returns, that could also benefit share prices.
Clearing up the Brexit snags
Despite the agreement of the EU-UK Trade and Co-operation Treaty and its ratification on 30 December 2020, it is important to understand that the Brexit process is not yet complete. First it needs to be ratified by the EU Parliament, expected by end of February. It is possible that some MEPs and nation states may object to elements of the accord and ask the UK for adjustments.
Second, there are numerous areas where agreements with the EU need to be developed or put into practice. One of the most critical of these is financial services, where the two sides have said they intend to agree a Memorandum of Understanding by the end of March. This is especially important for the UK, as financial services is where we run our biggest trade surplus.
Leaving aside the residual Brexit snags which need tying up, we also have to face the ongoing serious threat of the coronavirus. There is an old city expression that bull markets climb a wall of worry, and this one may be no different.
This article isn’t personal advice. If you’re not sure if an investment is right for you make sure you ask for advice.
George Trefgarne is CEO of Boscobel & Partners, a political consultancy. Hargreaves Lansdown may not share the views of the author.
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