STOCK markets are increasingly worried about President Trump’s efforts to disrupt global trade.
The prospect of a trade war between the US, Europe and China has brought nervousness to global markets, with emerging markets and Europe in particular seeing some weakness as the US dollar has strengthened.
As if this wasn’t enough, UK investors also have to contend with Brexit, which lurches from crisis to crisis daily, leading to a weaker pound and a reluctance to invest in the UK. The process remains slow and highly uncertain, with timescales likely to extend well beyond the initial 2019 deadline.
There is a clear and present danger to the economy now.
As a result, the UK stock market has rarely been less loved by investors, who have fled from UK equities since the Brexit vote in June 2016, leading to a material underperformance against other global markets. The recent Bank of America Merrill Lynch Global Fund Manager Survey showed extreme levels of negativity towards UK shares, the highest since their records began.
This ongoing decline of UK equities against global equity markets and the yield gap between shares and UK gilts makes the investment case for the UK increasingly compelling in our view. The yield difference between shares and government bonds is now at levels we have not seen since the second world war, with the UK index dividend yield around four per cent and the 10-year UK gilt offering only 1.3%, well below inflation of 2.4%.
Investing in supposedly safe assets such as gilts is increasingly fraught with danger. Bond yields have rarely been lower despite inflation continuing to rise and the huge monetary stimulus we have seen courtesy of quantitative easing will one day come to an end. This is before we even consider the notion of a hard Brexit.
The astonishing dominance of the technology sector in recent years has also meant it has been a miserable time for value investors globally. Today’s masters of the universe are no longer to be found on Wall Street but in Silicon Valley. In a world of low growth, investors are willing to pay an extraordinarily high price for future prosperity. However, should cracks appear in such high-growth companies there could be considerable risk to current valuations .
If we believe that there is a case for increasing investment in the UK then what does one buy today? We continue to see the financial sector as an important source of dividend income and sectors such as life assurance and banks should benefit from higher interest rates and rising bond yields. Despite considerable restructuring and much reduced risk profiles, the UK banking sector has yet to recover its poise since the global financial crisis of 10 years ago.
We are conscious that investments in companies serving the UK consumer face an increasingly tough environment as Brexit drags on, with economic shocks possible, leading to further dips in confidence. Sectors such as retail and leisure are likely to find growth hard to come by over the next few years. Despite this we see exceptional long-term value in some higher-quality UK domestic businesses, but it is a path which needs to be navigated carefully.
We believe that there is still plenty of potential value to be unlocked from the UK stock market. The income on offer from UK shares remains highly attractive relative to gilt yields and the market remains firmly out of favour with global asset allocators. There has been a pickup in takeover activity, with businesses such as Sainsbury’s, Sky, GKN and Shire all seeing approaches so far in 2018. This is likely to continue if valuations remain low and sterling weak.
There is now an opportunity to buy well-established businesses with strong balance sheets at highly attractive prices. Careful buying when things look bleak can often prove rewarding.
Scott McKenzie is investment director at Saracen Fund Managers.
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