La rentrée: business as usual post-Brexit
Article | 31 October 2016
The political events of June made for a stormy summer in UK equity markets, but after a quieter August, I expect UK companies to be very much business as usual as the market goes back to work.
The UK equity market has staged a remarkable recovery from its post-Brexit shocks; in aggregate, equity prices have risen strongly since the referendum, buoyed by the flight to perceived safety in defensive and international stocks, and by weakened sterling.
Economic data released through the summer months has captivated a market looking for recessionary signals, but, by and large, the first signs have been fairly encouraging. Fears over the sharp decline in July’s Purchasing Managers’ Index (PMI) were allayed by the surge that followed in August, driven largely by export growth on the back of the weakened pound. Inflation looks set to increase into 2017 and, if higher-than-expected, growth data could take the market by surprise.
Fundamentally, the UK equity market remains dominated by a collection of very international companies whose fortunes and share prices (currency adjusted) are closely correlated with global markets. Looking beyond Brexit, I maintain the view that downward pressure on corporate profitability and subdued global growth will present the greater challenge to the UK equity market’s long-term growth potential. Since the vote, I have continued my bottom-up approach to stock selection, focusing analysis on identifying opportunities in the areas suffering the worst of the sell–off. History suggests this is the most productive course, particularly since valuations were already very depressed for well-versed reasons. I believe that the stock market will reward visibility of earnings over the long term, and so continue to favour businesses with strong management and which, in view of the more challenged outlook, are capable of self-help.
The scale of the decline in certain domestically-focused sectors, notably financials, construction and travel, was more severe than expected. But the subsequent reversion in share prices of some of the hardest-hit companies, speaks volumes for the irrational pricing and unusual asset correlations at play in the current market environment. By taking advantage of what I believe to be pricing anomalies in depressed areas of the market, alongside some profits from inflated dollar-earners, I have increased my portfolios’ domestic exposure.
UK equity market valuations are currently trading at levels around 18 times 2016 earnings1 and, in my view, look inflated. The slump in government bond yields since the referendum has driven up the price the market is willing to pay for equities with more stable cashflows; favourable currency movements have also provided some uplift to the outlook for UK earnings derived overseas. Should GDP growth be maintained through the second half of 2016 I anticipate improved confidence in domestic-facing companies. In view of this, the marginal reshaping of my portfolios has included a venture into the retail sector with the purchase of clothing business Next – a stock which I viewed as particularly oversold in an already depressed sector.
UK financial stocks, including portfolio holdings Provident Financial, Legal & General and Derwent London, were also hit hard in the sell-off, but all three bounced back strongly in July and August. These businesses continue to fulfil the characteristics I look for in this sector: the ability to adapt and grow in a shifting regulatory landscape, embracing new technology to maximise customer satisfaction, minimise costs and help sustain future profit growth.
Provident Financial’s recent second quarter results showed robust performance across the group’s three businesses and provided shareholders with a 10% interim dividend increase; Chief Executive Peter Crook said the non-standard lender’s strong performance and sound credit quality through the first half of the year provide a foundation for continued growth and firm trading through the UK’s current economic uncertainties.
Insurance and financial services group Legal & General’s share price fell 30% over the two days post-Brexit, but strong Q2 results went some way to demonstrate Chief Executive Nigel Wilson’s contention that the business’s five long-term growth drivers - ageing populations, globalisation of asset markets, creating real assets, welfare reform and digital - remain resilient.
Despite the dramatic slump in the share prices of UK major banks, I have maintained my zero weighting in these businesses: the regulatory outlook remains challenged, while recent downgrades to UK interest rate expectations have dealt another blow to banks’ ability to pay and grow their dividends, a key requisite of my long-term investment approach.
1 Source: Lazarus Partnership, 2 September 2016.
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Where securities are mentioned in this document they do not necessarily represent a specific portfolio holding and do not constitute a recommendation to purchase, hold or sell.
Where Mark Barnett has expressed opinions, they are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco Perpetual investment professionals.
For the most up to date information on our funds, please refer to the relevant fund and share class-specific Key Investor Information Documents, the Supplementary Information Document, the Annual or Interim Short Reports and the Prospectus, which are available from the Literature section.