UK equities set to revive as vaccine roll-out boosts economic recovery hopes
Asset managers are preparing for a rebound in UK equities, as an easing of coronavirus restrictions is expected to follow a swift roll-out of vaccinations.
Last week, the chief economist of the Bank of England Andy Haldane said that the UK economy is “like a coiled spring” with “enormous amounts of pent-up financial energy waiting to be released” once the effects of the mass vaccination programme kick in.
The UK economy shrank by almost 10 per cent last year, resulting in a contraction more than twice as large as any on record, said the Office for National Statistics.
The IMF expects the UK economy to expand by 4.5 per cent this year, and another 5 per cent in 2022.
At the end of January, London-headquartered asset manager Schroders, upgraded its outlook on UK equities to ‘positive’.
“We upgraded UK equities as we expect it to benefit as the global recovery broadens into multinational and commodity-sensitive markets,” wrote Schroders, noting strong recent gains from oil and gas and basic materials companies.
The FTSE All-Share index posted negative returns in January as companies in the financials, industrials, and consumer goods sectors all weakened.
Growth stocks, especially technology companies, outperformed traditional value stocks across major markets in 2020, but Schroders says this could change in the year ahead.
“The roster of top performers is quite likely to be different this year. But anyone who has been sucked into the hype to believe that it is only high-growth companies that can offer high returns needs to think again,” the firm said.
Research from Citigroup shows that more than half of the stocks in the MSCI UK index are value companies, giving London’s stock market the highest weighting towards value out of all its major peers.
Schroders notes that value’s performance is stronger in the UK than in many other markets, with 30 per cent of value stocks outperforming the average growth company. In comparison, only 18 per cent of US value companies outperformed their growth peers.
Among traditional value sectors, oil and gas could be due for outperformance in 2021, says Ian Lance, co-manager Temple Bar Investment Trust.
Lance notes that in the past, investors have “wrongly perceived” companies in industries such as tobacco and utilities to be ‘value traps’ – meaning that falling stock valuations are driven by the industry’s structural decline.
He says that many investors now consider oil and gas companies as “un-investable” due to the belief that peak oil demand has been reached. According to Lance, this narrative fails to “take account of the potential impact that capital being retired from the industry will have on energy prices or of the way the energy businesses are re-inventing themselves”.
“Energy today could well be the tobacco of 2000 and this goes for other sectors where, post-pandemic, there are some stocks with very low valuations that the market has given up on as a whole,” says Lance.
“The UK may be full of old economy stocks, but that doesn’t mean you can’t make money out of them. BP and Anglo American are strong examples, energy and mining stocks about as old economy as you can get, yet their valuations remain promising.”
Later in the year, a return to higher inflation could give another boost to value stocks.
In January, the UK’s Consumer Prices Index was 0.7 per cent driven by rising prices for food, transport and household goods.
“Expectations are for a rebound into the end of this year, with the potential for inflation to return to a level close to the Bank of England’s target,” says Oliver Blackbourn, Multi-Asset Portfolio Manager at Janus Henderson.
Changing tax and regulatory policies, such as the end to the hospitality VAT cut and a rise in the domestic energy bill price cap, could drive higher inflation, according to Blackbourn.
He adds that a spike in savings rates last year suggests that consumer spending power has increased, adding that a “surge in consumption may lead to prices rising as service companies take time to return to full operations”.
“There are competing forces in terms of the demand outlook for the economy,” warns Blackbourn. “Re-opening of the economy in response to the roll-out of vaccines may actually lead to unemployment rising as those that have been kept on due to the government’s furlough schemes are deemed surplus to requirements. This will be a drag on demand and therefore inflation.”
Other factors that could continue to hold back UK equity performance include the failure of UK and EU negotiators to secure ‘equivalence’ for UK-based financial services firms post-Brexit, which would allow them to trade freely within the EU.
The EU’s refusal to grant equivalence could deal a significant blow to London markets, as the financial sector makes up almost a fifth of the UK’s large-cap index.
The City of London lost its crown as Europe’s leading centre for euro share trading and also for euro-denominated swaps in January.
Data from Liquidnet shows that the proportion of activity in EU stocks traded on UK-based venues now represents just 2.75 per cent of EU addressable liquidity, compared to 25 per cent pre-Brexit.
The EU’s financial services chief Mairead McGuinness has warned that the bloc would demand to know the UK’s future regulatory plans as “there cannot be equivalence and wide divergence” in financial regulation.
The Bank of England Governor Andrew Bailey has hit back, calling the EU’s position on equivalence a demand for “rule-taking” by the UK.