We discuss the outlook for UK equities.
- The UK stock market is home to many global businesses with sustainable competitive advantages that are exposed to structural growth trends.
- UK equities have underperformed global equities since the 2016 referendum on EU membership, and we believe a good degree of pessimism is already in the price.
- The best opportunities can often arise when uncertainty is greatest.
As I write this (9 December), uncertainty remains high as to whether the UK and EU (European Union) will reach a Brexit deal, with time rapidly running out before the year-end deadline, and three remaining sticking points in the negotiations that are proving a challenge to resolve.
It is not a surprise that we are seeing protracted negotiations going down to the wire. Since the referendum in 2016 it has been anything but a smooth ride and, by the nature of negotiations, neither side will be wanting to yield ground before the eleventh hour to avoid the perception that they are ‘giving in’ to the other’s demands. It is ultimately strongly in the interests of both sides to reach a deal, so this is still by some way the most likely outcome in my view.
But what happens if there is no deal? Whatever your view as to the likelihood of a deal, it is important to consider this as a potential outcome. History of ‘shock’ political events would suggest that there will be a knee-jerk market reaction on the day – in this case we are likely to see a sharp weakening of sterling and share-price declines of domestically exposed UK equities. However, I would expect this to be followed by a recovery as the market digests the situation and comes to terms with the new reality, which may not be all that bad.
While a ‘no-deal’ Brexit would be unhelpful, it won’t necessarily have too dramatic an effect. It has taken a long time to get to this point, a lot of arrangements are now in place, and companies are well prepared, carrying additional inventory in case of delays at borders. Life will go on.
Much is written about the potential negative long-term impact of Brexit on the UK economy, but we should avoid reading too much into this when thinking about UK equities for several reasons.
Most importantly, the prospects for UK equities do not necessarily correlate with the prospects of the UK economy. The UK stock market is home to many global businesses that are rich in intellectual property, with sustainable competitive advantages that are exposed to structural growth trends. Among those businesses that are domestically oriented, there are many that will be minimally affected since they sell goods that people will still need and want regardless.
While Brexit may cause some disruption, we are all used to living with disruption. People and businesses adapt. A changing environment has been a constant, whether it be from evolving consumer habits, such as the decline of the high street and the growth of online retail, or owing to events such as the pandemic. Companies and economies can prosper once they recognise and adapt to a new environment. Furthermore, it could well be the case that, over the long term, thematic changes will prove more instrumental in shaping the investment landscape than Brexit.
Finally, UK equities appear to be attractively valued; they have underperformed global equities since the referendum, and we believe there is a good degree of pessimism already in the price. The best opportunities often arise when uncertainty is greatest. This feels like that point.
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