UK Equities: Navigating the road to recovery

We are optimistic at the prospects for UK equities in 2021 as the UK, and also the global economies, begin to recover from the huge dislocations caused by the Covid-19 pandemic. The pace of roll out of vaccinations against Coronavirus is progressing rapidly in the UK and is supportive of an easing of lockdown restrictions in the UK that should this time prove to be sustainable. However, the range of possible outcomes for economic activity over the near term is still much wider than normal.

A quick recap reminds us that UK equities had markedly underperformed global equities since as far back as the EU referendum in June 2016. Initial uncertainties in the aftermath of the referendum were then compounded in subsequent periods by UK domestic politics, and by ongoing failure to agree with the EU on lasting arrangements post Brexit. Despite the strong end to the year, fuelled by the start of the mass Covid-19 vaccination programme and the announcement of a long-awaited Brexit deal, the impact of the Covid-19 pandemic on global equity markets in 2020 has been disproportionately felt in the UK.

Although the impact of the pandemic on the UK economy is  likely to be broadly similar to that felt in other European countries, the increased risks to UK-listed businesses, as perceived by global investors with an already low appetite for UK country risk, has resulted in further marked underperformance by UK equities in 2020. As such, the UK equity market recorded its overall worst year since the 2008 financial crisis.

The valuation of UK equities relative to both US and European Equities is compelling in our view. We look at a blend of analyst valuation measures and these show that UK listed companies look attractive relative to these global peers.  When we look specifically at the US this analysis tells us that the UK looks more attractive on a relative basis in all 10 of the key industry sectors (source: Refinitive, Panmure Gordon, as at 31 December 2020).

The antipathy towards UK equities should further be seen in the light of the geographical mix of business – only around 27% of the revenues of companies in the FTSE All-share index is actually derived from the UK. It follows that the UK market can therefore reasonably be regarded as an attractive valuation strategy relative to global equities.

Whilst we expect a significant rebound in the economy and for UK listed businesses later this year, the pathway to recovery for both is likely to remain volatile.

While the UK Covid-19 vaccination programme continues to gather pace (more than 24 million people have now received their first dose, as at 21 March 2021), challenges and restrictions will remain until all, or at least the majority of adults have been inoculated. Whilst optimism may well be tempered periodically by fears of mutated strains of the virus and temporary disruption in the supply of the vaccines, there is a strong sense that we are now well on the way to seeing the end of the economically damaging lockdowns.

UK government job support, and business support schemes have provided short-term shelter that will ultimately need to be withdrawn. Unemployment in the UK remains low by historical standards at just over 4% although we expect this to rise appreciably once the support schemes are eventually phased out.

But the residual challenges in the UK resonate with similar challenges in other developed Western economies, surrounding: a levelling up of geographical and social imbalances, the need for housing, and also improvement in productivity.

The cost of Covid-19 in terms of the human tragedy as well as the economic cost of disruption will take years to be fully appreciated, however it is already clear that the crisis has also acted as a catalyst to accelerate positive change in the global economies and also businesses that would have taken place anyway, but over a longer time frame. In this climate of change, we expect that Environmental, Social and Governance (ESG) criteria (a set of standards for a company’s operations that socially conscious investors use to screen potential investments) will be increasingly recognised as an important driver of long-term, sustainable, value creation.

Almost without exception, governments of all political colours have been moved to increase substantially the level of fiscal stimulus alongside accommodative monetary policy. The “Great Reflation” as it may well become known is, we expect, ultimately likely to result in inflation and a gradual steepening of interest rates at the long end of the curve, that is to say that the effect on interest rates in the long-run will be that they will rise.

In such an environment, we expect commodity exposed stocks – including gold miners – to be notable beneficiaries, along with a number of companies that we believe offer an attractive yield and provide defensive qualities in a challenging environment, such as selective utilities firms; we would term these stocks as high quality “value” exposures.  This reflationary environment is likely to increasingly favour those investment styles which are less exposed to inflation risk over the promise (or hope?) of long-term growth styles which may be more challenged by such an environment.   

If approved by shareholders, the enlarged Invesco Select Trust Plc UK Equities Share Portfolio will seek to capitalise on these themes by holding high conviction positions across the market cap spectrum, in businesses with strong balance sheets, that are cash generative, have access to sufficient liquidity, and that we believe will emerge from the pandemic with their competitive position enhanced.