‘UK equities are still deeply unfashionable but that creates investment opportunities’

13 December 2017

Investors looking for value in 2018 might want to consider ‘unfashionable’ UK equities (companies), according to one fund manager.

With the constant grind of Brexit negotiations and a significant wobble from the governing Conservative party in June’s general election – investors might be forgiven for not stuffing money into the nearest UK equity fund.

In fact, according to a survey of UK investment trust managers by the Association of Investment Companies (AIC), nearly one in four (23%) think that disappointment in Brexit negotiations is the biggest threat to equities in the next 12 months.

But some managers are taking an alternate view. Thomas Moore, manager of Standard Life Equity Income trust thinks there is good value on offer in UK companies for investors. At an AIC briefing this week he said: “The UK political environment remains highly uncertain, which has resulted in a divergence in valuation between stocks and sectors, as investors have tended to spurn small and mid-cap stocks in favour of defensive large-cap stocks. 

“We continue to identify many examples of companies that offer good dividend and capital growth prospects at attractive valuations.”

Mr Moore explained that short-term uncertainty in a political context can be a distraction to investors: “Heightened short-term political uncertainty can result in a shift in investor focus away from corporate fundamentals, which has historically provided us with some of our most compelling valuation opportunities.

“We remain cautious on some of the traditional large-cap income sectors, such as pharmaceuticals and consumer staples, where dividend growth is set to be constrained by weak growth and low levels of dividend cover. While we have recently found some valuation opportunities among large-cap sectors, notably resources, we continue to identify superior dividend growth prospects within mid-cap and small-cap stocks.”

‘There are a number of UK stocks that look like they are heavily misvalued’

Mr Moore added: “The last 18 months have been riven with political intrigue, coming to a head last week with the agreement that Theresa May struck in Brussels.

“What we now see actually is that the UK is still deeply unfashionable but that creates opportunities. The market is now bifurcated between quality overseas stocks which people feel very comfortable having in their top 10 and then domestic UK stocks that people are feeling very nauseous over.”

But while Mr Moore thinks last week’s first stage Brexit deal was not necessarily the turning point, it does provide a signal to investors that confidence in UK equities could begin to return soon: “What we saw last week could turn out to be quite important but as the political heat moderates we’re going to find people go back to the corporate earnings data. They will look again at the cash flows rather than the political headlines. There are a number of UK stocks that look like they are heavily misvalued at the present time. I think it’s going to be interesting to see how quickly those stock rerate particularly if the UK continues to take part in the global economic recovery we’re seeing.

“Clearly, we had a relatively high inflation at 3.1% but that looks like about as far as it will go. As we annualise last year’s nadir in the dollar/sterling exchange rate which was $1.20, now we’re at $1.34. It’s looking like the UK consumer is going to have a little less heat in 2018 than he or she did in 2017.

“Not only will there be a GDP impact from improved real wages, if anyone doubts the underlying momentum in the UK economy just take a look at the vacancies data – companies are still hiring despite Brexit. I think economists suffered from groupthink perhaps as well as fund managers and that has led to this bifurcation in valuations.

“There are going to be opportunities and of course we want to buy a growing company, but we want to do that on the right valuation and we think now is a great time to find those names.”

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