The UK stock market is firmly back on the radar of many of the world’s major investors after years of avoidance. According to data released a few days ago by Bank of America, more international investors – mostly fund managers – are now overweight UK equities than they are underweight.
In other words, they love the UK stock market. This is the second month in a row that this has happened – after seven years of widespread disinterest in UK stocks by large institutional investors. This drastic change, which could signal a period of outperformance for the UK stock market in the coming months, is the result of several factors: a decrease in the Brexit ‘question’ despite the ongoing feud between the EU and the UK – United on the supply of British sausages to supermarkets in Northern Ireland; the successful deployment of the vaccine in the UK; and the prospect of a strong rebound in the UK economy despite the government’s controversial decision to postpone an easing of foreclosure restrictions until the middle of next month.
The highly regarded Organization for Economic Co-operation and Development (OECD) now predicts Britain’s economy will grow 7.2% this year, its fastest rate since World War II. Next year, the OECD estimates that economic growth will be sustained at a healthy level of 5.5%.
Sit down instead: is a period of outperformance for the UK stock market over the next few months on the agenda?
While a mix of expected economic growth and renewed optimism doesn’t always translate into a robust stock market, there is another compelling factor that is persuading investment experts to view UK stocks more favorably. They call it âcatching upâ.
UK stocks, they argue, are cheap compared to other markets such as the US and therefore offer more value – and more opportunities for long-term investors to generate net returns.
Charles Montanaro is the founder of boutique investment house Montanaro Asset Management, a company that seeks to make money for its clients by investing in small and medium-sized businesses. He rarely talks about the outlook for the stock markets, but he is firmly in the “catching up” camp.
Last week, Montanaro told The Mail on Sunday: “Over the past five years, the value of the UK stock market has barely changed as other global markets – the US in particular – have performed much better. As a result, UK corporate valuations have become relatively more attractive and the UK may well be catching up. ‘
As for small businesses listed on the UK stock market, he says the 2016 Brexit referendum and more recently Covid-19 “scared foreign investors away.” But in recent months he has detected “the first signs of international investors turning to British small businesses again”.
In response, the company’s main investment fund, Montanaro UK Smaller Companies, increased its borrowing in order to increase its exposure to equities. “This could be a good time for British small businesses,” Montanaro believes.
The relative underperformance of the UK stock market has been around for a long time. According to figures compiled by data specialist Lipper, the FTSE100 index – the 100 largest companies listed on the UK stock market – has generated a total return (capital and income) of 151% over the past 20 years. In contrast, the S & P500 Index, which tracks the fortunes of America’s 500 largest companies, returned 397 percent.
Jason Hollands, director of wealth manager Tilney, also believes the UK is on the verge of catching up. He says a combination of record interest rates – not just here but elsewhere in the world – and a wall of money printed by central banks to support the global economy during the pandemic has pushed global stock indexes to record highs.
But UK stocks, he says, “are still trading at a discount to other developed markets.” He adds: âThe UK stands out as a stock market with a strong history of profit recovery. Moreover, despite the steep dividend cuts last year, the UK remains the number one destination for income seekers. ‘
Russ Mold, chief investment officer at wealth manager AJ Bell, said the UK stock market has “many advantages”, although he also warns that there is always a possibility that “clear dangers” emerge to remove stock prices. He says: âThe FTSE100 has underperformed against other major stock markets since the Brexit vote in June 2016. This means it could be cheap and offer value.
âIt also offers a decent dividend yield – around 3.5% this year and 3.8% next year. These numbers far exceed the income savers can earn from cash – as well as inflation, which is rising to 2.1 percent. ‘
Finally, and crucially, Mold says the FTSE100 index “is well positioned if we have a strong global recovery”.
Indeed, the index is dominated by banks, mining and oil companies – companies, he says, “that would benefit from a strong recovery in profits if global trade accelerates and the pandemic is pushed back. “.
Investment experts are divided on how best to capture the âcatch-upâ effect. As AJ Bell’s Mold has previously stated, any strong recovery in the wider global economy will likely result in a more dynamic FTSE100. Investors can better understand this with an investment fund that tracks the performance of the index.
Legal & General, iShares, and Vanguard all offer such funds – with annual fees of less than 0.1 percent. Ben Yearsley, chief investment officer at Shore Financial Planning, is a fan of this approach. âMoney flows overseas from institutional investors to UK stocks are more likely to go to larger companies,â he says. Ryan Hughes, head of active portfolios at AJ Bell, says an alternative approach is to invest in a fund such as Threadneedle UK Equity Income which has a portfolio focused on financially sound companies such as AstraZeneca and Rentokil Initial (both FTSE100 ) and supermarket giant Morrisons (part of the FTSE250 index). âI see this as a core UK fund,â he says.
Another option is the River & Mercantile UK Recovery investment fund with a third of its assets in FTSE100 shares. Dzmitry Lipksi, head of research at wealth manager Interactive Investor, says the fund is well diversified and focuses on recovery stocks – good companies that are currently posting below-par profits. Its top five holdings are FTSE100 BP, HSBC, Lloyds Bank, Prudential and Shell. Some experts prefer investment funds that have a penchant for a small business. Indeed, most of the UK-based small businesses are very focused on the UK domestic market. So, as the economy is booming, their profits are expected to soar.
Yearsley loves River & Mercantile UK Equity Smaller Companies and Montanaro UK Smaller Companies investment trust. Darius McDermott of Chelsea Financial Services is a fan of Liontrust UK Smaller Companies while fund expert Brian Dennehy opts for Liontrust UK Microcap and Schroder UK Dynamic Smaller Companies.
Although the likelihood of successfully investing in the UK stock market has improved in recent months, returns are not guaranteed. Dennehy, of Fund Expert, said that looking to the future over five to ten years, a market that has gone awry in the last 20 years and looks cheap (the UK) is a much better proposition that one who behaves “in an obvious mania” (the US).
But he warns that a “shock” could occur and cause the bursting of the US stock market bubble. If that happened, the UK market would not be immune to a sharp correction. Nationally, AJ Bell’s Mold says higher interest rates “would deprive the stock market of some of the free and easy liquidity that has supported stock prices.” Other potential dangers include a pandemic that refuses to go away and rising unemployment as government support programs are withdrawn.
Other investors, according to Mold, might prefer to keep their exposure to the UK stock market light due to its overdependence on cyclical industries such as banking, oil and gas and commodities which are renowned for their volatile and unpredictable returns.
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