Only a no-deal Brexit can justify current valuations for many UK exposed companies versus peers around the globe, with the binary outcome leaving some of the domestically-focused UK stocks at a 30% discount to global equities, Smith & Williamson’s Enterprise Fund team has said.
Managers Mark Boucher and Mark Swain said UK equities have been held back significantly compared to global peers because of the threat of a no-deal Brexit.
The government’s negotiations have weighed heavily on investor sentiment, with UK stocks down more than 10% from the peak level seen in May.
However, in all outcomes apart from a no-deal – which is not the most likely outcome in the team’s view – UK equities offer good upside potential.
“Brexit negotiations have left domestically-focused UK equities undervalued by around 30% versus global equities in the event of anything other than a no-deal outcome,” Mark Boucher said.
“Many domestic UK businesses are still trading well, and, versus global peers, are the cheapest they have been for nearly three decades.”
Although a hard Brexit cannot be ruled out, Boucher and Swain believe it is more likely that a deal will be reached, with the domestic names likely to see a ‘Brexit bounce’ if a no-deal scenario is avoided.
“A lot of UK equity fund managers have been hiding in international names and avoiding the domestics, and areas like the exporters have outperformed materially,” Swain said.
Big losers so far include the housebuilders, and it is areas such as these which the team would expect to begin to recover if a deal can be agreed.
“The housebuilding sector has continued to produce good numbers, but nonetheless housebuilders’ share prices have fallen significantly since the summer – hence we have only been running pair trades in this sector, as opposed to getting aggressively long. However, valuations are clearly very depressed – they are all trading on single-digit PEs and offer double-digit dividend yields in some instances.”
Conversely, areas looking stretched if a deal is reached and the pound rallies include the exporters. Such businesses have benefitted from the weak pound which has tumbled against major currencies such as the euro and dollar as Brexit negotiations have rumbled on. A reversal of this trend could impact such businesses very quickly.
“A resolution to Brexit could reverse that trade very quickly as they have outperformed by a big margin,” Swain added.