With the FTSE All-Share still trailing other global indices, MATTHEW FEARGRIEVE says that now is the time to buy UK stocks and investment funds before Biden stabilisers, vaccine uplifts and Brexit certainties kick in.
The FTSE All-Share Index is up just 15.9% over five years, versus a 93.1% gain for global stock markets, with that performance lag exacerbated this year as the coronavirus crisis has hit the UK stock market hard.
Notwithstanding the recent uplift in the FTSE on the back of vaccine hopes, a prolonged period of disappointing absolute and relative returns, compounded by 2020's rollercoaster markets, have left unloved UK stocks trading at significant discounts.
Rife volatility in the UK blue-chip index has sparked an investor exodus from UK shares. The latest figures from UK fund manager trade bodies show that retail investors withdrew £2.7bn from investment funds invested in UK stocks in Q3, with asset allocators placing a sizeable discount on London listed companies.
But this flight has left some UK investments looking decidedly cheap. And this is still the case in spite of the FTSE100 closing on 30 November at 6,266 leaving it 12.4% higher over the month, falling short of the 14.4% record set in January 1989.
And with economic stabilising factors pending - chiefly the incoming Biden administration, COVID vaccines in the pipeline and Brexit nearing its endgame - now is the time to take advantage before the inevitable global uptick kicks in, likely sometime in 2021, particularly when you keep in mind that the FTSE100's constituent companies generate three quarters of their earnings overseas.
For the moment, at least, there are tactical opportunities to be had in large (FTSE100 listed) and mid-cap (FTSE250 listed) companies and the mutual funds that invest them, as a glance at valuations and share price performance will confirm.
The FTSE250 looks particularly interesting, given the seemingly permanently low base of interest rates in the UK, which creates economic conditions that historically favour higher growth companies because the discount rate is lower for longer-projected profits. This typically assists favourably with the the valuation of such growth companies. With UK interest rates at an historically low 0.1% base rate, there is a large amount of financing available to these companies from private equity shops.
Keep in mind, though, that this will change over the short- to medium- term, when the cost of borrowing rises as investors of UK gilts demand higher yields in exchange for accepting the inflationary risks that normally accompany any economic recovery. This might suggest that buying the FTSE250 should be a "today" rather than a "tomorrow" thing.
A weak pound is an added incentive to invest in UK stocks and investments funds.
And the UK Chancellor's spending review in November, which disclosed debt at record peacetime highs and warning of a state of "economic emergency" in the UK. The increasing - perhaps inevitable - likelihood of tax hikes in the UK will deter certain types of work and investment, which in turn will depress UK economic output for years to come.
There is also the real and present danger right now that the mere threat of possible higher taxes will cause UK businesses and consumers to retrench.
All of which, whilst making grim reading at an economic level, will discount FTSE100 stocks in the short term, before markets wake up to two realities:
(a) Biden and vaccines will provide buoyancy in 2021; and
(b) the FTSE100's constituent companies generate three quarters of their earnings overseas, and so will derive a high degree of immunity from economic woes at home in the UK.
These factors would tend to suggest buying UK large- to mid- cap stocks sooner rather than later.
The bleak domestic outlook makes the trajectory of UK small-cap stocks looks distinctly dispiriting. It will be a brave investor that ventures away from unloved UK blue-chip stocks into the UK value small-cap space which, having been out of favour with investors for years, is currently on the floor because of COVID and looks set to slip further on the UK's 2021 economic prospects.
Any play into UK small-cap stocks has been freighted with risk for several years, and the relentless pressure on small UK companies is coming to a head for many of them, as the recent suspension of MI Downing's UK Micro-Cap Growth Fund demonstrates. Over three years the fund has lost 33.8% and is at rock bottom in the Investment Association’s UK Smaller Companies sector. The average fund in the sector has returned 11.2% over the same period.
UK small caps seem set for an incredibly tough 2021 as unemployment, reduced consumer spending and tax rises loom. Investors are evidently not encouraged by the somewhat surprising fact that the FTSE Small Cap index has declined less this year than the FTSE 100 and FTSE 250.
And, as Nick Train of the £6.4bn Lindsell Train UK Equity Fund says: "the value available in FTSE 100 companies just seems so great that why bother messing around in smaller cap stuff when the big, real opportunities are in liquid, globally significant companies".
This writer wouldn't disagree with that.
Matthew Feargrieve is an investment management consultant. You can read his investing blog here and see his Twitter feed here.
Important information: the views expressed in this article are opinion only, and are not intended to be relied upon as financial advice or treated as a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
