Domestic politics dominated the narrative around UK assets in the final quarter of 2019. The UK general election brought a surprisingly strong victory for the Conservative Party. The new government now looks set to use its large majority to take the UK out of the EU by 31 January 2020, entering a transition period when the next stage of negotiations will begin. UK equities performed relatively well and, within the market, domestically focused areas significantly outperformed as they responded very favourably to the reduction in near-term political uncertainty.
These trends were further reflected in the sharp recovery in sterling from the lows struck in the summer. More widely, sentiment towards equities improved after the US and China tentatively agreed a “phase one” trade deal and central banks continued to ease monetary policy amid an uncertain outlook for the global economy. The US Federal Reserve cut base rates by a further 25 basis points to take the target for the federal funds rate to 1.50%–1.75%. Meanwhile, incoming European Central Bank president Christine Lagarde committed to keep interest rates at current levels or lower and maintain the pace of quantitative easing until inflation rises to more satisfactory levels.
Domestic politics dominating the narrative
Domestic politics dominated the narrative around UK assets in the final quarter of 2019. The UK general election brought a surprisingly strong victory for the Conservative party. We expect this to mean that the UK will leave the European Union (EU) as planned on 31 January 2020, under the existing withdrawal agreement. This election outcome in many ways makes the UK stock market investable again for those who had shied away due to the previously high level of political uncertainty.
Despite rally, valuation of UK stock market still compelling
Despite the relatively strong performance of the UK equity market in the final quarter of 2019, the UK remains one of the most undervalued major stock markets in the world. UK shares have traded at a median discount of 17% to their global peers over the last 45 years, based on an average of three valuation metrics. The UK market is also supported by an attractive dividend (12-month forward) of c. 4.8%.
Pound strength, but still towards bottom of long-term trading range
Sterling has strengthened by around 8-9% since its August lows, however it remains near the bottom of its 40-year average trading range against the US dollar. As a result of this, within the UK market, there has been considerable divergence between those stocks exposed to the global economy – which have benefited from weaker sterling until recently – and those exposed to the domestic economy – which have tended to lag. If this trend continues to reverse, a strong pound can weigh on the earnings of some internationally-focused stocks due to translational currency effects. However, despite this negative impact on earnings, we believe that international investors will likely rotate back into the UK equity market overall. We would therefore expect that a number of international stocks quoted in the UK will benefit from greater buying interest, albeit domestically-focused stocks would likely be most favoured. In addition, with this resolution to political uncertainty, we expect fundamental factors such as valuations to play a greater role in share price performances.
International developments still a key driver of market sentiment
Global economic data increasingly points to deteriorating fundamentals with many forward-looking indicators pointing to a softening in the outlook for growth and inflation. This has caused central banks to once again loosen monetary policy in order to try and keep economies stable. The last 12 months have also been characterised by the to-ing and fro-ing of trade wars, predominantly between the US and China. In recent weeks there have been tentative signs of progress towards a phase one trade deal. A better environment for global trade would likely be supportive of industrial cyclicals (i.e. economically sensitive stocks) across global markets as well as in the UK.
The Fund’s performance in the fourth quarter of 2019 was positive in both absolute and relative terms with a return in excess of the FTSE All-Share Index.
The Fund’s outperformance was notably driven by some of the Fund’s highest conviction, domestically-focussed stocks, such as Pets At Home, Legal & General, Hollywood Bowl and Lloyds Banking, amid a reduction in Brexit and political uncertainty as discussed above. The Fund’s holding in outperforming G4S also aided performance with the market encouraged by the company’s solid trading and the potential for strategic value creation from the announced demerger of the cash solutions division. Additionally, not holding underperforming Diageo was a positive for performance with market participants shunning a stock that looked fully valued and vulnerable to sterling strength after a sustained period of outperformance.
The more internationally-exposed UK stocks have been less favoured by investors over this period. This has impacted some of the Fund’s attractively-valued international holdings quoted on the UK market, such as Pearson and Johnson Matthey, which were weak over the period, weighed down in part by the recovery in sterling. Regarding Pearson, investors continued to fret about trading in the company’s legacy textbook business and the ongoing challenges inherent in the move from print to digital. We continue to engage with management on the issues facing the company as we have done in the past with Pets at Home and G4S where recovery plans are now being successfully executed.
Meanwhile, speciality chemicals business Johnson Matthey’s share price retreated following the release of its first half year report, which showed a greater reliance on a stronger second half to meet profit expectations for the year together with weaker cash flow due to higher working capital requirements.
|Q1/2015 - Q4/2015||Q1/2016 - Q4/2016||Q1/2017 - Q4/2017||Q1/2018 - Q4/2018||Q1/2019 - Q4/2019|
|Net Asset Value||5.6||11.7||12.6||-11.8||23.3|
|FTSE All Share Total Return||1.0||16.8||13.1||-9.5||19.2|
Source: Morningstar, net income reinvested, net of ongoing charges and portfolio costs and where applicable, performance fees, in GBP.
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Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.
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