This week’s footage of President Biden’s inauguration wasn’t quite as powerful as the hope that flowed through the US in 2009 with President Obama as this time, for me anyway, it felt like relief rather than hope. President Trump’s time in power was plagued by chaotic politics and often a void of leadership, especially on the global scene evidenced by the US pulling out of the Paris Accord on climate change and the WHO. It feels like President Biden and the US are pressing the reset button, hopefully with positive results.
We have made some changes to our portfolios over the last week that also feels like a fresh start and the reset button pressed for an unloved part of the market, UK equities. If you have heard from any of the team talking about markets since we started last April, you’d have been told that the UK equity market was one that we were light on, with exposure only to the small and mid-cap part of the market.
A lot of investors use the MSCI PIMFA index series as their benchmark and if they are positive on an asset, they might invest a couple of percent more than the benchmark suggests or a little underweight if they are negative. The current weight to UK equity in the MSCI PIMFA benchmark is 30%. We finished 2020 with a 13% weight. We have no benchmark constraints; we invest in areas because we think it is the right thing to do. We can and do zero weight areas if we don’t like them.
The large cap end of the UK equity market is almost the opposite of what we tend to invest in. We generally target growth sectors with strong structural tailwinds and capital light business models. The largest companies in the UK are often capital-intensive businesses in industries that are challenged or in structural decline, such as oil & gas, banking and tobacco. Earnings growth has been weak for years and the political landscape has been a mess meaning international investors have stayed away. However, we think the tide is turning. The whole of the UK market has been dragged down and we think it is starting to look interesting.
We increased our UK equity positions last week, for example in our Balanced portfolio from 13% to 17%. Still relatively low, however the 30% increase we think is warranted, we are excited by it and we won’t be filling portfolios with oil & gas, banks and tobacco either. Why now?
There are a few technical factors that will help; however the main reasons are earnings, price and politics. The UK market is expected to have earnings growth of 42.6% in 2021, that’s double the estimate for the US. Even if that is wrong, there is a big margin for error. Earnings growth is estimated to be 16.2% in 2022 (source; IBES). Even if you strip out the very cheap banks and oil & gas sectors, the UK is 30% cheaper than the World index or 40% cheaper than the US market. With Brexit uncertainty largely behind us, we think that the UK has effectively hit the restart button and has a fresh start. The UK is unloved, with low expectations and has the potential to surprise on the upside. Its earnings growth is expected to beat most sectors, even the strongly growing emerging markets in 2021 and 2022. Is the UK set to become a re-emerging market?
We’ll be discussing this more at our webinar on 3rd February at 10am, which you can register for here.
Thanks for reading and