2020 was not a good year for UK equities, which largely missed out on the tech-driven recovery rally seen in the US and Asia. The outlook for 2021 is potentially bumpy, but it could turn into a profitable year for investors in the UK’s undervalued companies.
UK equity performance in 2020 was particularly poor compared to the US market, with the MSCI North America Index up almost 17% while the MSCI UK fell almost 12% . Then, just as the UK equity market was celebrating the approval of two vaccines, a Brexit deal and a new US president, a resurgence in COVID-19 cases and a new national lockdown whipped the wind out of its sails.
There are various reasons for the huge disparity between the UK and US equity markets, but the top ten contributors account for almost two-thirds of the difference in returns. While the US market is dominated by large tech stocks, most of which have had a good pandemic, the UK market’s big names include a bevy of deeply unloved oil and financial companies that were hit hard by the pandemic.
This could be about to change, which is why the UK is currently our most-favoured market in the LF Canlife multi-asset managed funds and the LF Canlife Global Equity Fund. While the pandemic rally favoured stocks that benefit from home working and restricted travel, the next phase will favour companies that extract commodities, make things and provide transport and financing.
With a Brexit deal now secured, a long-standing uncertainty over the future of the UK and a key deterrent for would-be investors in UK markets has been removed. At the same time, UK equities appear extremely undervalued and a suitable target for M&A activity.
The UK’s GDP remains substantially lower than its pre-pandemic level, leaving significant room for recovery once vaccines are rolled out. Furthermore, the UK could be the first major western economy to implement its vaccination programme and return to social normality, which bodes well for the UK’s consumer-focused economy.
Reasons to be Cheerful
According to the UK COVID-19 vaccine delivery plan (January 2021), two million people in the UK have been vaccinated. Without making too many assumptions, it is a fair bet that life will begin to feel much freer as the months roll on and that UK consumers will be freer with their cash.
Worried about what the future might bring, or simply unable to buy what they want, the British have become tidy savers. An unheard-of 29% UK savings rate in June 2020 dwarfed previous peaks of around 15%. But old habits die hard, and UK consumers have not stopped spending entirely. Lockdowns have focused minds closer to home and spending on home improvements, household goods and home office equipment has been robust.
Once restrictions are eased we can expect to see consumption increase significantly as pent-up demand backed by high savings is let loose. In particular, the currently strong housing market is likely to remain resilient, which is good news for sectors linked to housing transactions and construction.
National spending and consumer confidence could be affected by headline-grabbing unemployment rates when support schemes such as furlough wind down. However, with the majority of job losses likely to be concentrated in lower-paying jobs the effect on overall spending should be muted, particularly if longer-term support schemes are used to assist small businesses in hard-hit sectors such as hospitality.
A Greener and More Pleasant Land
The UK government also has spending on its mind. In October, HM Treasury began a process that could lead to regulatory changes designed to put UK life insurers’ capital to work in decarbonisation, ‘levelling up’ and infrastructure projects. Two months later the UK government announced its ambitions to decarbonise energy supplies. It is still early days, but the government clearly wants more capital flowing into climate change and infrastructure projects. That’s good news for employment, the economy and, of course, the environment.
Through a more global lens, other countries are also embarking on large-scale spending plans that will benefit the UK’s miners, engineers and oil companies. The US recently approved a US$900bn economic relief package and the EU has a seven-year clean energy plan worth €1.8trn. Economic data from China also points to a continued recovery that will benefit commodity prices and mining companies.
After dropping below US$20 per barrel in April 2020 , the oil price is back to what could be considered a normal range. At current price levels, oil companies – including the UK’s international roster of oilies – will have cash flow to invest in transitioning to low-carbon energy, reducing debt and paying attractive dividends.
The Great Unwinding
A major theme of 2020 was the squeezing of already thin bond yields to previously unimaginable low levels as central banks and governments cut interest rates and expanded their quantitative easing programmes. This drove up the value of higher growth and more defensive companies, while depressing the share prices of more cyclical and ‘value’ names – the very companies that account for the lion’s share of the UK market.
It is worth considering what could happen when stimulus programmes begin to have their desired inflationary effect and bond yields begin to rise. Through the latter part of 2020 the benchmark US 10-year bond yield rose gently and largely unnoticed. On 6th January 2021 it broke 1% and global markets took notice. On that day the MSCI UK Index rose almost 3%, with the banks sector rising over 8.5%, the oil and gas sector up over 6% and mining up over 5.8%.
Clearly, what we saw on 6th January a strong reaction by the markets to an unusual situation, but the general direction of travel is clear. If bond yields and inflation expectations rise as the global economic recovery gathers pace in 2021, we are likely to see further and possibly strong rises in UK equities.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.
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