The beaten-down UK stocks are now once again getting traction within the global investment community. The investment sentiments are changing towards the London equities on hopes of better move in 2020. Amid uncertainties of December 12 general election outcome, investors are looking for opportunities after years of Brexit-driven underperformance in the UK equity market.
Investors are optimistic about Boris Johnson returning to the British Parliament with a thumping majority. This would bring investors and traders attraction back on the sectors which could benefit from Boris Johnson-led conservatives’ manifesto.
The recent political drama and a fear of a no-deal Brexit have jolted investor sentiments, especially global portfolio investors, who had not created any positions as they were having investments in other major markets like US, Japan and emerging markets.
Now, no-deal Brexit risk has been substantially reduced, which is turning back institutional player's attention to the UK stocks.
Things which are making UK stocks potential buy for 2020
No-deal possibly off the table
British Prime Minister Boris Johnson negotiated a Withdrawal deal from the EU administrators in late October 2019, which went through the House of Commons successfully. The development set financial instrument since then, under the impression that Britain would not crash out of the European Union without any Withdrawal Agreement. This helped Pound Sterling to rebound from its 52w low level of 1.959 against the US greenback, which supported movement in the UK's mid-cap and small-cap equity gauges and both the domestic indices recorded decent and steady gain after no-deal Brexit risk cooled down. A further surge in Pound would benefit these domestic stocks.
PM Johns most likely to lead snap election
However, opinion polls for General election are in full swing, yet everyone given higher chances for PM Johnson’s return as the British Prime Minister. If he gets a majority at the British Parliament, it will help to resolve Brexit saga by the end of January 2020. A thumping majority for PM Johnson-led conservative would provide political stability, and Brexit saga would come to an end. Which will boost Sterling and equities and take the fear of a no-deal Brexit altogether from investors and businesses.
It will act as a booster and could bring back UK equities in focus for global portfolio investors. Especially the small-cap and mid-cap counters could witness increased buying interest in 2020, as they are the most beaten-down stocks since the Brexit referendum took place in 2016. Also, they witnessed strong sell-off after no-deal Brexit risk heightened since mid-2018 to till October 2019, but after a withdrawal deal got negotiated between the UK and EU in late October, both mid-cap and small-cap started witnessing strong buying interest at the London Stock Exchange.
Valuation at Discount in relative terms
At the current levels, the UK market is trading at a substantial discount against its peer equity market. For instance, US broader equity benchmark S&P 500 index was trading at a LTM Price-to-Earnings ratio of 22.4x, whereas the UK’s broader FTSE 100 index was trading at a Price-to-Earnings ratio of 15.5x, which reflects, despite the global financial market went through a crucial time in the past couple of months, amid increased chances of recession recognised post US bond market sent some classical recession signals, as long-term yields on bonds invested and the short-term bond yields; still US stocks are trading at a substantially higher premium against the UK stocks.
As we aware that the broader index of the UK is more of global index as majority of its constituent companies are mostly global companies holding significant market share outside the UK and Europe, like Unilever PLC (LON: ULVR), GlaxoSmithKline PLC (LON: GSK), Diageo PLC (LON: DGE) and many others. Therefore, FTSE 100's discounted valuation reflects that more global companies are available at a relative lower valuation and its not just UK stocks are available at a discounted price.
In percentage terms, PE multiple of FTSE 100 index is at approximately more than 40% discount against its peer S&P 500. So, it states that the downside risk is relatively lower in the UK market as compared to its peer indices.
Also, the FTSE 350 index of the UK, which reflects a mix-portfolio of large-cap FTSE 100 and mid-cap FTSE 250 indices is trading at a PE multiple of 15.62x, which is at a discount of 30% against the S&P 500 index.
It reflects that if things move favourably next year, the valuation gap between the UK’s stocks and other global indices like S&P 500 will be filled and to close the valuation gap UK stocks have to deliver more than 30% return in next year.
Higher Dividend Yield
Together with a discounted valuation against the peer indices, the UK stocks are offering relatively higher dividend yield to the potential investor. As the dividend yield of the FTSE 100 index stood at 4.5% against the S&P 500 dividend yield of 2.31%, which is almost 2x of the S&P 500 dividend yield.
A higher dividend yield together with a lower valuation provides several value investing opportunities in the UK market, as we had discussed earlier that many of the FTSE 100 companies are global stocks, which have past track record of paying higher and consistent dividend and are trading at a substantial discount against their global peer companies with a higher dividend yield.
Also, FTSE 350 dividend yield stood 4.3%, which shows that there are many large and mid-sized value investing opportunities still lying in the UK equity market.
Recently it was witnessed that many Central banks including Federal Reserve have reduced headline interest rates and world is moving towards a lower interest rate environment, which reflects fixed income securities will no more provide lucrative interest rates, which would shift investor’s focus on higher dividend stocks, and for global portfolio managers UK market would be most preferable investment destination, as here they could find high dividend yield stocks with relatively lower downside risks as UK equities are trading at a comparatively lower valuation.
Therefore, based on above four rationales, we believe that 2020 would bring many global investors back to the UK market as no-deal Brexit is out of table, if Johnson comes with absolute majority it will help the scenario with stable government, and that would led to appreciation in the British currency against other major currencies, and all these will stimulate equity prices at the LSE. As equities are the best reflector for economic prosperity if things are moving in the right direction. We also believe that the valuation gap between UK stocks and their peers will shrink and that will bring the focus of strategic and portfolio investors.
With Bank of England reducing the interest rates to a historic low level, the spotlight is back on diverse investment opportunities.
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