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Tough times for UK equities

October 2018

After a difficult run for UK equities, investors need to believe that neither a Labour Government nor a no deal Brexit is a possibility.

  • A combination of a no-deal Brexit and a Labour government could deal a fatal blow to the UK economy
  • The risk of both is relatively low, but continues to deter investors
  • A ‘Brexit bounce’ is a possibility should a deal be announced

It has been another dismal few months for UK equities. Attention may have been focused on emerging markets, but the UK Equity Income sector has been nearly as bad. This suggests recent, tentative interest in the UK from global investors may have been misplaced.

The reasons are clear. Brexit is in the news daily with UK and European policymakers trading insults, each blaming the other for a lack of progress. UK corporates warn of the disaster inherent in a no-deal Brexit. There are fears of food shortages, a lack of medical supplies, planes being grounded. That may be overblown, but it’s a significant risk.

To re-embrace UK equities investors have to believe two things: that there will be a deal and that there will not be a Labour government. Many investors appear to fear a Labour government – with its tax-and-spend, renationalisation programme – more than they do a no deal Brexit. Certainly, a combination of the two could deal a fatal blow to the UK economy. 

A Labour government still looks relatively unlikely. There is a theory that voters have reached ‘peak’ Corbyn and are starting to recognise that many of his policies are not deliverable. At the same time, Theresa May’s government has unexpectedly clung on through some exceptionally rocky periods. It appears the Conservatives have recognised that a leadership election is still too risky to contemplate (though there are still a number of challengers lurking on the sidelines). However, even if the odds are 90/10 in favour of the Conservatives remaining in power, it is perhaps not enough for investors. 

What is clear is that there could be a major rally, in sterling and in domestically-focused UK equities should a deal be announced. It probably wouldn’t have to be a particularly good deal. Simply avoiding the cliff-edge would be good enough. 

There is considerable scope for a rally. The FTSE All Share has a dividend yield of over 4%, dividend cover at over 2x and a P/E ratio of just 12x. Almost no other developed market appears to offer that kind of value. The yield on the FTSE World index is just 2.5%. 

For investors, there is a lot of pain priced in, but that doesn’t mean it wouldn’t go lower on a no deal Brexit, and – potentially – the ensuing Labour government. However, for a brave investor, a ‘Brexit bounce’ remains a real possibility.

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