The Week: Has the UK stock market gone low enough?

The UK is still an important weighting in many investor portfolios, but it’s been a dismal performer. Is that about to change?

  • The Pound has been compared with an emerging market currency
  • The FTSE 100 is around 25% behind the US and Japanese stock markets over the past 12 months
  • The risk is that the UK becomes an irrelevance for global asset allocators

The Pound now has more in common with the Mexican Peso than the UK Dollar, says a Bank of America analyst. An ‘emerging market currency in all but name’, in his view sterling’s volatility reflects the UK’s small and shrinking economy and weakening global power since voting to leave the EU. Certainly, this damning assessment would seem to explain the poor performance of UK stock markets in recent months.

To put this into context, the FTSE 100 is currently down 16.8% over the past 12 months. The S&P 500 is up 5%. Of course, much of this disparity can be explained by the extraordinary performance of the technology stocks that dominate the US index, but it doesn’t explain away its weakness entirely. After all, the Nikkei 225 is up 5.9% over the same period, the Dax is flat. The Hang Seng is the only major index that comes close to the UK’s dismal performance – it is down 13%.

It is not all gloomy. Active managers have delivered a notably better performance. The average UK All Companies fund is ‘only’ down 8.9% over the same period and smaller companies have done better still. Nevertheless, the UK still trades at a discount. It is clear that in areas such as healthcare, a UK company commands a far lower premium than its international equivalent. This has led to the rise of cross-over listings – where UK companies move to list in the US because they know the share price will better reflect their prospects.

However, this gets no closer to answering the question of whether the UK should form a large chunk of portfolio allocation – as it does for many advised clients. Certainly, it is cheap and there are some great companies, but this has been true for some time. There appears to have been some revival in the very short-term for active UK managers with UK smaller companies funds up an average of 32.4% and UK all companies funds up an average of 26.4% over the past three months.

Any revival faces a number of headwinds: Brexit negotiations are likely to dominate news flow as Coronavirus coverage ebbs and, whatever the eventual outcome, it will create volatility in the interim. Equally, the UK is a ‘value’ market, dominated by cyclical companies such as banks and miners. Any revival for value has failed to take off with any vigour. The biggest risk, perhaps, is that the UK becomes an irrelevance for global asset allocators.

It is difficult to make a strong argument in favour of the UK large caps, even though some are trading at all-time cheap levels. There are great companies poised for growth in the UK and they are undoubtedly cheaper than their international peers. However, it remains unclear what will prompt a change in fortunes.