The UK equity market has been underperforming ever since the Brexit year of 2016. Now that Brexit is finally behind us, is this the moment for the asset class to shine again?
John Surplice, who has headed the Invesco Pan European Equity Fund since the end of the last century, is cautiously optimistic. ‹Partly because of Brexit, investors have been wary of UK equities for years. That’s one of the reasons for the underperformance.› The fact that sterling has started a gradual rise since the Brexit deal on Christmas Eve (the currency is now at its highest level since May), at least seems to be a sign that confidence is slowly returning.
But will that immediately lead to outperformance? ‘In periods of cyclical recovery, like we will probably see from the second half of the year once the pandemic is sufficiently under control, continental equities tend to do better than UK equities. This is mainly due to their higher exposure to industrials and other cyclicals,› Surplice says.
M&A wave
According to Surplice, a post-Brexit wave of M&A would be the main hope for UK equity outperformance. ‹Valuations of many UK companies are extremely low, and we are now at a point in the market cycle that you only see once every 20 or 30 years. That could unleash a wave of M&A,› he says. Foreign companies in particular have been reluctant to acquire British companies in recent years because of Brexit, according to figures from the UK statistics agency
Now that Brexit is behind us, and the uncertainty surrounding the pound’s exchange rate as a result of the Brexit deal has been reduced, it is once again becoming more attractive for foreign companies to buy a British company. ‹What’s more, although the pound has risen to 1.13-1.14 in recent weeks, that is still much lower than before Brexit,› Surplice adds.
Asked about possible attractive takeover candidates, Surplice mentions aircraft engine maker Rolls Royce as an example. ‘They’re in a tough position with their balance sheet. And their end customers aren’t flying, but in the end they have 50% market share in the long-haul sector. That will still be worth something.› At the other end of the spectrum, there are also companies that (sometimes literally) have the wind in their sails, but are still attractively priced due to the low sterling exchange rate. ‘Such as SSE Utilities, a utility company with many offshore wind projects. A big European utility or energy company that wants to get a position in British wind energy may find it an interesting opportunity.’
Reopening plays
Many Europeans also envy the successful vaccine rollout in the UK. Surplice himself, having just turned 50, should be getting his first shot as early as next month. Most of his peers in the rest of Europe will have to wait months more. Still, investors should not draw too many conclusions from the UK›s vaccination lead, Surplice believes. ‘We will probably be able to open the economy a few months earlier, but for most companies it will make little difference in the long term whether this happens in March or June.’
Moreover, the companies that stand to gain most from a quick reopening of the economy, such as pubs (which are often listed in England) or fast-food chain Greggs, are not part of the FTSE 100 index. Surplice says there are some interesting reopening plays in that stock market index, but they would mainly benefit from a reopening of the economy across Europe. ‘For example, we increased our position in Easyjet after the vaccine news in November. But Easyjet has little to gain from the British being vaccinated so quickly. Although most of the company’s customers are British, they cannot fly anywhere while their holiday destination is still in lockdown.›
The company’s share price has therefore slumped since November. Surplice: ‹As a result of the new lockdowns and the vaccination issue, we have seen more than once that the share price gains from November have partly evaporated again. This is also the case for banks, for example. They are now valued at a lower level than at the height of the financial crisis. But if you take a step back and don’t let yourself be led by the issues of the day, you have to conclude that the second half of the year looks very good.
4-5% growth from 2022
Surplice expects the vaccination programmes to have advanced by enough around the summer for normal life in the rest of Europe to gradually resume. ‘From that moment onwards I foresee three years of solid economic growth, of about 4-5% per year,’ he says.
That seems like a rosy prediction, considering that economic growth in Europe before the pandemic was only around 1%. ‘I am indeed an optimist, but I believe that after 13 years of below-average growth, it is now time to make up for this lost growth.’
In this respect, the Briton expects a lot from the European Recovery Fund. ‘There really is a huge stimulus package coming, of a size we have never seen before. What’s more, this growth is coming in stages, and not almost all at once like in the US. I therefore expect Europe to lag behind this year, but to catch up from 2022 onwards.’