UK equity market descends into ‘uninvestable’ zone
Investors spooked by Brexit uncertainty and Corbyn government fears
Fears that the Conservative government’s pursuit of Brexit will cause lasting damage to the UK economy have battered the confidence of many investors who also view the alternative of Jeremy Corbyn as prime minister as a deeply unappealing prospect.
The toxic mixture of extreme uncertainty around Brexit and the risk that a hard left tax-raising Labour party could win a general election has prompted a massive retreat from UK equity funds.
Investors are voting with their wallets and have pulled $1.01tn from UK equity funds since the referendum vote in June 2016, according to EPFR, the data provider.
Asset managers and brokers have become increasingly alarmed at the possibility that the UK parliament will vote down Prime Minister Theresa May’s agreement with the EU, raising the threat of a chaotic no-deal Brexit.
Political instability has reached such an extreme pitch that investors are being warned to shun the UK equity market.
“The UK equity market is close to uninvestable in the sense that the near term movement is likely to be dominated by political forces that are very hard to model,” said Inigo Fraser-Jenkins, a senior analyst at Bernstein.
He added that any tactical call on the direction of the UK stock market or sterling is now just a “punt” because of the highly unpredictable political environment.
This view was echoed by Stefan Kreuzkamp, the chief investment officer of DWS, the $803bn German asset manager, who said that “extreme outcomes have become more probable” via a chaotic hard Brexit or a second referendum.
“We have previously advised clients to stay on the sidelines, until Brexit-related political uncertainty recedes. We can only reiterate that advice in light of recent events,” said Mr Kreuzkamp.
UBS hosted a meeting of large institutional investors earlier this month where Brexit was discussed. “The consensus among those investors is that the UK is uninvestable at this point because it is not amenable to rational economic analysis,” said Mark Haefele, global chief investment officer at UBS Wealth Management.
Aversion to UK equities is widespread among large international investors. The UK stock market rated as the least popular asset class in October among global fund managers, according to a widely watched survey conducted by Bank of America Merrill Lynch.
A net 27 per cent of 174 respondents that together manage $513bn in assets held an underweight position in UK equities last month, an increase of 8 percentage points from September.
Carolyn Fairbairn, director-general of the employer’s organisation CBI, warned last week that international investment was being withdrawn from the UK as a result of Brexit-induced uncertainty.
“Recently £100m which was to be invested in the North East has instead gone to eastern Europe, a pattern repeated elsewhere across the country,” said Ms Fairbairn at the UK business group’s annual conference in London.
Alex Wright, a portfolio manager with Fidelity International, said he has heard anecdotal evidence that US investors are refusing to buy UK oil companies simply because they are listed in London, even though their dollar-denominated earnings have benefited from weakness of the pound.
“Closer to home, I can’t remember the last time I met a UK-based client that was increasing their UK exposure,” said Mr Wright.
He believes this “unrelenting negativity” is misplaced and that attractive valuations can be found in large and small companies, both international and domestic-facing, across the UK market.
“Some clarification in the relationship between the EU and Great Britain would act as a catalyst for investors to revisit the UK equity market,” he said.
But Mr Fraser-Jenkins disagrees, saying that the continuing political uncertainty is likely to curtail investment in UK equities over the next two years.
“The instability of the government means there is also a risk for investors of a general election being called with the possibility of a Corbyn government. Such an outcome would likely be priced by risk assets as being even more of a problem than Brexit,” he said.
Valuations for UK equities have fallen this year, with the stock market currently trading on a price multiple of 12 times one-year forward earnings, down from 14.5 times at the start of the year. This is only slightly cheaper than the 13 time P/E ratio attached to the FTSE Europe ex UK index.
“One would be hard-pressed to say that a worst case is priced in for the UK,” said Mr Fraser-Jenkins.
Jonathan Stubbs, an equity strategist with the US bank Citigroup, believes that valuations suggest that “a lot of Brexit risk already appears priced into domestic shares”.
Over the past 25 years, the dividend yield on the FTSE All Share, currently at 4.2 per cent, has only been higher during the 2007-08 financial crisis.
But Citi also warns that the UK is descending into an “increasingly acute” constitutional crisis as neither the resignation of the prime minister nor a Conservative party leadership challenge or a general election is likely to lead to greater political stability.
“Risks and uncertainty have clearly risen and it makes sense for investors to tread carefully,” said Mr Stubbs.