The UK market has pillars of strength, but investors have been too busy focusing on the negatives, according to JOHCM UK Equity Income fund manager James Lowen, and JOHCM UK Dynamic head Alex Savvides.
Since the Brexit vote, domestic analysts have been calling for a repricing of UK valuations, with almost the entire market looking cheap. But this positive attitude hasn’t seemed to resonate with investors, who have been timid in taking advantage of the cheap prices for fear of interest rate hikes and the perceived likelihood of a recession.
Those concerned by these external factors have had plenty of reasons to be fearful, including the Covid pandemic, Boris Johnson’s downfall and a short-lived Liz Truss administration, but Savvides suggested they should look at fundamentals instead.
“The price you pay for an asset will always be one of the key defining factors of whether you can generate value from the investment that you're making, and it just so happens that at the moment, the starting valuations that you can find on the UK stock market are extremely cheap, relative to history and relative to overseas stock markets,” he said.
According to the manager, this is because there is a negative perception of the UK, both internationally and domestically, post-Brexit, post-Covid and around UK politics, as well as around the country’s ability to withstand shocks.
“But the reality that we see when we speak to companies is actually much better. This is also true for banks, for example, who are very geared into what's going on in their local economies and are not seeing stress conditions amongst corporates and consumers, whose balance sheets are in a good place,” he said.
“So I do concur with the view that the UK is more resilient than everybody thinks and I do concur with the view that the perception of the UK that has led to low valuations is not right. Are we betting the whole fund on that view? No, we're not.”
Lowen added that, as well as fundamentals, there are actually pockets of optimism in the economic data, even though “it's all doom and gloom in the national press”.
For example, while there is high inflation, this is proving “stickier” because we are at near full employment, which promotes wage growth.
“Another positive is that the level of credit card debt versus previous cycles is very low,” he said as “everyone paid off all their” during the Covid pandemic – a rare positive from the time.
However, most investors have focused on the negatives, including sky-high energy bills which have caused a cost-of-living crisis in the UK.
“Obviously energy prices have come down now and in the latest PMI survey, consensus was that we haven’t seen this really deep recession that the Bank of England was talking about. That has simply not transpired and the bank has had to upgrade its forecasts,” he added.
There could be more help on the way for the most affected parts of the UK in tomorrow’s spring Budget, he added, including public sector pay moves as well as other goodies such as extra defence spending.
Lowen argued that this combination of a supportive government, lowering inflation (albeit slowly) and a stronger economy than expected could also mean an end to the macroeconomic fear.
The Bank of England, he said, is likely to plateau rates to prevent a recession, as long as inflation comes down. In fact, he argued that the BoE could be satisfied if inflation never reaches 2%.
“I think central banks don't even want inflation to go back to 2% – even though they say they do – because that was what led to the misallocation of capital zero rates and quantitative easing, it's not healthy,” said Lowen.
As such, the manager of the JOHCM UK Equity Income fund said investors should expect inflation to remain above the 2% target, with UK central bank likely satisfied providing it remains in a 2%-4% range.