It will soon be “business as usual” for UK companies and markets will go back to work after a challenging summer, according to Invesco Perpetual’s Mark Barnett (pictured). 
The FE Alpha Manager, who is head of UK equities, notes that the shock EU referendum result has made for a stormy summer, but argues there are other headwinds investors should focus on rather than the impending Brexit.
For instance, he says subdued global growth and downward pressure on corporate profitability are more likely to bruise markets than the triggering of Article 50.
As such, the manager says now is a prime market for stock-pickers and is focusing on identifying opportunities in some of the most oversold areas of the UK market.
“The political events of June made for a stormy summer in UK equity markets, but after a quieter August, I expect UK companies to be very much business as usual as the market goes back to work,” Barnett said.
“The UK equity market has staged a remarkable recovery from its post-Brexit shocks; in aggregate, equity prices have risen strongly since the referendum, buoyed by the flight to perceived safety in defensive and international stocks, and by weakened sterling.”
Performance of index since 23 June
Source: FE Analytics
The UK market has indeed performed well since the referendum results were announced on the 23 June. There are some investment professionals who are still concerned about what will happen when Article 50 is put into place in April, however.
In an article published last week, Rathbone Global Opportunities manager James Thomson explained he has reduced his exposure to the UK equity market from 25 per cent to 15 per cent throughout the course of the year.
“I still think [Brexit] will be a pretty strong headwind for the UK economy, even if it’s in areas where you don’t see it; where investment decisions would have been made but they’ve been further delayed before going somewhere else. It’s almost the absence of growth that may be a problem,” he warned.
Barnett, on the other hand, says economic data from the summer shows markets are looking for signs of a recession despite the fact that fundamentals look encouraging.
For instance, he says concerns surrounding July’s fall in the PMI index were soon denounced following a rise in August, which he attributes to the weakness of sterling and subsequent export growth.
He also says that, while many investors are concerned about the global slowing of growth, UK inflation looks as though it is set to rise over the medium term.
“Fundamentally, the UK equity market remains dominated by a collection of very international companies whose fortunes and share prices (currency adjusted) are closely correlated with global markets,” the manager explained.
“Looking beyond Brexit, I maintain the view that downward pressure on corporate profitability and subdued global growth will present the greater challenge to the UK equity market’s long-term growth potential.
“Since the vote, I have continued my bottom-up approach to stock selection, focusing analysis on identifying opportunities in the areas suffering the worst of the sell–off.”
Barnett is looking for companies that have fallen on hard times as a result of the uncertain economic outlook but boast strong management teams and have the ability to improve their businesses.
For instance, he has increased domestic exposure across all of his portfolios given that some UK sectors – such as travel, financials and construction – have suffered more than anticipated.
He says unusual asset class correlations and irrational pricing are rife in the current market, which he says is shown in the sharp reversion of some share prices that were particularly hard-hit following the initial sell-off of UK domestics.
“UK equity market valuations are currently trading at levels around 18 times 2016 earnings and, in my view, look inflated,” the manager continued.
“The slump in government bond yields since the referendum has driven up the price the market is willing to pay for equities with more stable cash flows; favourable currency movements have also provided some uplift to the outlook for UK earnings derived overseas.
“Should GDP growth be maintained through the second half of 2016 I anticipate improved confidence in domestic-facing companies.”
One domestic-facing stock Barnett has just bought into is clothing retailer Next, which is down 29.64 per cent since the start of the year.
Performance of stock vs index in 2016
Source: FE Analytics
He says retail is already a depressed sector and believes the company is particularly oversold compared to its peers.
Another area of the market he has exposure to is domestic-facing financials and continues to hold the likes of Provident Financial, Legal & General and Derwent London across his portfolios, all of which suffered in the immediate aftermath of the EU referendum results.
However, he says all of the aforementioned businesses bounced back during July and August. The manager says all three have shown the ability to adapt to changing environments and utilise new technology in order to minimise costs, increase customer satisfaction and sustain future profit growth.
“Provident Financial’s recent second quarter results showed robust performance across the group’s three businesses and provided shareholders with a 10 per cent interim dividend increase,” Barnett continued.
“Chief executive Peter Crook said the non-standard lender’s strong performance and sound credit quality through the first half of the year provide a foundation for continued growth and firm trading through the UK’s current economic uncertainties.
“Insurance and financial services group Legal & General’s share price fell 30 per cent over the two days post-Brexit, but strong Q2 results went some way to demonstrate chief executive Nigel Wilson’s contention that the business’s five long-term growth drivers – ageing populations, globalisation of asset markets, creating real assets, welfare reform and digital – remain resilient.”
Despite holding a reasonable weighting in UK financials, Barnett still has a zero weighting in banks given recent downgrades to UK interest rate expectations and their challenged regulatory outlooks.
He says their ability to both pay and grow dividends therefore looks challenged, which is a key component to the manager’s long-term stock selection process.
Barnett has been manager of the five crown-rated Invesco Perpetual UK Strategic Income fund since 2006.
Following star manager Neil Woodford’s departure from the firm in 2014, he also runs Invesco Perpetual Income and Invesco Perpetual High Income funds, which have four and five crowns respectively.
Since he has managed these funds, Barnett has more than doubled the average returns of his peer group composite with a total return of 14.75 per cent.
Performance of fund vs sector and benchmark
Source: FE Analytics