Expectations of a UK-EU free trade deal and a strong economic rebound are among the reasons that investment bank Goldman Sachs is tipping UK equities as a ‘buy’, despite the current uncertainty and the economic pressures of the Covid-19 pandemic. 
While trade talks have taken longer than originally planned, economists at Goldman Sachs expect a ‘thin’ free-trade agreement in goods, which could be confirmed at the EU Council meeting of the bloc’s leaders on 10-11 December.
Additionally, the bank believes there is “substantial room” for a rebound next year as economic activity remains depressed and with the UK well-positioned for Covid-19 vaccine distribution.
“We expect widespread vaccination from Covid-19 to be underway across Europe in Q1 2021, with a large share of the population vaccinated by end-Q2, a quarter earlier than we had previously expected,” the bank's analysts noted.
“Our economists look for UK growth of 7 per cent in 2021 and 6.2 per cent in 2022, significantly above consensus.”
Based on a ‘thin’ trade deal, tailwinds from cyclical optimism and vaccine distribution, the bank’s FX strategists expect sterling to maintain an upward trend, which will benefit UK stocks.
While the UK market has underperformed its developed market peers over the past decade, and particularly since the EU referendum vote in June 2016, it has not always lagged.
“The UK has not always been an underperformer; from 1970 to 2009 the FTSE All Share was up 7.6 per cent per annum in sterling, slightly above MSCI World at 6.3 per cent,” the bank noted.
“But since 2010 the UK market has lost roughly half of its value versus the World index.”
Additionally, given the discounts that UK stocks are currently trading at, relative to other European markets, the bank believes there is room for further re-rating.
“The UK market remains comparatively cheap – both versus other asset classes and relative to other equity markets,” reported the Goldman Sachs analysts.
“Some of the discount is down to sector exposure, but looking sector-by-sector most UK sectors are on a substantial discount to both Europe and the US.
“We think this reflects two factors: under-positioning in UK indices by global investors, and diminished holdings of UK equities by UK pension funds and insurance companies as they continue to switch into bonds.”
Although stronger sterling might drag on the performance of the FTSE 100 – which is more internationally orientated, with around 70 per cent of revenues deriving outside of the UK – the Goldman Sachs analysts do not believe a trade deal-driven boost for the pound will be a “significant impediment” for the blue-chip index.
“We’d note that the relationship between FTSE 100 and FX moves has not been consistent through time, and in the last three months the correlation with sterling has been slightly positive,” the analysts reported.
While the FTSE 100 has been one of the worst-performing equity markets in 2020, the bank does not believe poor performance has been driven by Brexit uncertainty, but by commodity prices and the value/growth dichotomy.
“FTSE 100 has 8 per cent of its weight in energy, 17 per cent in financials, and 10 per cent in basic resources,” Goldman Sachs noted. “Value sectors are more than a third of the index, whereas the UK has very little weight in tech, especially in the large caps.”
Nevertheless, the bank has previously noted that the valuation gap between the value and growth styles has become too extended and that expectations of economic improvement next year would likely catalyse the shift into value and cyclical stocks.
This has been seen more recently as positive news on Covid-19 vaccines has emerged in recent weeks.
“The speed of the move into value so far has been fast, but we continue to believe there is more to go – markets often under-price inflection points – and we would argue the UK, in particular, should stand to benefit from continued re-positioning,” the bank noted.
Goldman Sachs’ commodities team also believes that all major commodity markets are in deficit and expect rises next year, which would be a particular benefit for the UK market.
Furthermore, increased clarity over Brexit would likely tempt international investors back to the UK.
“An economic recovery in 2021 combined with a trade deal with the EU agreed before the end of this year would, in our view, catalyse a catch-up for UK stocks,” the analysts added. “We continue to expect FTSE at 7,200 over 12 months.”
Looking ahead, while there might be medium-term damage to UK growth even if a zero-tariff/zero quota trade deal is agreed, the UK continues to look appealing on several viewpoints.
“The expenditure related to the pandemic has pushed up UK debt to GDP over 100 per cent and our economists expect it to be sticky at that level through to at least 2024,” the bank highlighted. “Of course, the UK is not alone in this respect and debt to GDP is a similar level in the US and France and much higher in Italy."
It concluded: “Finally, in one respect the UK is more like the US than it is euro area. Working-age population growth is set to be slightly positive in the next few years and roughly zero thereafter.
“In contrast, it is deeply negative in several euro area countries; and far closer to that in Japan than we see in the UK or the US.”