February 2020: your client asks...with coronavirus hammering global shares, where next for UK markets?
With coronavirus causing shares to fall, what’s the outlook for UK stocks ?
Coronavirus is now looking like a more significant headwind to the global economy, causing UK stocks to fall sharply this month, in line with other major markets around the world. However, our base case remains that economic growth and markets will recover once it is clear that the threat from the virus is contained.
We are modestly overweight UK stocks, which look attractively valued in a global context. Coming into 2020, the UK market traded at a forward P/E multiple of 13.4, a little above its long-term average. Prior to the coronavirus shock, global equity markets were trading at the highest valuation level in twenty years. The disconnect should narrow as the remaining Brexit uncertainties are resolved.
In the immediate aftermath of the election, the UK market enjoyed a broad-based rally. However since the start of the year, its performance has become more nuanced. Sectors such as housebuilding, which stand to benefit directly from targeted fiscal spending, have built on gains. Others, such as banking, have retreated as investors weigh up longer-term challenges unrelated to recent political developments. We think this environment will offer rich opportunities for stock pickers.
We also expect to see a buoyant M&A market this year, with many UK companies trading at a significant valuation discount to international rivals. There has not yet been a significant uptick in UK M&A following the election. However, we expect it will be an important theme for the UK market this year.
Where next for the UK economy?
There are signs that the UK economy is gathering steam following last year’s decisive election. The latest monthly data on retail sales, manufacturing and employment all surpassed economists’ expectations.
The new Chancellor, Rishi Sunak, could add to the momentum – either in next month’s budget or in his autumn statement. Investors believe he is more likely to agree to significant increases in government spending than his predecessor, Sajid Javid, who advocated running a balanced budget. While Sunak’s plans remain unclear, the disciplined approach of previous chancellors has left the government with more room for manoeuvre than it has had for many years. Public sector net borrowing peaked at just under 10% of GDP in the 2009/2010 tax year, according to the Office for National Statistics. It currently stands at around 1%.
Even allowing for some increase in spending under the new Chancellor, our economist expects UK growth to remain close to 1% this year. Though unimpressive in absolute terms, this is a significantly faster pace than the average post-referendum growth rate of around 0.5%.
One reason for the sluggish outlook is continued uncertainty over Brexit. The government insists that current transitional arrangement with the EU will end in December, creating the risk of a “no-trade deal” Brexit at the end of the year. The risk was quickly priced into sterling, which gave up its post-election gains early in the year.
We think that such a cliff edge will most likely be avoided. While there is probably not enough time – or the political will – to reach a comprehensive trade agreement, we expect the government and EU to reach agreements covering specific sectors over the course of this year. Transitional arrangements for other sectors could allow negotiations to extend into next year.
While this may avoid major disruption, it does mean that at least part of the economy will be grappling with trade uncertainty for some time to come.
This article is issued by Cazenove Capital which is part of the Schroder Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Cazenove Capital unless otherwise stated.