UK assets are cheap – for now

Concern about the implications of the UK’s withdrawal from the European Union has meant the pound has fallen and international investors have avoided the UK shares. This is likely to change.

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  1. Garry White

Last week’s bid for pubs group Greene King has lifted the veil on the undervaluation of UK assets. Whatever happens with Brexit, it’s obvious that British equities are relatively cheap and under-owned. However, this could change in the coming months as the Brexit outcome becomes clearer and uncertainty lifts. So, when should investors get more positive on UK equities? Is now the time to buy?

Global investors have turned their back on the UK stock market for almost three years because Britain’s economic fundamentals and corporate earnings have played second fiddle to the uncertainty surrounding Brexit. According to Bank of America fund manager survey, just under a quarter of global investors are underweight the UK. This means that the UK has been the most disliked region for 41 consecutive months.

As a result, since the UK voted to leave the EU in 2016, the FTSE 100 is up just 17% and the FTSE 250 19%. This compares with sterling-equivalent gains of more than 30pc in the MSCI Europe index, 62pc in the S&P 500 and 50pc for Japan Nikkei 225. It’s not just professional money managers that are shunning UK investments. Data published this week by platform Interactive Investor showed that 24pc of its clients surveyed were holding fewer UK assets than normal because of the uncertain political backdrop.

The FTSE 100 is international

However, as we know from the market action following the referendum in 2016, any fall in sterling is likely to boost the share price of multinationals listed in London as they generate most of their sales abroad. Owning UK blue-chips is arguably a hedge against a sterling fall should a no-deal Brexit occur, as is a portfolio of foreign shares.

Last week’s bid for pubs group Greene King at a 50pc premium to its market value by Hong Kong billionaire Li Ka-shing shows that some investors are now looking through any Brexit disruption and envisage the economy bouncing back strongly. This purchase is significant because Greene King is an entirely UK-facing business relying on British consumers – and not a global company such as Arm Holdings, Cobham and Inmarsat, which have also been subject to foreign bids. Greene King is not the first UK-dependent business that has been sold to an overseas buyer – Dairy Crest, Fuller’s brewing operation and fellow pub group Ei have also been sold abroad – but coming this close to Brexit it is a real vote of confidence in UK plc.

The Greene King deal is likely to be attractive due to its substantial property portfolio, with other beaten-down businesses attractive for this reason too. Shore Capital, house broker of Wm Morrison, recently concluded that the supermarket was a potential target for a foreign buyer. The broker argued that a share price fall of more than 30pc in a year, combined with Morrison’s strong freehold property portfolio and relatively low debt pile, made it an attractive acquisition.

Sentiment not reality

The fall in the pound is not being driven by the UK’s fundamentals. Sure, the economy shrunk by 0.2pc in the second quarter, but this was mostly due to a destocking effect, as the first quarter figures were boosted by companies stockpiling ahead of the original 31 March EU departure date. In fact, the UK economy is holding up pretty well, with both government and household spending remaining robust and a likely rebound in the third quarter GDP that will ensure the UK does not fall into a technical recession. Boris Johnson’s government also plan a fiscal blitz that should be positive for growth.

The recent fall in sterling relates entirely to the perception that the UK is heading for a no-deal Brexit, which is now looking like the most likely outcome following Boris Johnson’s promise to the country that Britain will leave the bloc on 31 October. Analysts at BNP Paribas, for example, now put its probability at 50%, up from 40%.

Sterling has already priced in a lot of bad news and a sharp fall even in the case of a no-deal Brexit is unlikely to be as severe as in 2016 as the market is expecting the outcome. It really won’t be a surprise. Investors can expect further bids for UK listed companies because of the undervalued level of sterling. However, volatility is likely to increase as we approach the 31 October deadline so it may be best to sit on the side lines and take advantage of any wobbles should they present themselves. UK equities are cheap – but they may get cheaper before the recovery finally comes. Get ready to pounce.

A version of this article appeared in Friday’s Daily Telegraph.

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