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Why UK equities are back in favour

Thomas Moore, senior investment director at Aberdeen Standard Investments, shares his views on why UK equities are back in favour.

It’s now a little over five years since the Brexit referendum and over that period UK equities have found themselves decidedly unloved on account of a number of factors, including:

  • Substantial political uncertainty regarding the shape of UK’s relationship with Europe
  • Index being composed of sectors deemed to be “old economy”
  • The UK suffering one of the most severe downturns in developed markets in the immediate aftermath of COVID

 

However, times of uncertainty can create opportunity and if we consider a long term, evidence-based approach to asset allocation, UK equities currently offer a great deal of interest.

Attractive valuations and a healthy yield

Regional equities have followed different paths in recent years. US equities, powered by some of the world’s most important technology stocks, have outperformed other regions by a large margin. As a consequence, US Large Cap valuations have moved sharply above their long term averages over the last five years with a cyclically-adjusted P/E ratio currently around 32.5x. By contrast, the UK equity market is just below its long term average with a cyclically-adjusted P/E ratio of 17.6x. This is a great starting point for investors because, over longer periods, the starting valuation you pay has been a key determinant of future returns.

“2020 was a particularly challenging year for UK dividends given the market’s concentrated pay-out profile and the enormous impact COVID had on economic activity, commodity prices, and companies’ willingness or regulatory ability to pay dividends. Those companies that were at risk of cutting their dividends have now done so. Dividends are now growing again as the cyclical backdrop improves. Today, the FTSE All Share yields around 3.5%, which remains attractive relative to other equity markets and asset classes.”

A number of catalysts

Over the last seven years, UK Equities have been firmly on the back burner, with BofAML’s Global Fund Manager surveys showing that investors have been materially underweight. For much of this period, Brexit has been a major overhang, followed on by the severe impacts created by COVID on the UK economy and stock market. However, with much more certainty on the UK’s relationship with Europe, the release of vaccines in the fight against Covid-19 and continued monetary and fiscal policy support, risk appetite towards the asset class is starting to inflect.

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